The Future of Cryptocurrencies
qLegal students Tomisin and Zara explore the potential future of cryptocurrencies given their recent regulatory attention.
Cryptocurrencies: What are they?
Cryptocurrencies refer to digital or virtual currencies secured by cryptography. They are created using blockchain, which is a form of decentralised ledger technology. A blockchain is a digital ledger of transactions, which is duplicated and distributed to the network of computer systems on the blockchain. Each block on the chain contains transactions and every new transaction is recorded on every participant’s ledger.
The transactions are recorded with a cryptographic signature, called a hash. Cryptography is used to confirm the identity of users and control access to the blockchain, which means every user has a public and private key for authentication. The process of a new transaction can be seen in the below Investopedia diagram:
Bitcoin, was the first blockchain-based cryptocurrency launched in 2009 and remains the most popular cryptocurrency today. There are now over 10,000 different varieties of cryptocurrencies, with a total market cap of $2.159 trillion (as of 21 August, 2021).
Cryptocurrencies based on the original Bitcoin blockchain are called alt coins. The other most popular cryptocurrencies include:
· Ethereum.: is an open-ended decentralised software platform, where smart contracts can be deployed and decentralised applications built and run, using the native cryptographic token Ether (ETH).
· Tether, which is a stablecoin. The value of stablecoins is tied to an outside asset, e.g. traditional ‘fiat’ currencies, in order to lower its price volatility. Tether is tied to the U.S. dollar, and it is often used to buy cryptocurrencies, providing liquidity.
Cryptocurrencies are traded as a digital currency on exchanges including Coinbase.
Pros and Cons of Cryptocurrencies
The purported benefits of cryptocurrencies include that they allow for private, secure transactions, they are not controlled by any one organisation, and protect against inflation as most cryptocurrencies have a fixed amount, meaning as demand increases so will value, keeping with the market. Cryptocurrencies also allow for cost-effective, fast transactions (especially for money crossing borders), and promote easy currency exchanges, as they can be exchanged for multiple currencies using different cryptocurrency wallets and exchanges.
However, the disadvantages include the ability to use cryptocurrencies for illegal activities (including for money laundering and tax evasion), the risk of financial loss (as the loss of a private key to a wallet cannot be recovered), and risk of exchanges getting hacked. There is also the lack of refund policy making it easier for fraud to occur, and the high volatility of cryptocurrencies, as Bitcoin illustrates. Further, the effect of mining on the environment as mining is highly energy-intensive, with Cambridge researchers finding Bitcoin uses more energy than Argentina (University of Cambridge Bitcoin Electricity Consumption Index).
Cryptocurrencies Become Mainstream
Recently, cryptocurrencies have been increasing in popularity due to celebrity endorsements and social media trends. Numerous celebrities including Kim Kardashian West, Elon Musk and TikTok star Charli D’Amelio have endorsed a form of cryptocurrency to their millions of social media followers. The U.S. Securities and Exchange Commission (SEC) has, in the past, cautioned against investing in something simply due to celebrity involvement. The power of social media hype can be seen through meme stocks (where social media chatter heavily influences stocks), and it has increased interest in cryptocurrencies as the original meme coin, Dogecoin, illustrates.
Dogecoin received its first social media boost in July 2020 in the form of a TikTok trend aiming to get the coin’s price to $1. In January 2021, Dogecoin was the beneficiary of not only a concentrated social media trend initially pushed by Reddit users, but also received further attention on Twitter, spearheaded by the phrase ‘To the moon’, which aimed to see the price of the coin skyrocket. The coin also received a highly revered celebrity endorsement by Elon Musk promoting the cryptocurrency through a series of tweets. This helped push the price of Dogecoin over 800% in 24 hours, attaining a price of $0.07 before subsequently reaching a price of $0.08 following further tweets from Musk.
Cryptocurrency Critique
As cryptocurrencies have increased in popularity, they have also attracted critique from a variety of parties. Warren Buffet, in 2018, likened Bitcoin to the Tulip Mania, describing Bitcoin as a speculative asset that produces nothing and is without inherent value. The viewpoint of central banks can be seen with the Bank for International Settlements (BIS) Annual Report referring to cryptocurrencies as speculative assets rather than money, used in financial crimes and noting ‘Bitcoin in particular has few redeeming public interest attributes’.
Additionally, the UK’s financial regulatory watchdog - the Financial Conduct Authority (FCA) - has released many warnings regarding cryptocurrencies, including that those investing in cryptocurrencies ‘should be prepared to lose all their money’. Worryingly, the FCA found that as the popularity of cryptocurrencies has increased, so has the lack of understanding of cryptocurrencies. The FCA has recently created an £11 million digital marketing campaign to warn of the risks associated with crypto investments, targeting 18- to 30-year-olds who are vulnerable to social media influences.
The FCA’s regulatory measures can also be seen in the recent attention paid to Binance, the world’s biggest cryptocurrency exchange. On 13 July 2021, following complaints by UK customers that they were unable to make withdrawals from their bank accounts, Binance announced that it would be unable to process GBP withdrawals, although it described this as a ‘temporary suspension’. Binance Markets Limited has been issued a ban by the FCA who, when warning customers, stated that the platform was not permitted to undertake any regulated activity in the UK. This statement would have been intended to dissuade UK customers from continuing to trade on the platform and to encourage UK customers to withdraw their assets from the platform.
Regulatory authorities around the world may follow the FCA’s lead and regulate these exchanges, as they have in Italy, Japan and Malaysia.
Although competitors of Binance have benefitted from this crackdown, including Bitstamp, Kraken and Gemini, further regulatory measures may reduce the popularity of cryptocurrencies, as it becomes more difficult for investors to take their money out. The power regulators hold can be seen by looking at Facebook’s Libra proposal, which aimed to revolutionise the global payments system but has since been delayed, scaled back and renamed Diem.
Further, central banks are considering releasing their own digital currencies using distributed ledger technology, in order to maintain control of the monetary and payments system. BIS has released a report recognising the potential use of CBDCs (Central Bank Digital Currencies) for the monetary system. Currently, the most advanced CBDCs are in China, Sweden and the Bahamas, but developments are expected in the US, Europe and the UK.
When it comes to the future of cryptocurrencies, their biggest potential impact is replacing fiat currencies. Money has three purposes: it is a medium of exchange, a store of value and a unit of account. Currently, cryptocurrencies do not achieve any of these purposes. Cryptocurrencies are not universally accepted as a unit of account or a means of payment and are too volatile to be a stable store of value. Further, as illustrated above, if governments feel threatened, regulation will render cryptocurrencies obsolete. However, the value of cryptocurrencies may lie in the distributed ledger technology. The potential use of blockchain has been considered in bond issuance, settlement and insurance, via smart contracts. Although cryptocurrencies are currently largely unregulated, it is unlikely they will remain so in the future.
This article was written by Zara Mahmood and Tomisin Bakare who are participating in qLegal as part of their Law Masters studies at Queen Mary, University of London.
qLegal provides pro bono legal advice to start-ups and entrepreneurs on intellectual property, data protection, corporate and commercial law. See the qLegal website for more details and to book your appointment now. Follow us on Twitter and LinkedIn for regular updates on issues relevant to your business.