The cryptocurrency bitcoin turned 11 years old in January. Starting with just a handful of technical enthusiasts (whose identities are still unknown), it has grown significantly in popularity since. Online investment resource Bitcoin Market Journal estimated there were 25 million users worldwide in 2019, holding around 32 million wallets (ie accounts) denominated in bitcoin. The price of one bitcoin peaked in December 2017 at just over US$20,500.
The inventor or inventors of bitcoin made their software open source, which has meant that other enthusiasts can download that software and refine it to create their own cryptocurrencies. There are now thousands of cryptocurrencies, often developed with particular applications or purposes in mind.
One leading cryptocurrency is ether, the currency of Ethereum, a global distributed ledger platform launched in 2015. Ethereum was designed to enable the programming of automated applications on top of blockchains, something that was specifically limited in bitcoin for security reasons. Although Ethereum was not intended primarily as a cryptocurrency platform, ether has become the most popular cryptocurrency after bitcoin itself.
The values of both bitcoin and ether prices have been highly volatile. Some alternative currencies have tried to reduce volatility by tying their value to the value of something else – either a physical commodity (such as gold), a national currency (such as US dollars) or a basket of currencies. Such cryptocurrencies are called stablecoins.
Initially, many of the applications of bitcoin involved payments for illegal purchases (of, for example, illicit drugs) or transactions to evade international trade sanctions. As a result, the cryptocurrency space gained a reputation for illegality; indeed, in some countries, all bitcoin transactions are banned. This reputation has hindered the adoption of cryptocurrencies by large companies and major banks. Increasingly, however, organisations allow customers in countries that permit bitcoin’s use to purchase goods with it; examples include Amazon, Microsoft and Starbucks.
Distributed ledger-based tokenisation systems may be viewed by investors as more trustworthy than traditional paper-based securitisation
The name game
Although it is commonly believed that bitcoin transactions are anonymous, strictly speaking they are pseudonymous, as users interact with the platform via pseudonyms. Transactions on the bitcoin platform are all public, so the possession of particular bitcoin may be traced as its ownership changes.
Because, by various technical means, it may be possible for governments and others to identify the real identities of bitcoin owners, some alternative cryptocurrencies have been developed to provide greater privacy. Monero, for example, mixes transactions together, which makes it much harder to trace possession and ownership.
Blockchain, the technology that underlies bitcoin, is software that runs independently on multiple computers. Owners of these computers (ie the users of the software) agree to use a particular version of the software. If they all subsequently agree to adopt a new version of the software, then that new version is called a ‘fork’ of the underlying blockchain.
Of course, not all of them might agree to use the new version, or not all from the same time, and some people may even wish to use both versions. In these cases, two blockchains may spring up where previously there was one. The most prominent cryptocurrencies are forks of bitcoin or other leading currencies, created to incorporate particular features.
A great impetus to the commercial adoption of cryptocurrencies was given by the June 2019 announcement by Facebook that it was developing a private cryptocurrency for use by its members and other participating companies. Libra, the proposed currency, will be a stablecoin, backed by a weighted basket of ‘fiat’ currencies (ie money decreed into existence by government): US dollars, euros, Japanese yen, pounds sterling and Singapore dollars. The underlying technology will be a closed distributed ledger with a planned 100-strong network of global organisations validating transactions. At the time of the announcement, Facebook had in-principle agreement to participate in libra from 28 organisations. The company said libra would launch only when it had regulatory approval from around the world – an effort that is ongoing.
The development of libra has ramped up the attention paid by central banks to electronic currencies. The trend in many countries towards a cashless society has led central banks to consider having their own cryptocurrencies. These currencies might simply be electronic versions of existing fiat paper currencies, or alternatives to the existing currency. So far, no central bank has launched a cryptocurrency.
An associated trend is the use of open-source cryptocurrency software to readily support the tokenisation of other assets. For example, electronic tokens can be created for an underlying physical asset, such as a container ship or an aircraft, with the tokens providing their owners with defined rights to the use of that asset. Those rights could be a share of the profits made by the asset or its resale value, or partial ownership of the asset. Such a financial structure is similar to the use of the financial instruments of securitisation and unitisation, where a collection of assets – for instance, a group of mortgages – are bundled together and sold to a holding company whose shares are then sold to investors.
Advantages of tokenisation
Where tokenisation is legally permitted, it can provide several advantages over similar financial structures. First, establishing the technical infrastructure for the token system, and for the online purchase and resale of tokens, is generally faster and easier, thanks to open source software. Second, the use of a distributed ledger platform to support the token system and to record token sales may be viewed by investors as more trustworthy than traditional paper-based securitisation systems run by financial brokerages or law firms. This greater trust, in turn, may attract a wider pool of investors, particularly investors who are not known to the organisers of the tokenisation system. Companies now considering the tokenisation of physical assets are often keen to broaden their base of investors, both to allow smaller investors to participate and to add liquidity to the marketplace.
These are exciting times for fans of cryptocurrencies, both state-backed and private, and we should expect to see many new developments over the next few years.