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Q1: What is Crypto?
Courtneidge: The term crypto is a short form of the word ‘cryptography’ (the computerised encoding and decoding of information). A cryptocurrency is a digital or virtual currency secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. The best known Crypto is Bitcoin.
Q2: What are the different types of Crypto?
Courtneidge: There are several different tokens available that fit this description, but there are also other tokens technically crypto, but more like money, all set out below:
Utility tokens – these are tokens that have a defined purpose. Often it is a marketplace in which they can be accepted to purchase goods and services.
Exchange tokens are Utility tokens accepted on recognised crypto exchanges like Binance and Kraken.
Meme tokens have no defined purpose and are defined by the now famous ‘Dogecoin’ made famous by Elon Musk. These tokens are often made for fun but have tokenomics behind them to drive their price. Tokenomics are the features of the token such as how many are mined, how the tokens are distributed (e.g. x% for pre-sale, y% for full sale, z% for marketing, what tax/gas is paid on transactions, when tokens are burned, what loyalty programmes apply to buying and holding tokens etc. etc.).
All of the above are generically known as Crypto or Cryptocurrencies. Although typically used as an investment asset, their market volatility makes them a stronger store of value than a medium of exchange.
Stablecoins represent a better medium of exchange than traditional cryptocurrencies, as they are pegged to the value of fiat assets. They are either issued by groups of individuals (a consortium) to create a consortium stablecoin or by single private corporations (such as JPMorgan and Meta).
Central Bank Digital Currencies (CBDCs) are digital fiat currencies under development by central financial authorities. As central banks would issue CBDCs, they could balance the benefits of blockchain technology and necessary regulatory controls in the financial system. However, the development of CBDCs is not without risk, especially considering interoperability, distribution and macroeconomic consequences.
Q3: What is mining, and how is it used in crypto?
Courtneidge: Mining is the discovery of the next block on the blockchain. A proof of work is needed to accept a new block to the blockchain. The mining process involves identifying a block that, when hashed twice with SHA-256, yields a number smaller than the given difficulty target. To clarify this, we first need to understand what a blockchain is. It is a growing list of records, called blocks, linked using cryptography. It is an open, distributed ledger that can efficiently record transactions between two parties verifiable and permanent. It uses distributed ledger technology (DLT)- a consensus of replicated, shared, and synchronised digital data geographically spread across multiple countries or institutions. There is no central administrator or centralised data storage.
Instead, the DLT database is spread across several nodes (computers) on a peer-to-peer network. Each replicates and saves an identical copy of the ledger and updates itself independently. The “mining algorithm” used by Bitcoin allows the network to reach majoritarian consensus as to which Bitcoin transactions are valid and which are not, without the need for a trusted 3rd party.
The proof of works is a piece of data that is difficult (costly, time-consuming) to produce but easy for others to verify and satisfies specific requirements. Bitcoin uses the Hashcash proof of work system. The hashcash algorithm is relatively simple to understand. The idea builds on a security property of cryptographic hashes that are designed to be hard to invert.
Mining ensures “digital scarcity” in a decentralised system by preventing the same bitcoin from being spent twice by the same person (i.e., it solves the double-spend problem). Minors act as the network’s scrupulous accountants by dedicating computing power to solving the mining algorithm. For their efforts, miners are rewarded with newly minted Bitcoins and transaction fees roughly in proportion to the computing power they provide. Mining makes decentralisation possible by taking all the costs associated with centralised trusted 3rd parties out of the system, giving the Bitcoin network and Bitcoin the asset its intrinsic technological value.
With so many cryptos in the marketplace, there are many blockchains and different mining techniques used to create and distribute the crypto tokens created. Moreover, in recent times there has been a lot of noise about the amount of electricity used by Bitcoin minors to discover the following block (because many minors are chasing the one solution, so all the electricity used by the unsuccessful minors is wasted. As a result, a new method of mining has been developed that is greener.
Q4: How do today’s fiat currencies compare to the leading crypto Bitcoin?
Courtneidge:
- Scarcity: Bitcoin’s supply is fixed at 21M; fiat’s is not. In contrast, since 2008, the US Fed Reserve has more than tripled the US monetary base with its quantitative easing policies.
- Durability: Bitcoins have been lost or stolen but never destroyed. Fiat currency can be easily lost, stolen, or destroyed, however, damaged banknotes can be replaced without loss of value, however, with proper backup, bitcoins can last forever.
- Portability: Bitcoins are digital; therefore, any amount can easily be transported over any distance with an internet/data connection for free. It is relatively easy to transport cash up to a certain amount (i.e., wallet), however, more significant amounts can require infrastructure (i.e. armoured truck), customs declarations for cross-border transportation and/or instruments (i.e., debit/credit cards and their fees).
- Divisibility: One bitcoin can be divided into 100 million pieces; the GBP, by contrast, is divisible only into 100 pieces (i.e. a penny).
- Authenticity Verification: Bitcoins are digital; therefore, they must be identified in the public ledger by software; banknotes and coins are easily identifiable by eye or chemical tests (i.e. markers).
- Storage: Private keys that control Bitcoin ownership can be stored on paper, in your brain (brain wallet) or on a USB stick. You can only store a limited amount of fiat before requiring infrastructure (i.e. a safe or a bank vault).
- Fungibility: Fiat currencies are all fungible (i.e. can be spent); however crypto like Bitcoin have limited acceptance.
- Difficult to Counterfeit: It is mathematically impossible to counterfeit a Bitcoin, and a “double-spend attack” has never been successfully perpetrated. Fiat currencies have had. To deal with the risk of counterfeiting since their inception and still have issues.
- Widespread Use: Fiat money achieves legal tender status via government decree. As a result, merchants must accept it, and citizens must settle their taxes with it. Bitcoin is 11 years old and does not currently have widespread adoption; however, large scale retailers are beginning to accept it as a form of payment. In addition, many institutional and professional investors have added bitcoin to their portfolios alongside gold and other commodities/capital asset holdings. The biggest coup in recent times is the Government of El Salvador making Bitcoin legal tender in their country.
Q5: Is Crypto being banned in some countries, and if so, why?
Courtneidge: Crypto banning laws have been around for a while, typically in totalitarian states with concerns over fiscal management. However, the number of countries banning crypto has more than doubled in the last three years, and the acceleration is continuing. Currently, from the Library of Congress, we can see that nine countries have an absolute ban and a further 42 have an implicit ban.
In the report, an absolute ban means any “transactions with or holding cryptocurrency is a criminal act”. In contrast, an implicit ban prohibits cryptocurrency exchanges, banks and other financial institutions from “dealing in cryptocurrencies or offering services to individuals/businesses dealing in cryptocurrencies.” The nine new jurisdictions with an absolute ban are Egypt, Iraq, Qatar, Oman, Morocco, Algeria, Tunisia, Bangladesh and China. In addition, in November 2021 in Sweden, the Swedish Environmental Agency called for a ban on Proof of Work mining due to the large waste of electricity in the process. In Europe, ML/TF are the critical drivers against crypto and new laws imposed across Europe based on the 5th Money Laundering Directive – including European countries. More than 100 countries require compliance with ML/TF laws.
Final thoughts
Whilst it is unlikely that anyone could have predicted the growth of Bitcoin and other cryptocurrencies over the last decade, Courtneidge does foresee a digital future for money in the blockchain with stablecoins and CBDCs taking over from traditional money in the next 10-15 years.
Cryptocurrencies like Bitcoin are really quasi investments and a hedge against other assets like shares and commodities. Courtneidge does not believe they were ever really going to be a replacement for fiat currencies even though in Satoshi Nakamoto’s original white paper, he envisioned this:
“A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.”
There are several reasons for this including, the cost of transactions, the energy wasted in mining the blocks, the incredible volatility of Bitcoin and the slowness of transactions (Bitcoin processes 7 transactions per second whereas Visa processes around 1,700 transactions per second on average and Mastercard utilises a network that claims to handle around 5,000 transactions per second).
However, Courtneidge’s research shows that some of the new blockchains, for example, in April 2021, A blockchain network (ParallelChain, developed by Hong Kong-based blockchain start-up Digital Transaction Limited) delivers unlimited scalability and a record-breaking 100,000 transactions per second — features that could transform the way this technology is used. It is the first blockchain platform in the market that has successfully solved first-generation blockchains’ three major pain points with no compromise: Scalability, speed, and security. As these blockchains are brought in to provide the basis for CBDCs and Stablecoins (both of which can have complete stability of price by being tied to a fiat currency), then we can really see a future in which everyone is their own wallet holding their value in these tokens in a safe and secure environment being able to transfer value to anyone anywhere in real-time and with the least friction. Delivering the vision from Satoshi Nakamoto’s White Paper.
About Robert Courtneidge
Courtneidge has been in the Payment Industry since starting work at Citibank in 1990. He had qualified as a solicitor that year and moved inhouse to look after the UK Consumer bank, Citibank Life and Diners Club, where he got his first taste of payments which was to follow him the rest of his career. Always a commercial lawyer with a technology bias, Courtneidge’s career led him into several roles in law firms working for many big-name clients but always there to help new players. These start-ups became more prevalent as Fintech became a major force post-2000. In this series, Courtneidge will look at the key topics in the Payments Industry today and give his informed answers!
