Crypto-assets: The Future of Money
As we near the end of 2020, the subject of crypto-assets could not be more topical given the emerging tokenized economy. The FCA defines crypto-assets as ‘cryptographically secured digital representations of value or contractual rights that use some type of distributed ledger technology (DLT) and can be transferred, stored or traded electronically’. To deconstruct the word, ‘crypto’ means concealed and ‘currency’ stands for a system of money. In this particular case, the concealed element reflects the secure and impenetrable nature of blockchain as well as the pseudo- or full anonymity granted to participants and transactions of digital cash. Crypto-assets are becoming an increasingly popular choice for investments and transactions due to its efficiency, as the technology means the traditional third-party involvement is rendered obsolete, consequently saving time and costs.
Diagram created by Rory Copeland, Associate, Allen & Overy LLP"
What are digital assets? There exists a plethora of digital assets, such as crypto-assets, stablecoins and central bank digital currencies. There are two main types of crypto-assets which we will focus on. Firstly, there are mined tokens such as Bitcoin and Ethereum which exist on a blockchain. Second are tokenized investments which are issued in an initial coin offering (ICO). An ICO is the cryptocurrency industry equivalent to an initial public offering (IPO) and its function is for companies to pool money for new creations, such as an app. These coins can have a functional value or can otherwise be used to simply represent a stake in the company. Tokens are described by the Blockchain Council as ‘an asset, utility or unit of a value that is issued by a company’ and are ‘managed through a smart contract and underlying distributed ledger’. Security tokens are specialised in that they adhere to a set of legal guidelines and pay investors in dividends. For instance, if you invested in a certain type of security token the company legally has to supply certain information, such as their business proposals and location. Utility tokens, by contrast, do not benefit from such regulations. They instead have a specified purpose, an example being the Sia, a token network which pays people in Siacoin in exchange for the rental of extra space on their computer.
Stablecoins, on the other hand, can either reference a single asset or multiple assets, such as the dollar or gold. As their name suggests, they are expected to retain a stable value overtime due to being asset backed, whether that be fiat collateralised, crypto collateralised or controlled by an algorithm. By virtue of their reliability, investors may choose to back stablecoins such as DAI over Bitcoin (a crypto-asset) due to the latter’s intrinsic link with financial volatility. Investor confidence in the cryptocurrency market is consistently inconsistent; fluctuations occur as a result of geopolitical events, news scandals and regulation proposals. Albeit limited, stablecoins offer a more risk adverse option for investment.
Central bank digital currencies (CBDC) differ from other crypto-assets as they are centralised in nature. In other words, it is a token which aims to represent a historically physical fiat currency and is regulated by a country’s monetary authority or central bank that can function on a single or distributed ledger. CBDC’s are an option governments are actively inquiring into as it allows them to retain an element of control; a preferable option to the rise of wholly decentralised cryptocurrencies, which they otherwise have no control over. An example of such developments include China’s first CBDC known as the digital Yuen, or more officially, as DCEP (digital currency/electronic payment). It is hoped in the future that CBDC’s will be used to pay for items by scanning barcodes and peer to peer transactions by touching phones in close proximity.
Key legal and regulatory issues
In our corresponding webinar, Heenal Vasu, Senior Professional Support Lawyer at Allen & Overy, rightfully introduces this area as the picture being ‘by no means settled’. With regards to dispute resolution, crypto assets add a layer of complexity to an area which demands details. When contentious investigations occur, where is the appropriate place to look? The location of the parties or the location of the assets? How do officials track down the e-wallet on which the token is held? Furthermore, the concept of blockchain technology and data protection issues conflict. Blockchain is praised for its immutable nature, however this quality seems to overlook the ‘right to be forgotten’ (Article 17 of the GDPR), which allows for an individual’s erasure of personal data without undue delay. In an age of technological revolution where data is likened to ‘the new coal’ (Neil Lawrence, quoted in Alex Hearn, ‘Why Data is the New Coal’), is it really possible for blockchain and GDPR to co-exist? The same issue arises when considering the use of blockchain to tackle KYC policies. Know Your Customer (KYC) policies were introduced as an identification method to verify an individual or company with the aim of preventing money laundering, fraudulent activities and terrorist funding. The right to be forgotten with blockchain is not an option and therefore the associations these companies make using KYC will forever remain in the blockchain. Furthermore, it takes no expert to fathom the prized target a global KYC blockchain would become for cybercrimes (PrimaFelicitas "Will Blockchain address the existing issues of KYC?"). In short, the quench for a robust legal framework is incredibly apparent by the current case-by-case analysis methodology.
EU Digital Finance Package
The thirst for ordinance was met by the European Commission Digital Finance Package, released on the 24th of September 2020, presenting legislative proposals for crypto-asset regulation. Provisions in MiCA (Markets in Crypto-Assets Regulation) tackled clarification issues by putting forward a taxonomy of definitions of different types of crypto-assets. It is likely these definitions will be met with opposition by market participants who suggest further lexical tightening before an official roll-out. An additional element includes the DLT Pilot Scheme, which will allow derogation from existing rules to allow technology firms to test their technology whilst regulators gain experience using DLT (Distributed Ledger Technology). The package serves as a dynamic proposition which is sophisticated in nature and hopefully workable in future.
The Future of Money
During The Legal Chain's webinar, Rory Copeland, associate at Allen & Overy, posed the question: ‘What is the future of money? Bank money, cryptocurrencies or CBDCs?’ The answer points towards a blend. CBDCs are a prosperous option as they not only address the increasing pressure for quicker and cheaper cross border transactions, but they also serve to benefit banks. By removing the need for pre-funding with regards to correspondent banking, CBDCs will free up liquidity and prevent counter party risks. Most importantly to central banks, CBDCs will allow the same to retain monetary sovereignty, which is an element of control that is otherwise lost with cryptocurrencies. Crypto-assets are likely to be increasingly adopted by the public due to collaborations such as Paypal allowing its customers to buy bitcoin through its platform, which will consolidate its use as a payment method. As for the orthodox use of bank money, it is to be expected to be used for the foreseeable future, or at least until CBDCs are firmly soiled in our financial sector.
The Legal Chain would like to take this opportunity to extend a warm thanks to Heenal Vasu and Rory Copeland, who conducted our latest webinar titled ‘Cryptoassets: The future of money’. This article serves to summarise the points mentioned during the webinar, which was recorded and can be located on our website and Linkedin page.
Follow us on LinkedIn and Eventbrite to receive further updates:
Article written by Sophia Ramaer