Establishment slowly coming to terms with borderless currencies

Ledgers have had a new incarnation in the digital economy. Debits and credits have made way for algorithms, writes Eleanor Doyle.

The capabilities and properties of electronic ledgers have little if any similarity to their old, familiar, paper-based ancestors. What keeps the modern digital ledger honest, offering an authenticated reflection of transactions of monies in and out, is the anonymous collaboration of third parties to the transactions.

Anonymous collaboration, plus the incentive of financial reward for the technological savvy: Those people with the wits and capability to maintain secure and accurate account of the assets through solving cryptographic puzzles.

That keeps the ledger’s asset listing visible — across networks of internet sites, physical locations, and institutions — to anyone wishing to add transactions to the ledger. This distributed ledger system is what has underpinned Bitcoin since its emergence as a peer-to-peer digital cash system since the late 2000s.

The cryptocurrency movement brings together those with an ability and inclination to mine for currency on the back of their technical capability to solve the puzzles. Apart from earning Bitcoin, or other cryptocurrencies, for their efforts, the techies, at the same time, aggregate transactions into blocks, adding them to previous blocks, across chains of transactions. They are creating currency through blockchain technology.

A number of factors have led to the introduction and acceptance, albeit limited as yet, of cryptocurrencies. Like many systemic developments in the economy it is hard to imagine that cryptos could have been as successful without any one of them: Technology, timing, anti-establishment attitude, and old-fashioned greed.

Blockchain technology underlying crypto allows for innovations, since payments can be made directly between payers and payees without either transactions fees associated with the traditional banking system or involvement of any intermediary.

Holders of digital currency do not need to disclose what they control and neither is it known who has holdings or their location.

The timing of the financial crisis hardened attitudes. Financial players and institutions were paid by the public to look after their money, paid by them to loan them money, and paid by them again when they mismanaged that money through everything from faulty risk rating systems to fraudulent pyramid schemes.

General dissatisfaction with the mainstream financial system increased the attractiveness of a system beyond government control or big financial institutions. 

A bunch of online activists had been advocating for social and political change through privacy-enhancing technologies. The group emerged from the late 1980s hoping to make Big Brother obsolete. By the 1990s they came to be known as cypher-punks and were focused on how to enable privacy, reduce government monitoring, and corporate control of information.

The timing of the crisis, a stock of tech activists, cryptographical technological development, and a means of enticement for individuals to create and earn money within the Bitcoin system allowed for the crystalisation of alternative currencies. Blockchain and Bitcoin were the beginning.

The establishment has generally shunned crypto. JP Morgan Chase chief executive Jamie Dimon, as recently as September, slammed Bitcoin as a fraud. He predicted a collapse and, such is his impact, its value dipped by 3% in the next 24 hours. The Chinese have outlawed cryptocurrency exchanges since November.

But anyone following Bitcoin’s fortunes will have seen its astonishing, and volatile, growth. It has appreciated in value over 17 times since the beginning of 2017 alone — an impossible return, for any other class of asset, of 1,700%. So where’s the value coming from?

The value in standard government-backed money is that it serves functions like allowing for ease of payment and exchange, and it acts as a store of value so it can be relied on and trusted over time.

Government functions include monetary policies that control the interest rate through control of the supply of money. And they regulate financial institutions — well or otherwise.

Bitcoin, and crypto more generally, are not regulated, yet. Given that they are borderless, how regulation can (and no doubt will) impact remains unclear. Even in the China case, crypto exchanges just went off the mainland.

One major driver for regulation is the nefarious use of crypto by criminals for laundering and supporting terrorism. A solution may be for “government” to create competing crypto — India is considering this.

How that would work is unpredictable and potentially destabilising and if international funds flowed to such a currency the implications for others could be catastrophic.

The way Bitcoin works means mining additional chains in the block requires steady increases in computing power. Estimates in November put the mining requirements for one Bitcoin as similar to a standard house and all its appliances, for a week (or over 20 barrels of oil equivalent). Cheap electricity explains China’s popularity for mining. The environmental footprint is large, and growing. Strangely, indirect regulation through energy efficiency might be an option.

From an investment perspective, and for anyone who has not taken the crypto plunge, the biggest risk around crypto might well be not having invested in them, given their past return. That sounds like a real bubble-based mentality. We know how that story ends.

Meanwhile, JPMorgan is said to be considering helping clients trade contracts linked to Bitcoin.

As an encrypted database of agreed information, blockchain assures records cannot be changed. This could have applications for health information and records, digital identities (certification), for smart (inalterable) contracts, online voting systems: Potential exists where data storage matters for business.

The real innovation from crypto appears to lie in the promise of blockchain technology. This is its long-term impact, whatever bubbles burst in the short term.

Eleanor Doyle is professor of economics at Cork University Business School, University College Cork