Insights

Over a decade ago, emerging out of the turmoil of the 2008 Great Recession, was Bitcoin. Bitcoin has since been leading a silent revolution against the legacy financial system with the libertarian promise of giving people more control over their money. That it would displace the reliance on third-party banks and other financial institutions to provide a censorship-resistant and immutable way to send money peer-to-peer, anywhere in the world.

Adoption of Bitcoin remains low however and many people are still confused about what it really is. Let alone how thousands of other cryptocurrencies (or “cryptos”) would play in the new world of finance. That is understandable as cryptos today are not widely accepted as payment for traditional goods and services. But soon, that could all change. Imagine a new normal using cryptocurrency to pay for a ride in an Uber self-driving car or to purchase essentials at your local grocery store. Also consider in the mix that governments are already converting their physical cash into central bank digital currencies (CBDCs).  

This research article provides an overview of cryptos and ultimately aims to clarify whether they should be classified as currency or digital assets.

What are cryptocurrencies?

Cryptocurrencies are virtual currencies that do not rely on any central authority to circulate and can serve as an alternative medium of exchange, or a store of value. Cryptocurrencies typically exhibit these main characteristics¹ :

• Decentralization. Where governments and central authorities govern the current financial system, which is based on fiat currency² , cryptocurrencies are usually not issued or controlled by such entities. Or arguably so. Instead, cryptos are processed and validated by a distributed and open network of computers, called nodes. All transactions are recorded on a public distributed ledger, known as the blockchain. Blockchains are like a bank’s balance sheet or general ledger, but every participant on a specific network can access it. Having a copy of the ledger rids the need to trust intermediaries – which, like everything else, has pros and cons.

• Security. Cryptocurrencies use complex algorithmic mechanisms to verify the accuracy of incoming transactions and data on a blockchain network. A public-private key cryptographic system is also used to encrypt and decrypt messages between senders and receivers. The public key is used to encrypt information and can be shared with anyone, while the private key is kept secret. Only the intended receiver can decrypt information using the corresponding private key. This makes it very difficult for hackers to compromise a transaction.

• Privacy. Trading directly on a blockchain network does not require the parties to adhere to Know Your Customer (KYC)³ guidelines. So, the risk of sensitive data being shared with third-parties, or a person’s identity being stolen, is reduced. KYC is however required when trading on centralized exchanges, banks, and other investment management services.

• Transferability. Cryptos enable seamless cross-border payments. A sender can instantly send cryptocurrency directly to an intended receiver anywhere in the world, at any time, without using an intermediary that could block a transaction or charge for it. But there are exceptions. For example, the Ethereum digital wallet MetaMask and digital marketplace OpenSea have both silenced accounts based in countries sanctioned by the U.S, thereby blocking any transfer or trade⁴. This raises the debate on how decentralized blockchain really is (which we would save for another day). 

• Portability. Since cryptos are not tied to a specific financial institution or government, they can be easily accessed by asset holders regardless of geographic location.

• Transparency. All transactions are publicly published on its native blockchain. Anyone can join a specific network, and by so doing, view all the information on that network, including the entire history of transactions. This adds a degree of accountability and prevents data from being modified unjustifiably. 

• Immutability. Transactions are irrevocable once they are settled on the blockchain. Payments can only be returned as a separate transaction if the receiver agrees to it. However, transactions have been reversed by developers in the past for various reasons. For example, in 2016, Ethereum took what was deemed as necessary action to recover 3.6 million Ether – valued at USD 50 million at the time – which was stolen by a hacker due to some loophole⁵ in the system. More recently in August 2022, decentralized finance (DeFi) protocol Acala (which is built on the Polkadot network), saw a hacker mint 1.29 billion of its native stablecoin – aUSD – causing it to de-peg and crash. Acala’s community voted to burn the 1.29 billion aUSDs to reverse the action⁶. The irreversibility of crypto can therefore be questioned.        

• Deflationary. Some cryptos, not all, are launched with a limited and pre-determined supply cap that is embedded in its blockchain protocol, as opposed to fiat currencies which can be issued and/or printed at any time by central banks. This makes fiat currencies inflationary causing them to inherently lose value over time

Cryptocurrencies are also called coins. Bitcoin is the first of its kind that was successful. It was invented in 2008 and remains the most popular. All other cryptos are called altcoins, like Ethereum and Dogecoin. 

Coins and tokens are sometimes used interchangeably when explaining cryptos – but there is a distinction. Tokens are not native to the blockchain they reside on as BTC is to the Bitcoin network and Ether (ETH) is to Ethereum. Tether, Uniswap, and SHIBA INU on the other hand are tokens built on top of the Ethereum network. Tokens are decentralized projects designed for a variety of purposes, and like coins, they can be bought, sold, and traded. However, they are not used as a medium of exchange.

Cryptocurrencies are a subclass of digital assets.

Digital assets are practically anything of value that can be created and stored in a digital format. In the U.S., President Joe Biden recently legitimized all cryptography-based assets as digital assets through the Executive Order on Ensuring Responsible Development of Digital Assets⁷. It referred to three main types of crypto assets:

• Cryptocurrencies. Which as mentioned earlier, can be used as payment for goods and services, and as a store of value. But there is debate whether cryptos are a true store of value since the market suffers frequent price swings and is relatively young compared to other stores of value, like fiat currency or precious metals. 
  
• Stablecoins. A type of cryptocurrency that stabilizes its value by pegging to a more credible asset such as the US dollar, the Euro, or gold. Examples include USDC which is fixed to the US dollar, and PAXG which is fixed to gold.
  
• Central bank digital currencies (CBDCs). CBDCs are essentially the digital form of fiat currencies issued by central banks. They are therefore centralized and more acceptable compared to other cryptos. The sand dollar was fully launched in 2020 by the Central Bank of Bahamas, making it the first-ever national digital currency in the world. And in October 2021, Nigeria launched Africa’s first digital currency, the eNaira, which was the most recent launch⁸. 

Other main crypto assets include:

• Utility tokens. Designed for a specific use case within a specific blockchain ecosystem. For example, gamers on the Axie Infinity network, which is a popular play-to-earn (P2E) game in the market, can earn or purchase Smooth Love Potion (SLP) tokens to unlock special in-game tasks – but outside of the Axie Infinity metaverse, SLPs are practically useless.

• Security tokens. Similar to traditional securities, security tokens are smart contracts that represent fractional ownership of an asset, such as shares in a company, a piece of art, intellectual property, or real estate. They are heavily regulated, which means they are less prone to fraud. One example is the INX platform where users can purchase digital securities from a variety of businesses to earn investment income through dividends, interest payments, or capital gains.

• Non-fungible tokens (NFTs). Can be described as a collector’s item, just in digital form. Almost anything can be “NFTized”. From art and music to even real estate and famous tweets. They are unique and cannot be duplicated. Like each piece of art in a private art collection, or like a rare trading card, the value of NFTs is derived from their popularity and rarity. Their worth also depend on the blockchain that it was minted on, with factors such as gas fees, account fees, and listing fees contributing to the minting cost.

Despite significant market volatility, cryptos have grown exponentially over the last 14 years. In 2021, it was recognized as the fastest-growing asset class when comparing the market cap of the 30 largest crypto assets against the 30 most valuable companies, combined with gold and silver⁹. Cryptos are therefore a reasonable liquid asset. They are just very high risk and not yet a mainstream investment option.  

Demand is increasing however. In recent news, the largest assessment management firm, BlackRock, partnered with Coinbase to provide its institutional clients a Bitcoin investment option¹⁰. It is speculative to say that other cryptos would later become available under this arrangement.

The question remains: are cryptos currency?

Cryptocurrencies are only ‘currency’ if they are issued by the government.

When considering the main properties of currency as we know it, cryptos do fit the bill. These are¹¹:

• Store of value. Any asset or commodity must retain value or appreciate over time and should be readily exchangeable for something else. Yes, the crypto market is super volatile – but there is a silver lining with the emergence of stablecoins. Pegging cryptos to more legitimate assets such as gold or government securities, offers them as a more reliable store of value. The argument can however spin against fiat currency as over-printing can lead to the devaluation of currency. 

Interestingly, Bitcoin has appreciated since its inception. Though it declines in a bear market like any other asset, it is worth more now than it did in 2009 when it was introduced to the public.

• Medium of exchange. Quite simply, money must be widely accepted as a form of payment for goods and services. While fiat currency is the dominant medium of exchange in today’s economy, cryptocurrencies are gaining traction. For example, Home Depot, one of the largest hardware store chains in the United States, accepts Bitcoin as payment for all their home improvement products and services, and as recent as August 2022, Vaculug, a large European tire retreader, announced that it would be accepting Bitcoin and Ethereum as payment for its tires and related services.  
  
• Unit of account. Which is essentially a measurement of monetary value. Like centimeters (cm) help us measure distance and length, unit of account helps to compare market prices of different products and services. For example, we can evaluate the value of a house versus the value of a car in terms of dollars and cents. However, a unit of account is not constant as a centimeter is because of inflation, deflation, and other economic impacts. In the crypto world, cryptos are valued based on traditional supply and demand economics, where the value of each crypto unit is based on prevailing market prices.
  Each unit of money must also be divisible into subunits to be a valid unit of account. For example, one US dollar (USD) can be broken down into one hundred cents. Likewise, one Bitcoin (BTC) can be broken down into fractional subunits – the smallest being one Satoshi, which is one hundred millionth of a single BTC. This means that even if the price of a single BTC explodes to one hundred thousand, smaller purchases would still be possible due to its granular denomination.

Although cryptocurrencies uphold these fundamental aspects, they are only a valid form of payment, or official currency, if a government makes them legal tender. Legal tender refers to bank notes and coins that are issued by the government. So, for example, in Canada, Bitcoin and other cryptocurrencies are not managed by the government and central authority such as the Bank of Canada – only the Canadian dollar (CAD) is considered official currency in Canada¹².

However, consider the following developments as evidence of advancing legal status of cryptocurrencies across the globe:

• Bitcoin as legal tender. Countries have started to adopt Bitcoin as legal tender. In mid-2021, El Salvador became the first country to do so¹³, followed by the Central African Republic in April 2022, which recognized BTC as official currency alongside its regional Central African CFA franc¹⁴. 

• More regulations are coming. The more regulations in place, the more stable the crypto market can be. Government officials are working aggressively to implement their regulatory framework.
  For example:
  • The European Union has plans to enact its Markets in Crypto-Assets (MiCA) bill by 2024¹⁵ – which, through stricter compliance requirements, would provide regulatory clarity to the growing crypto industry in Europe while helping to prevent crypto disasters like the recent Terra-LUNA collapse. South Korea has even stated that it would use MiCA as a guide to develop its own Digital Asset Basic Act.
    
  • Japan also passed a bill in June 2022 to regulate stablecoins, allowing licensed banks, registered money transfer agents and trust companies to issue coins that are pegged to the yen, the dollar, or other fiat currencies¹⁶.  
    
  • In the United States, thirty-seven states are working on legislation around cryptocurrencies and other crypto assets¹⁷. For example, the state of New York has a bill to allow state agencies to accept cryptocurrencies such as Bitcoin, Ethereum, Litecoin, and Bitcoin Cash as payment. The states of Arizona, Texas and California have also introduced bills to adopt Bitcoin as legal tender. A new bill, The Virtual Currency Tax Fairness Act, was also introduced by U.S. Senators in July 2022, to allow citizens to make tax-free crypto purchases under USD 50¹⁸. 
    
  • At the Federal level, the Responsible Financial Innovation Act (RFIA) was introduced in June 2022 to serve as the first comprehensive regulatory framework for digital assets in the United States¹⁹. And there is a bill being drafted by the US House of Representatives to regulate stablecoins, but that is expected to be delayed until September 2022 when Congress returns from its late-summer break²⁰. 
    
  • It is also worth mentioning the ongoing lawsuit between the US Securities and Exchange Commission (SEC) and Ripple on whether Ripple’s XRP should be treated as a security or a commodity. The final ruling in this landmark case will set the precedence for determining whether a specific crypto is a security versus a commodity, therefore helping to bring regulatory clarity to the matter.
    
• Sanction-free economy. Anti-Western countries are using cryptos to circumvent US sanctions. In August 2022, Iran made a ten-million dollar import order using an undisclosed cryptocurrency. This could be the first of many for Iran and could unlock new trade opportunities with other countries facing similar bans, such as Russia²¹. In fact, Russia is also currently pushing to legalize use of cryptocurrencies in international trade²², and with the proposed launch of its own digital currency, the digital ruble, cross-border trade with countries restricted by US sanctions could be facilitated²³.
  
• The rise of “digital money”. Most countries are in the process of issuing their own CBDC According to a research paper published by the European Central Bank (ECB) in August 2022²⁴ , 90% of central banks (out of the 81 respondents) were already evaluating the issuance of a CBDC as of the end of 2021. The EU itself is discussing the replacement of its physical cash with a digital euro to address several challenges, including the potential loss of control of its current monetary system with growing adoption of Bitcoin, Circle’s and Tether’s US dollar-pegged stablecoins, as well as other cryptocurrencies. There is also concern that big tech companies like Google and Amazon can roll-out their own digital currency that challenges the Euro. 
  While CBDCs can serve government agendas very well, they do pose major obstacles, including the displacement of commercial banks as well as privacy risks and loss of control for users.
  
• Real-time payments. Trillions of dollars are transacted overseas every day. However, traditional legacy payment systems are too slow and inefficient to manage the liquidity of cross-border commerce. It can take several days to settle a single transaction. Cryptos such as Ripple’s XRP enable seamless cross-border transactions which help businesses to better manage their cashflow. In August 2022, Travelex Bank in Brazil became the first bank in Latin America to partner with Ripple for XRP-based remittances²⁵, and just days after, Ripple expanded its solution to the United Arab Emirates (UAE) in partnership with global payments firm Tranglo²⁶. The US Federal Reserve is also launching its real-time payments system FedNow, which is considered as a stepping stone toward rolling-out its CBDC²⁷. 

Cryptos are unmistakably part of the future and blockchain technology would continue to bring significant change to the world as we know it.

One can argue that physical cash is still in high demand as it offers the masses a form of trade privacy and censorship-free money. Bitcoin seems to have censorship-free qualities while other cryptos are gaining traction as investment vehicles. As actual currency, CBDCs are shaping up as the primary form of digital money while Bitcoin (and other cryptos) is gradually becoming a legitimate payment instrument. 

There is a lot happening in the crypto world leaving a strong signal that mass adoption of cryptos may come sooner than we think. Large institutions and corporations like BlackRock, Morgan Stanley, Alphabet Inc, Microsoft, and PayPal continue to invest heavily in crypto, which indicates lucrative investment opportunities. But the opportunity could slip away for late adopters. The markets are currently in a bear cycle, and there may be further downturns to come. It just might be a good time to start investing in cryptos before the market becomes bullish again. 

References:

1. Coinbase. What is cryptocurrency?
   https://www.coinbase.com/learn/crypto-basics/what-is-cryptocurrency
2. Fiat currency refers to paper money and coins that are issued by a government but is not backed by a commodity such as gold or silver. In broader terms, fiat currency could mean any form of money that is made legal tender through a government decree (or fiat) – meaning that it is recognized through courts of law as a legitimate payment instrument for any monetary debt.
3. Know Your Customer, or Know Your Client, is the mandatory process of identifying and validating a client’s identity.
4. Fortune. March 2022. NFT marketplace OpenSea confirms it will block accounts hit by U.S. sanctions, reviving debate over how decentralized blockchain really is.
   https://fortune.com/2022/03/04/opensea-metamask-block-users-sanctions/
5. CoinDesk. August 2022. Ethereum: Understanding The DOA Attack.
   https://www.coindesk.com/learn/2016/06/25/understanding-the-dao-attack/
6. Decrypt. August 2022. Acala Stablecoin Edges Back to Dollar Peg After Burning 1.29B aUSD.
   https://decrypt.co/107526/acala-stablecoin-edges-back-dollar-peg-burning-1-29b-ausd
7. Holland & Knight. June 2022. “Let’s Talk Cryptocurrencies and “Digital Assets”: A Primer for Trust and Estate Lawyers. Based on Executive Order, Sec. 9 (c).
   https://www.hklaw.com/en/insights/publications/2022/06/lets-talk-cryptocurrencies-and-digital-assets-a-primer
8. Atlantic Council. “Central Bank Digital Currency Tracker.”
   https://www.atlanticcouncil.org/cbdctracker/
9. Gokhshtein Media. November 2021. “Cryptocurrencies Rank as the Fastest Growing 2021 Asset Class”.
   https://www.gokhshteinmedia.com/2021/11/cryptocurrencies-rank-as-the-fastest-growing-2021-asset-class/
10. Bloomberg. August 2022. “BlackRock Teams Up With Coinbase in Crypto Market Expansion”.
    https://www.bloomberg.com/news/articles/2022-08-04/blackrock-teams-up-with-coinbase-in-crypto-market-expansion#xj4y7vzkg
11. Cryptopedia. June 2022. Fiat Money vs. Cryptocurrency.
    https://www.gemini.com/cryptopedia/fiat-vs-crypto-digital-currencies
12. Canada.ca. Digital currency.
    https://www.canada.ca/en/financial-consumer-agency/services/payment/digital-currency.html
13. CNBC. June 2021. El Salvador becomes first country to adopt bitcoin as legal tender after passing law.
    https://www.cnbc.com/2021/06/09/el-salvador-proposes-law-to-make-bitcoin-legal-tender.html
14. CNBC. April 2022. Central African Republic becomes second country to adopt bitcoin as legal tender.
    https://www.cnbc.com/2022/04/28/central-african-republic-adopts-bitcoin-as-legal-tender.html
15. CoinDesk. July 2022. Here’s What Still Needs to Happen Before the EU’s MiCA Bill Becomes Law.
    https://www.coindesk.com/policy/2022/07/06/heres-what-still-needs-to-happen-before-the-eus-mica-bill-becomes-law/
16. Nikkei Asia. June 2022. Japan adopts law to regulate stablecoins for investor protection.
    https://asia.nikkei.com/Spotlight/Cryptocurrencies/Japan-adopts-law-to-regulate-stablecoins-for-investor-protection
17. National Conference of State Legislatures (NCSL). July 2022. Cryptocurrency 2022 Legislation.
    https://www.ncsl.org/research/financial-services-and-commerce/cryptocurrency-2022-legislation.aspx
18. Forbes. July 2022. New Bill Could Allow Americans To Buy Coffee With Crypto Tax-Exempt.
    https://www.forbes.com/sites/jasonbrett/2022/07/28/new-bill-could-allow-americans-to-buy-coffee-with-crypto-tax-exempt/
19. Greenberg Traurig, LLP. June 2022.The Responsible Financial Innovation Act: A Comprehensive Proposal to Regulate Digital Assets.
    https://www.gtlaw.com/en/insights/2022/6/the-responsible-financial-innovation-act-a-comprehensive-proposal-to-regulate-digital-assets
20. The Wall Street Journal (WSJ). July 2022. Bipartisan Bill to Regulate Stablecoin Is Delayed for at Least Several Weeks.
    https://www.wsj.com/articles/bipartisan-bill-to-regulate-stablecoin-is-delayed-until-september-11658770520
21. Reuters. August 2022. Iran makes first import order using cryptocurrency – report.
    https://www.reuters.com/business/finance/iran-makes-first-import-order-using-cryptocurrency-tasnim-2022-08-09/
22. Bitcoin Magazine. September 2022. Russia to Legalize Use of Cryptocurrency in International Trade.
    https://bitcoinmagazine.com/business/russia-to-legalize-use-of-crypto-in-international-trade
23. The New York Times. February 2022. Russia Could Use Cryptocurrency to Blunt the Force of U.S. Sanctions.
    https://www.nytimes.com/2022/02/23/business/russia-sanctions-cryptocurrency.html
24. European Central Bank (ECB). August 2022. The economics of central bank digital Currency.
    https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2713~91ddff9e7c.en.pdf
25. The Daily Hodl. August 2022. Ripple Launching XRP-Fueled Payments Service in Brazil in Partnership With Latin American Bank.
    https://dailyhodl.com/2022/08/19/ripple-launching-xrp-fueled-payments-service-in-brazil-in-partnership-with-latin-american-bank/
26. Cryptoslate. August 2022. Ripple continues overseas expansion with Tranglo to UAE.
    https://cryptoslate.com/fuse-media-to-be-launch-partner-for-theta-metachain/
27. CoinDesk. August 2022. Federal Reserve’s FedNow Real-Time Payments Set for Mid-2023 Debut.
    https://www.coindesk.com/business/2022/08/29/federal-reserves-fednow-set-for-mid-2023-debut/