It is very likely that you will have heard of such terms as ‘crypto-currency’, ‘blockchain’ and ‘bitcoin’. Despite a growing awareness of the sector, there are many who do not understand what crypto-assets entail or, perhaps more pertinently, its applications and implications. The purpose of this article is to provide an insight into the crypto-assets sector. This article will in general terms use the term ‘crypto-assets’ as being inclusive of ‘crypto-currencies’, which are just one type of asset class.
What are crypto-assets
In its most simplistic form, crypto-assets are merely a modern form of a ledger. A ledger is a method of recording information. Ledgers have been used in varying forms for thousands of years, from ledgers on clay tablets to wooden tally sticks.
Modern society organises its data through trusted third parties. For instance, the Land Registry maintains a database record of who owns property; the DVLA keep a record of car ownership; and in the finance sector we entrust our money to banks who keep records of our data using computerised bank account ledgers. Crypto-assets are the next enhancement on how we store data in ledgers. How? Through ‘decentralised Mutually Distributed Ledgers’ (“MDLs”), which is fundamentally what crypto-assets are. If you break down this phrase it becomes much simpler to understand:
‘decentralised’: ledgers are decentralised because they are not run by a third-party custodian such as a bank or government. The middle man is cut out of transaction, which usually saves on costs and transaction fees. Ledgers are also decentralised by not needing to be stored in few locations; crypto-assets are portable and permanent;
‘distributed’: ledgers are digitally distributed amongst a group of people. That could be a very large group of millions of people who all have access to a currency ledger; or a just two people who want to share data for the purposes of a contract between them, perhaps to buy and sell a property;
‘mutual’: ledgers are mutual because everyone in the group to which the data is distributed has access to the ledger. Risk of fraud is therefore minimised because everyone can see changes made to the ledger, with transaction records being permanent.
Note that the term ‘crypto’ is just a fancy word for ‘concealed’ or ‘secret’. Data is stored securely using encryption. A ‘blockchain’ is merely a description of an MDL, i.e. the block representing the group of people and the chain representing the distribution of the ledger through a chain of people.
There presently is no one single definition of a crypto-asset, however, perhaps the best suggestion in English law has been from Sir Geoffrey Vos (a judge who has been appointed Master of Rolls as of 11th January 2021):
“cryptographically secured digital representation of value or contractual rights that uses some type of Distributed Ledger Technology and be stored or traded electronically”.
Sir Geoffrey Vos is part of a UK Jurisdiction Taskforce, which will be influential in determining the legal status of crypto-assets in the the UK.
Is there a need for crypto-assets? The world is becoming increasingly borderless and the volume of data is growing exponentially. There appears to be a need for a new method of storing data, in a secure and easily manageable way. Banking technology is often very outdated and only four ‘challenger banks’; Ziglu, Revolut, Starling and Monzo operate in the cloud. It will also be borne in mind that one of the purposes of bitcoin and MDL technology generally, is to be independent of government and third-party control, its creator becoming concerned after the 2008 financial crisis, caused in large part by those very institutions. Crypto-assets facilitate the disintermediation of many industries. There does seem to be a need or, at the very least, clear use cases for the benefits that crypto-assets can provide.
Types of Crypto-assets
The five main classifications:
BitcoinBitcoin was the first decentralised crypto-currency, released in 2009. It seems likely that bitcoin will be become a store of value in much the same way that gold is a store of value.
Alternative token (aka Altcoins)Crypto-assets other that bitcoin. There are currently over 5,000 altcoins, many of which have use cases that are not merely to store value. A key example is Ethereum, which is a platform on which to develop other MDLs such as smart contracts;
Blockchain The use of ledgers to record information. This could cover everything from exam results to criminal records;
Decentralised Finance (De-Fi)Finance that is decentralised away from traditional institutions using smart contracts. For example, one can now conduct peer to peer borrowing and lending of money between individuals using digital assets as collateral;
Interconnecting BlockchainThe connecting of different MDLs together so that you can have one network with multiple MDLs. The Polkadot altcoin is an example of this. You can have, say, a police database that seamlessly connects a criminal records ledger, a car registration ledger and a home ownership register.
The four main use classes:
CashIt is already possible to buy and sell using crypto-currencies. Some crypto-currencies, known as ‘stablecoins’ are pegged to traditional Fiat currencies (i.e. traditional government issued currency), such as Tether, which is pegged to the US dollar
SecuritiesTradable financial assets and instruments. Raising capital through shares, bonds and Initial Coin Offering (“ICOs”)
UtilitiesThe storage of data. Let your mind wander as to what data needs to be stored and MDL technology – crypto-assets – has a use case: insurance, credit, loyalty management, identification, medical data, qualifications. Such examples are the tip of the iceberg and many are already in use. Estonia has famously operated its national identity system on an MDL for years
PropertyIn the UK the Land Registry keeps records (i.e. a ledger) of property ownership. It seems likely that these records will be transferred onto an MDL in due course. Significant sum of money has already been spent to make this a reality
The regulation of crypto-assets is constantly evolving. The US and UK appear to be leading the way when it comes to plans for regulation. The UK’s position may change after leaving the EU from whom it no longer needs to align. Some of the legal issues facing crypto-assets are as follow:
Global Divergence – different countries have thus far adopted different stances to crypto-assets and crypto-currencies in particular. They are illegal in some countries (Bolivia, Ecuador), to be regulated (Russia) and prohibited by banks and financial institutions only (China). The UK is pro crypto-currencies. The Financial Conduct Authority wants a regulatory framework that supports crypto-assets.
UK Regulatory issues include:
a. Anti-money laundering Processes, including identity requirements, are the norm on the most reputable platforms that are likely to become mainstream;
b. Tax evasion This issue goes hand in hand with having acceptable anti-money laundering processes. Crypto-currency data is ultimately on a permanent MDL. However, some altcoins, such as Monero, are designed to facilitate anonymity;
c. Legal status In the UK, it seems increasingly likely that crypto-assets will be defined as a type of ‘property’. The law might then be codified through legislation or developed through case law (i.e. common law), Sir Geoffrey Vos preferring the latter. A predominantly common law approach seems likely given the fast-evolving nature of the sector; and
d. Contract law The law will almost certainly need to be adapted to allow for such issues as computer code forming the basis of a contract, and private keys replacing traditional signatures. Such issues are certainly not insurmountable but it will take time before there is legal certainty.
It is clear that there are many use cases for crypto-assets throughout society, many of which are already in use or are being developed. Crypto-assets offer numerous advantages over and above society’s existing trusted financial and legal architecture. Whether or not crypto-currencies challenge traditional money will likely be determined by the extent to which there is mass-scale adoption. The extent of adoption remains to be seen, but has been growing rapidly, particularly at institutional level. On 8th February 2021, Tesla invest $1.5bn into bitcoin, a likely seismic event for the crypto-asset sector, that could facilitate mass adoption. One things seems certain, it would be unwise to ignore the crypto-asset sector – the underlying technology is likely to permeate through all of our lives.