Jude’s Guide to Cryptocurrency

Wednesday 9th September 2020

Cryptocurrency. It is a buzzword among aspiring lawyers, but what exactly constitutes such a ubiquitous term? Investopedia accurately defines it as:

1.     A digital currency,

2.     Secured by cryptography,

3.     Decentralised and

4.     Typically based on blockchain technology, a system whereby the history of any digital asset is made unalterable and transparent through a technique known as cryptographic hashing.

Andrew Bailey, Governor of the Bank of England, has stated that cryptocurrency is not a currency but in fact an asset, rendering it no different from a table or paperclip. The attitude of courts, however, is shifting. In 2020, the New South Wales District Court approved the use of the claimant’s cryptocurrency investment account as security for costs (Hague v Cordiner (No. 2) [2020] NSWDC 23).

The most astute of you will immediately realise that Libra, Facebook’s plan for its own currency, does not in fact comply with the definition. Libra is managed centrally by the Libra Association and as such is not decentralised, an easy mistake I have previously seen be made. Though Libra is, therefore, not a cryptocurrency, it is important to consider the conditions which allowed its genesis, similar to that of many cryptocurrencies. The Libra Association estimated that 1.7bn people remain isolated from the traditional financial system, for reasons such as being physically too far from a bank, fearing high and unpredictable fees, as well as lacking necessary documentation to establish a bank account in the first place.

These factors are indicative of the demographics who use cryptocurrencies: they are not typically high-income earners, nor work in the traditional finance industry. As such, many developers of cryptocurrency bear anti-establishment tendencies, thus appraisals of Fintech from the FCA, PRA, Bank of England and the Treasury are hardly met with alacrity. Here we encounter the first hurdle in the global adoption of cryptocurrency: will its developers wish to engage in discussions with governments, bankers and directors of global companies, if these are the very people they claim to oppose?

However, a more urgent issue is the mercurial value of cryptocurrency, which has proved challenging even for Goldman Sachs. Only in 2018 did the investment bank express its adulation at a new asset class by considering the launch of a bitcoin trading desk. Following bitcoin’s crash, the bank issued a five-point document outlining why bitcoin is not in fact an asset class.

[The five points were: that cryptocurrency does not generate cash flow like bonds; does not generate any earnings through exposure to global economic growth; does not provide consistent diversification benefits due to their unstable correlations; does not dampen volatility; and does not show evidence of hedging inflation.]

The bank stated that ‘a security whose appreciation is primarily dependent on whether someone else is willing to pay a higher price for it is not a suitable investment for our clients’, and that bitcoin ‘abets illicit activities’. So much for global adoption.

Another source of volatility is the vast leverage adopted by some traders, amplifying already manic swings in cryptocurrency prices. During the long economic downturn ahead, however, investors will increasingly be drawn to cryptocurrency hedge funds by the promise of large gains in comparison to paltry yields from cash and bonds.

The popularisation of cryptocurrency need not be based solely on its use by consumers. American firm Ripple created a cryptocurrency for use as an intermediary for payments between countries with different currencies, and the governments of Singapore, Hong Kong, Thailand and Canada have explored creating their own versions. China is the most advanced in leading such efforts, having filed over 120 patent applications for a sovereign digital currency. However, this has been met with hostility from the White House, demonstrating the distrust obstructing international adoption of digital currencies.

Twinned with intergovernmental hostility and mercurial prices, the most immediate obstacle to large scale use of cryptocurrency is the sordid activities for which it is often used. Mere months ago, the Twitter accounts of Biden, Obama and Musk were compromised, with the fraudsters responsible requesting payment of bitcoin via tweets from these accounts, among many others.

Another market for cryptocurrency vendors is selling their service as a broader blockchain platform, analogous to Amazon becoming a platform for e-commerce. Presently, Ripple has distributed $500m, primarily in its own currency, to seed more new applications that use blockchain technology as well as indirectly benefitting Ripple by increasing interest in cryptocurrency generally. Businesses do not have an interest in deterring potential clients by limiting their payment methods, unless demand for the payment method is outweighed by its cost of provision (currently the case with cryptocurrency). Such measures by Ripple, therefore, could facilitate cheaper and simpler use of cryptocurrency by themselves and their clients. Watch this space.

Anti-establishment tendencies, volatile prices, inter-governmental perfidy and simply a bleak reputation are the obstacles that inhibit the global adoption of cryptocurrency. Such mammoth impediments mean that students of my generation need not become beacons of knowledge on the subject. However, explaining the issues behind the buzzword to clients is where such information will benefit your chosen law firm.