Everything You Need to Know About Crypto

Technology Policy Web3 and Crypto

Everything You Need to Know About Crypto

Commentary
Posted on: 21st October 2022
Jess Northend
Policy Lead, Science and Innovation Unit

Over the past decade, crypto has shifted from a fringe interest with a cult-like following, to mainstream adoption, with high-profile, if sometimes controversial, celebrity support.

For many of its proponents, crypto represents a radical, innovative new form of finance. For opponents, it is a speculative investment with little "real" value, that’s most often used for illicit trading across borders.

Given the debates, regular headlines and apparent scandals, what are the important things to know about what’s happening in crypto as we navigate the next stage of its evolution? Here are nine things worth considering.


1.       Crypto isn’t new and it’s here to stay.

Cryptocurrencies have been in use since 2009, and there are more than 18,000 in existence today. The most widely held are bitcoin and Ethereum, but all current cryptocurrencies can be openly tracked and traded via Distributed Ledger Technologies (DLTs) – like blockchain. Control and ownership is managed via a cryptographic key. Crypto is just one of several major classes of digital assets. The two major forms of crypto are: 

  • Unbacked cryptocurrencies: those not pegged to a fiat / government-backed currency, such as bitcoin.
  • Stablecoins: those linked to a traditional currency or asset.

Whatever the next steps are in regulating cryptocurrencies, crypto and DLTs will play a defining role in the 21st century.


2.       The jury’s still out on whether crypto is a security or a commodity.

Until now, the regulation of unbacked cryptocurrencies has been hazy. In the United States, it is unclear whether cryptocurrencies should be classed as a security or a commodity – as defined by the Howey Test – and therefore which government agency should have primary jurisdiction and what levels of taxation should be applied. President Biden issued an Executive Order in March, tasking agencies with finding a way to appropriately manage crypto. At the time of writing, little action has been taken on this central question. Meanwhile, some commentators propose an industry-funded organisation that would set basic standards for crypto instruments and institutions. Those that fail to comply would face legal consequences. With many nations looking at the US for a balanced model of regulation, how it decides to classify crypto could have widespread implications.


3.       The “crypto winter” shows no signs of thawing.

In November 2021, the crypto market began to nosedive, eventually losing around $2 billion in value from its peak. The question remains: how deep and long will this rout be? Prior dips in the market lasted an average of four years from peak to trough, and, as of yet, there are few signs the market will rebound in the near-term. For some, the downturn came at the right time for regulators. If, for example, and as argued by the Bloomberg Editorial Board, mainstream banks had been more clearly tied to now bankrupt crypto firms Celsius or Three Arrows Capital, their meltdown could have created much more widespread damage. The "crypto winter" could give regulators the breathing space they need to limit system exposure and dampen some of the consumer hype, before crypto’s spring starts to break.


4.       CBDCs are on the way – just very slowly.

Central Bank Digital Currencies (CBDCs) are a digitised form of fiat currency. While some countries, such as China, are pushing ahead with the widespread introduction of their CBDC (the digital yuan or e-CNY), many countries are moving at a much slower pace. The US Treasury recently suggested that the government should continue to work on scoping a digital dollar (without recommending that the US should have one). Meanwhile, the UK is amidst a lengthy process looking at the merits of a digital pound. There are a range of technical questions at play, including the use of DLTs like blockchain, how to design a system that delivers financial inclusion and how to address consumer privacy concerns. While it’s likely we’ll see CBDCs in the world’s leading economies, it may take some time to get there.   


5.       Stablecoins really aren't stable.

Stablecoins – a class of crypto pegged to an underlying asset like a fiat currency – are designed to be more stable than traditional cryptocurrencies, which are often subject to major fluctuations in their value. Yet stablecoins remain one of the most contentious areas of crypto, with regulators across the globe expressing concern after several high-profile stablecoins lost their peg to the dollar. Some fear that – as traditional banks and consumers increase their exposure to stablecoins and private sector firms create their own stablecoins – a crash in their value could trigger an exodus, potentially destabilising the financial system more broadly. The EU, UK and Japan are among those rapidly tightening regulations. Expect more action ahead.


6.       Crypto is bad news for the environment – but it might be cleaning up its act.

Crypto’s negative climate credentials are well known. For instance, bitcoin mining far exceeds the energy use of many medium-sized countries per year. For some, this is a price worth paying, especially given that its emissions are comparable to other industries; for others, crypto’s carbon footprint is unnecessary and unwelcome. The recent transition of Ethereum from the power-hungry "proof of work" mining protocol to "proof of stake" (which is far more energy efficient) is a major step forward and proponents of Ethereum, including founder Vitalik Buterin, have expressed hope that institutional actors will increase the use of Ethereum. The challenge is to demonstrate that Ethereum – and other more energy-efficient currencies – can simultaneously be scalable, energy efficient and decentralised.


7.       DeFi is gaining ground, but it’s still not widely accessible.

Decentralised Finance (DeFi) has been gaining ground as the next frontier of financial innovation. It covers any peer-to-peer financial interaction on public blockchains and doesn’t require an intermediary to process transactions. Yet there are still a range of issues limiting its potential. Several major DeFi firms have run afoul of "know your customer" rules, and users face high transaction fees and a poor customer experience. In place of DeFi, many customers have turned to centralised crypto financial intermediaries like Coinbase – often described as centralised crypto finance companies (or CeFi). Until DeFi becomes more straightforward and easily accessible, we are unlikely to see adoption at scale.  


8.       Scammers and hackers are a huge problem.

While theoretically, crypto assets are hard to steal because each transaction is recorded on blockchain, in reality, fraud is rampant. Since the start of 2021, consumers in the US have reported over $1 billion lost to scams. The main culprits are fraudulent "get rich quick" investment schemes advertised on social media that prey on those who may be tech-naïve and think crypto is safe due to readily available CeFi platforms and crypto ATMs. What’s more, hackers are always looking to exploit vulnerabilities in crypto networks. Because there are no intermediaries, once crypto assets are gone, they’re gone for good. Regulators still aren’t sure how to respond. 


9.       Everything is or can be a token.

For some, the most interesting elements of crypto lie not in cryptocurrencies but the tokenisation of assets. Using DLTs, such as blockchain, it is now possible to convert data into tradable assets. This has found application in the climate change space, with the tokenisation of carbon credits. Renewable sources of energy could also potentially be certified via DLTs. Compared with the use of green bonds today, which are often burdened by bureaucracy, these innovative use cases show promise.


While the crypto market continues to evolve, regulators are showing signs of moving quickly to tackle the most pressing areas of systemic risk without punishing experimentation with the underlying technology. Despite the "crypto winter", crypto is here to stay – and, with it, comes a new set of questions for policymakers around the globe to tackle if they are to harness the power and potential of this constantly evolving area of technology.

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