Crypto-assets Contents

1The crypto-asset landscape

Definition and terminology

4.The Committee’s inquiry examined the growing phenomenon of cryptocurrencies. Like traditional currencies, cryptocurrencies are intended to function as a means of payment for goods and services. They differ from traditional currencies in that they are not issued by central banks, and in that they can be transferred electronically between users without the involvement of intermediaries (i.e. private banks) or the oversight of a central authority (i.e. a central bank). Instead, holdings of cryptocurrency are typically stored on a publicly-visible, decentralised electronic ledger (known as blockchain), and transactions (changes to the ledger) are verified through consensus among users.1

5.However, despite the widespread use of the term, the Committee heard that there are no “cryptocurrencies” that perform the functions that are generally understood to define the term “currency”. Martin Etheridge, Head of Note Operations at the Bank of England, told the Committee that:

They [so-called cryptocurrencies] are not acting as a medium of exchange; they are not particularly good as a store of value, given the volatility; and they are certainly not being used as a unit of account. Although about 500 independent shops might say they accept bitcoin, you do not see many people pricing or receiving their wages in Bitcoin.2

Mr Etheridge said that the term “crypto-assets” was therefore more accurate. Izabella Kaminska, Editor at The Financial Times Alphaville, agreed with Mr Etheridge, adding that:

In the current environment, it looks like [cryptocurrencies] are mostly being used for speculation and as vehicles for potentially relatively quick gains or losses. They are definitely [on] the asset side.3

6.For the purposes of this report, the term ‘crypto-assets’ will be used in place of ‘crypto-currencies’.

7.As noted above, an electronic ledger underpins the transactions of crypto-assets. This ledger is known as blockchain. Blockchain is a means of storing data and crypto-assets use blockchain to record and verify transactions. A blockchain can be managed centrally or it can be decentralised.

8.Some refer to blockchain as ‘distributed ledger technology (DLT)’. These terms and definitions are fluid. However, for the purposes of this report, DLT is a decentralised and distributed ledger that is shared amongst its users.

Emergence of crypto-assets and the current crypto-asset landscape

9.In written evidence to the Committee, Izabella Kaminska, and Martin Walker, a Director at the Centre for Evidence-Based Management, explained that the “origins […] and the enthusiasm” for crypto assets and blockchain came from a paper published in October 2008 under the pseudonym Satoshi Nakamoto, entitled “Bitcoin: A Peer-to-Peer Electronic Cash System”.4 Ms Kaminska and Mr Walker wrote that “the objective of the paper was to create a peer-to-peer payments system i.e. a system that did not involve the current financial sector, much like the use of physical cash.”5 The currency proposed in the paper—Bitcoin—”took the basic concept of a private currency but decentralised the processing and storage of transactions, [and] the creation of the currency.”6 Ms Kaminska and Mr Walker note that private currencies—whether decentralised or not—“are not generally considered of any value and the creator of the currency would generally find […] problems in having them accepted as having value”.7 They went on to describe how Bitcoin came to have more widespread acceptability and value:

For the first two years of its existence, Bitcoin faced all the problems of acceptability for a private currency. Enthusiasts creating and accepting Bitcoins for any commercial venture faced the problems that they needed to cover their costs in conventional currencies. […] 2011–13 saw the formation of the closest thing to a crypto-economy, where websites such as Silk Road,8 made Bitcoin the currency of choice for criminals that wanted to buy and sell drugs, guns, stolen credit card details etc. online, as well as for the illicit gambling industry. This period also saw Bitcoin come to the attention of the press and alternative/libertarian groups such as WikiLeaks and the Electronic Frontier Foundation.

The use for Bitcoin in criminal enterprises and greater publicity fed the first spectacular price rises that brought the attention of cryptocurrencies as a form of speculation. […] Subsequent price rises were related to speculation driven by views on the future utility of Bitcoin and technologies […]9

10.The development of the crypto-asset market is emphasised by the rise of its market capitalisation. As shown in the chart below, in January 2017, the market capitalisation was $17 billion and grew significantly from July 2017 onwards, reaching a peak in January 2018 at $830 billion. Following the peak, market capitalisation has fallen and fluctuated. As of end August 2018, the total market capitalisation of the crypto-asset market was $191 billion.10

Source: CoinMarketCap.11 This chart was adapted from data from CoinMarketCap, a website that tracks the market capitalisation of crypto-assets.

11.Despite the rise in the value of crypto-assets, their overall market capitalisation remains small. The Bank of England’s written submission stated that:

The total stock of crypto-assets is small relative to the global financial system. Even at their recent peak, the combined global market capitalisation of crypto-assets was less than 0.3 per cent of global financial assets […] [and] the total value of crypto-assets worldwide was less than 1 per cent of global GDP, at $830 billion […] by comparison, at the peak of the dot-com bubble in March 2000, the combined market capitalisation of US technology stocks was close to a third of world GDP. […] Prior to the global financial crisis, the notional value of credit default swaps was 100 per cent of world GDP.12

12.A characteristic of crypto-assets to date has been considerable volatility in their prices. Ms Kaminska and Mr Walker argued that “the main drivers of the value of crypto-[assets] (particularly Bitcoin) [are] seen to be based on the facilitation of criminal activity, speculation and a strong probability of systematic market manipulation.”13 These issues will be explored later in the report.

13.Functioning currencies are generally understood to serve as a store of value, a medium of exchange and a unit of account. As yet, there are no so-called “cryptocurrencies” that serve all these functions. Well-functioning cryptocurrencies currently exist only as a theoretical concept, and the term “crypto-assets” is more helpful and meaningful in describing Bitcoin, and the many hundreds of other ‘altcoins’ that have emerged over the past decade.

1 Most digital currencies are ‘cryptocurrencies’, in that they seek consensus through means of techniques from the field of cryptography

2 Q168

3 Q97

4 Izabella Kaminska and Martin Walker (DGC0034)

5 Izabella Kaminska and Martin Walker (DGC0034)

6 Izabella Kaminska and Martin Walker (DGC0034)

7 Izabella Kaminska and Martin Walker (DGC0034)

8 An online black market operating on the ‘dark web’, used for buying and selling illegal goods and services.

9 Izabella Kaminska and Martin Walker (DGC0034)

12 Bank of England (DGC0055) para 12

13 Izabella Kaminska and Martin Walker (DGC0034)

Published: 19 September 2018