Crypto assets 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.

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.