Insights

Capital Quarter Winter 2020: Where are cryptocurrencies heading

Blockchain technology and Bitcoin have been with us for more than 10 years. Yet they are still viewed with caution in many quarters. But could the tide be turning for the cryptocurrency market? Here’s our industry update.

The value of Bitcoin has soared to near record levels over the last month, led by growing institutional interest and PayPal’s recent decision to allow its customers to buy and sell certain cryptocurrencies.

PayPal announced in October that customers could hold Bitcoin and other virtual coins in its online wallet and shop using cryptocurrencies at the 26 million merchants on its network.

This move could potentially help Bitcoin and rival cryptocurrencies gain wider adoption as viable payment methods. But will this change the definition of cryptocurrencies? For this we must look at how we define ‘money’ itself. The definition of money says that it must fulfil three main functions as: a medium of exchange, a store of value, and a unit of account. How do cryptocurrencies such as Bitcoin fare against these criteria?
 

An appropriate medium of exchange?

A medium of exchange is a payment mechanism used to pay someone for something, or to extinguish a debt or financial obligation. An appropriate medium of exchange must be widely accepted in the context in which it is being used. Although Bitcoin, for example, is certainly accepted within its community, this is not yet the case globally. But PayPal’s recent announcement could trigger a change of behaviour in the general population.
 

Store of value: too volatile?

Store of value means that your money will be worth almost the same amount in a year’s time, for example, as it is today. Even though Bitcoin as an investment has performed incredibly well since its introduction in 2009, would the average person move all their savings into this asset? Given its highly volatile price, the answer is probably ‘No’.

But since Bitcoin halved in value in May this year, values have been more stable, ignoring the recent price increase linked to the PayPal decision. Following current protocols, the number of bitcoins created will decrease over time until it reaches the present capped amount of 21 million. Many believe that as the generation of bitcoins reduces over time, the price will become more stable and Bitcoin may meet the ‘store of value’ definition.
 

Unit of account: too soon?

A unit of account is used to compare the value of two items, or to count up the total value of your assets. To be an effective unit of account, the money must have a well-accepted or understood price against assets. Otherwise it’s hard to figure out the total value across all your assets. Right now it could be argued that Bitcoin fails heavily as a unit of account, due to both its price volatility and the fact that hardly any merchants are willing to price items in Bitcoin.
While banks have been slow to adopt blockchain, innovators in the payments industry have quickly recognised the value of the technology.

Not yet money

While arguably there may be a gradual shift in the perception of cryptocurrencies, there is not yet enough substance for us to classify it as ‘money’. Until PayPal’s announcement, spending bitcoins online was largely restricted to selling through an exchange for fiat money. So it does represent a significant step in the evolution of cryptocurrencies and how they are viewed by the wider world.
 

Developments in blockchain technology

Blockchain has evolved markedly since its launch with Bitcoin, and is now seen to be a pioneering technology capable of providing services and applications for a wide scope of activities. These include payments, cyber security and charitable donations. We explain below how blockchain has developed into some of these new areas.

The future of payments

While banks have been slow to adopt blockchain, innovators in the payments industry have quickly recognised the value of the technology. Many financial institutions have been able to offer easy, trackable and secure payments for years. Now the large high street banks are beginning to explore the technology’s potential too. For example, Mitsubishi UFJ Financial Group, one of the largest banking institutions in Japan, is expected to launch its high speed blockchain payments network in 2021. Blockchain has clear advantages for the financial sector, and the technology’s application continues to grow in this industry. But for banks it still remains a largely untouched area so its full capabilities are yet to be seen.

Tighter cyber security

When it comes to cyber security, blockchain is one of the best solutions to ensure the integrity of sensitive data. Blockchain encrypts its data and creates a log of persons who accessed and modified it. This means that it’s really difficult to access, steal, or alter information without instant detection. Indeed many experts claim it’s impossible to tamper with data stored on the blockchain.

Blockchain resolves the ‘lack of trust’ problem between counterparties at a very basic level. It’s a distributed database used for both private and public applications rather than a centralised structure where all the information is stored in few, but very large, databases. The data pertaining to each batch of valid transactions is stored within its own block. Every block is connected to a previous block and the chain grows continuously as new blocks of information are added. Blockchains provide no ‘hackable’ entrance or central point of failure. So they provide more security than many current database-driven transactional structures.

Blockchain technology eliminates the human factor from authentication. There is decentralised storage, every transaction is traceable and, crucially, blockchain transactions can be easily denied in the event of any DDoS attack. Over 50 per cent of the nodes would have to work collectively for any invalid transactions to pass through.

A boost for charities?

Scandals in the charity sector have damaged the public perception and trust in lesser known charitable organisations. There have been growing concerns about where donations really end up and, as a result, fewer are being received. Coinciding with inefficient and underfunded administration and increased regulation, the drop in donations means charities are struggling. But how could blockchain help?

Blockchain technology will allow donors to confirm they have contributed funds to a real charity. The mysterious route of donated money could be tracked through the blockchain, so restoring lost credibility in the sector. Blockchain will allow full transparency by sharing financial information in real time. 

Written by Nick Joel in our London office.