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Understanding Cryptocurrencies and Blockchains

Understanding-Cryptocurrencies-and-Blockchains
Cryptocurrencies and blockchains are misunderstood phenomena and this miscomprehension is perpetuated by most media.
A typical example is the Technology Quarterly of The Economist dedicated to the subject1. It replicates the familiar clichés: “blockchains are databases” and “cryptocurrencies are money”. The latter preconception is invariably enforced by the repetitive use of Bitcoin as the arch-example of both cryptocurrencies and blockchains. Critiques have become unsophisticated mantras; blockchains are unsecure, slow and power-hungry; and cryptocurrencies are volatile, difficult to use and complicated to invest in.

But, as always, these matters are much more complicated and ask for a more subtle explanation. This is admittedly not an easy task for journalists, as in the absence of a clear regulatory framework such a clarification requires a wide understanding of information technology, management techniques and finance. Furthermore, the notorious inability of techies to communicate in conversational language does not contribute to the resolution of this conundrum, to the detriment of the development of the technology they try to promote.

This little article is a first attempt to bridge this communication gap by attempting to clarify two assertions: “blockchains are NOT (only) databases” and “cryptocurrencies are NOT (fiat) money”.

Blockchains are NOT (only) databases

Databases2 are organized3 collections of data. Database management systems (DBMS) can then be unleashed on a whole collection in order to retrieve parts of the data and organise them in a particular manner. Such queries are algorithms4 formulated in special computer idioms such as Structured Query Language, or SQL in short.
Blockchains are sequential repositories of data concerning transactions. These data are not organised primarily to be retrieved, but to allow for a consensual agreement about their content. Blockchains take the form of a ledger, the structure and of which is governed by a protocol5, which could be understood as a “fixed or conventional algorithm”.

Databases are revocable universes, no consensus is needed to revert to an earlier version of the dataset. Blockchains are – in principle – irrevocable universes, only a consensus can allow the clock to be set back.
It is unfair to compare database management systems (DBMS) to blockchains and to accuse the latter ones to be relatively slow and power-hungry. Blockchains are not designed for the same purposes as databases. Databases cannot eliminate the risk of data manipulation as blockchains can, so the allegation that they would be unsecure is quite pointless.

Many technical flaws still plague this infant technology and this will remain so in the future, but solutions will be found. Finding a scalable and flexible trade-off between speed, energy consumption, security and ease of use will certainly be the major technological challenge of the years to come.

Media easily accuse blockchains of under-delivering on the promises of the technology after ten years of operation, comparing them to “Internet’s” explosive development during it’s first ten years. What this type of statements shows is either ignorance6, or the hand of entrenched dark powers that feel threatened by the disruptive nature of blockchain technology.

Cryptocurrencies are NOT (fiat) money

“Fiat” currency or “money by decree” has the primordial purpose of being a universal medium of exchange. The idea is that any type of good or service should be paid for in government currency, including, capital goods, financial and intangible assets, …

Usually fiat currency is emitted via a central bank and its supply is supposed to be centrally controlled throughout the banking system.

These characteristics do not apply to cryptocurrency tokens. They provide access to specific processes, such as, transfer of value (Bitcoin), blockchain platforms (Ether), predictive markets (Stox, Augur), … If one does not hold the specific tokens needed to access specific processes, one needs to acquire them via exchanges.
In general, cryptocurrency tokens are not centrally emitted but earned as a reward for maintaining a specific blockchain (“mining”) and processing its transactions.

This fundamentally novel mode of value creation leads to regulatory confusion. Most regulators take a passive stance and try to assimilate the different types of tokens with existing types of assets (a one-way comparison between “objects”). But there is no consensus. The Financial Conduct Authority (FCA) recognises three instances of digital currencies: “as a means of exchanging value, … digital currencies in the context of ICOs. Here we add a third: digital currencies as an underlying or referenced asset.”7 The Securities and Exchange Commission (SEC), distinguished between utility tokens (lightly regulated) and security tokens (fully regulated). The SEC considers Bitcoin to be a utility token, whereas the Commodity Futures Trading Commission (CFTC) has designated bitcoin as being a commodity. This raises the juridical question whether a utility token is a commodity.

Crypto-enthousiasts on the other hand, tend to simplify the concept of money by identifying it to fiat currency and by omitting that money itself is a complex concept that covers many kinds of assets, cash, e-cash, deposits, bills, tokens and other IOUs of various types.

To make the mess complete, a misleading mantra is ubiquitously spread: “cryptocurrencies are a new asset class”. Such an assertion presupposes cryptocurrencies to be a group of “objects” that can simply be included into the current categorisation of assets. I am afraid this is probably an impossible task. Firstly, “cryptocurrencies” is an umbrella concept covering a very diverse group of digital entities, some of which are arguably not “assets”. Secondly, in order to achieve homogeneous regulation, the whole universe of assets would need to be reconsidered from a processual point of view. This means that the characteristics of other asset classes would have to be considered in a two-way comparison (objective / process) with crypto assets. This is a gigantic enterprise which regulating authorities will probably not engage into unless the crypto-token market capitalisation volume would significantly grow.

The reverse is the case at the moment of writing8, so we will probably have to wait for a significant re-organisation of asset classification in accordance with their underlying activity and process. What we however can be sure of at this point in time however, is that cryptocurrencies are not fiat money, and that blockchains are not only databases.

By Christophe J. J. de Landtsheer


1 The Economist, September 1st 2018
2 Theoretically ANY collection of data is a database. But the media usually refer to them in the more conventional sense explained here.
3 Usually by differing data-types and location in tables.
4 The description of a step-by-step procedure to accomplish a predetermined end.
5 A set of rules governing the treatment and formatting of data in an electronic communications system.
6 These journalists usually refer to the World Wide Web as being “the Internet” ignoring the fact the the latter predated the former by at least two decades.
7 Financial Conduct Authority. “Distributed Ledger Technology: Feedback Statement on Discussion Paper 17/03” (accessed 23 October 2018) https://www.fca.org.uk/publication/feedback/fs17-04.pdf
8 Cryptocurrency Market Capitalisation accessed on 20 November 2018: $170,980,490,089 (source: https://coinmarketcap.com/charts/)

Copyright © 2018 by Christophe J. J. de Landtsheer. All rights reserved. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the author.

Understanding Cryptocurrencies and Blockchains was last modified: January 4th, 2019 by MIUC
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