How Will Bitcoin Impact Banks and Finance Structures?

How Will Bitcoin Impact Banks and Finance Structures?What is finance, and how does cryptocurrency fit in to our current understanding of itAt the start of the unit, one of the first concepts we were asked to consider was a stage that is highly contended a philosophical question which has never borne more signifi ejectce than it does today, with the recent emergence and explosive harvest-tide of cryptocurrencies. We were asked to consider what finance was, and how it fit into society. flat it would be prudent to ask what finance is, and how cryptocurrencies fit in to our current understanding of it. Let me start to answer this with a brief description of fiat currencies, or legal tenders, with no material protect or value redeemable for commodities.Historically, the value of anations currency was pegged against a trade good with well-established value,such as gold or silver. This was the case for the majority of currencies upuntil 1971, when Richard Nixon decoupled the US dolla r from gold. Supply anddemand determines the value of fiat currency. Governments can instruction how muchis in circulation and control the value of notes as well as inflation. One ofthe biggest downfalls of cryptocurrency according to its critics, is theinability of more keepsakes to enter circulation when demand is high. The hitamount of Bitcoin, is limited by a digital production process analogous toprecious metal mining, which can stop its value from beingness decay by systematicover-production and debasement as has been the case with numerous fiatcurrencies historically.18 Thisinability to react to demand causes sharp volatility in the value ofcryptocurrency, qualification them unreliable stores of value. This has been mostevident with the steep spikes in Bitcoin value since the beginning of the year. Conversely,as fiat currencies be not linked to physical reserves, they risk becomeworthless due tohyperinflation. If mountain lose faith in a nations papercurrency, the specie ordain no longer hold value. Fiat bills serves as a good currency if it can handle the roles that aneconomy needs of its monetary unit storing value, providing a numericalaccount and facilitating exchange. Because fiat money is not a scarce or fixedresource like gold, central banks gift much greater control over its issue,which gives them the power to vie economical variables such as credit supply,liquidity, interest rates and money velocity. Cryptocurrencies on the early(a) hand do not serve as a currency for one triggericular nation, and ar not controlled by any government body either.Instead they employ what is k straightn as blockchain technology, which is a play ofdigital ledger that is maintained by all the users of the network. An on-goingrecord of all transactions is kept and added to, all(prenominal) time a new transactionoccurs. scorn this however there is an inherently high level of anonymity,given that bitcoin, tezos etc. addresses are not linked direct ly to any personor entity. This overly gives way to several problems for governments which areunable to control inflation or the amount of cryptocurrency in circulation,declaration of earnings and tax, prohibition of trading illegal goods and moneylaundering. There are several safe-guards in place to ensure against double-spendingand other fraudulent activities however which are built in to the blockchaintechnology. Further, as a bequeath of this peer-to-peer network in whichcryptocurrencies operate, there is no single point of blend inure, making it verydifficult for the system to collapse.17What potential effects will the use of cryptocurrency and decentralize of currency have, particularly on banks?The total value of allcryptocurrency in circulation is now$200 billion USD3. Eventhough this is almost double the value it was in July, it is still trumped bythe value of paper USD issued by the U.S. Federal Reserve, which alone amountsto about $1.4 trillion. We are therefore nowher e near the point yet wherecryptocurrencies pose a credible threat of supplanting central-bank-issuedmoney. Nonetheless it is worth thinking through some of the implications ifsomething like Bitcoin (which has about a 45% securities industry share of allcryptocurrencies) were to wholly or even partially supplant central bank fiatcurrency. The agreed protocols that govern Bitcoin, Tezos and other cryptocurrencies, are efficaciously their monetary policy. In exchange for mining blocks of bitcoins and consuming computing power to verify the legitimacy of transactions, Bitcoin miners get paid in Bitcoin. These rewards increase the supply of Bitcoin, though the increase in Bitcoin money supply is inhibited by the increasing difficulty of verifying transactions. Increasing computational power is required to verify each transaction and mine new blocks to create new Bitcoins, meaning that the total supply of coins is gradually approaching the limit of 21 million coins (currently there ar e 16.5 million in circulation).Fiat money has its ownprotocols that stabilise inflation using interest rates and bond-buying, and themoney supply that results from this is generally ignored. With cryptocurrencieshowever, money supply does not respond to shifts in money demand and with arelatively fixed supply, large fluctuations in value and determines result (in thepreceding 11 months the price of bitcoin has soared almost 8 fold5).This some argue, is specializedally the reason Bitcoin and other cryptocurrencies willnot take over2 and makes Bitcoin impractical as a money. Cryptocurrencieshowever have proven to be a useful alternative to traditional reservecurrencies in places with poor monetary policy and weak banks. In Kenya forexample, 1 in 3 people own a bitcoin wallet1, while in India, whererecently there has been a significant shortage in cash supply, greater numbersof people have converted to the use of bitcoin.4If a particular country wereto adopt Bitcoin to replace its cu rrency, the effects of doing so would likelybe felt by others in a knock-on effect. A larger credit cycle in one country wouldmean larger booms and busts for its trading partners. Foreigners outside thecountry that adopted the cryptocurrency, may also opt to deposit directlywithin that country and desert their own countrys banks in doing so thiscould affect the flow of swell into and out of a their home country, furtheramplifying the credit cycle. The latest difficulties with Bitcoin make theprospect of a crypto currency takeover jutm fanciful at the moment, however ifsolutions to these problems were found or a new currency were devised withbetter protocols, central banks would have to resolve these dilemmas one way oranother. Financial history what can we learn from historical breathes and is it reasonable to foresee the current growth as sustainable?Aneconomicor summation bubble,is trade inanassetat a price or price range that strongly exceeds theassetsintrinsic value.It co uld also be described as a situation inwhich asset prices appear to be based on implausible or inconsistent viewsabout the future19. The general consensus among industry professionals, is that the currentcryptocurrency market is in an unsustainable phase of bubble growth6,7.There were 30 ICOs each launching new cryptocurrencies in July, thenmore than 50 in August. Part of this mania is based on speculation. and itsalso pretend that there has been departure from a fundamental assumption of whata cryptocurrency originally was a scarce digital commodity where the valuederived from its scarcity. To be frank, if more than one hundred new sources ofthis digital commodity have been launched since June, then the concept ofscarcity, and therefore the supposed inherent value, begins to erode. In fact,many of these newer cryptocurrencies will need to fail in shape to maintain thevalue and viability of the most widely used currencies, bitcoin and ether.These look to remain viable over the i ntermediate and maybe long-term, thoughnot necessarily at the current prices. History has shown us that the majorityof cryptocurrencies fail dismally at some point soon later their conception16.Only a select handful have shown consistent growth over the last few years. Bitcoinitself has crashed significantly several times. Even so, though the pithblockchain technology left behind others, will provide value as a hiddeninfrastructure underlying future applications.Though bitcoin has seenastronomical growth over the last year one of the major problems in its use isthe extreme volatility in its value. On April 8th 2013 for example,Bitcoin was valued at $215 USD, cardinal days later this figure dropped to $63 USDthen seven months after this its price soared to $1,200 USD. This volatility wasin hindsight partly a consequence of strong conceptional demand from buyers fora new and unknown technology. There arehowever, more fundamental problems that cause the value of Bitcoin tofluctuat e. The algorithm that controls supply prevents the amount of Bitcoinfrom expanding to meet increases in demand. This inelasticity in supply leadsto price variations and also encourages speculation and excessive volatility,all of which render it unreliable as a store of value.7The cryptocurrency market is new and being filled with new currenciesalmost daily. As competition develops however and with little history, few canvalue them correctly, forecast which currencies will succeed, and whether they areall part of a larger bubble that will eventually burst. History has shown however that new financialinstruments are the authors of financial bubbles be they options for tulipbulbs in the 1630s, fiat money in the Mississippi bubble of the 1700s, stock inthe South Sea bubble, leverage in 1929 or collateralised debt instruments inthe credit crunch of 2007, the problem was the humanness was behind the knowledgecurve of the instrument and the power of greed drove the market wild and lastly into collapse.8 It would therefore not beunusual to see a similar crash with cryptocurrencies in the near future.Cryptocurrency regulation How is it possible to regulate an online currency based globally? In short, it isnt. The whole precede of cryptocurrencies is that theyare decentralized and ungoverned by any one government, but rather managed by apeer-to-peer network of users worldwide. The focus has thus shifted to thesoundness and legality of invest in them through means such as ICOs andderivatives markets. In the largely unregulated world off cryptocurrencies, one issue remainsat the new wave of the attention of regulators such as the SEC (in the U.S.)and ASIC (in Australia), and that is in the nature of ICOs, whether they areseeking genuine donations for the development of software, or whether they arein fact shares in a company or other investment, which contributors hope to redeemat a future date for financial benefit an illegal and unregulated questioninginvestment .Initial coin offerings have raised $3.6 billion USDso far this year15 with several currency developers generating vastamount of capital in a affaire of hours with little more than a website and apromise of a revolutionary new product. This unchecked source of crowd-fundinghas been banned by several governments, as other countries regulatory bodies suchas the SEC and ASIC, have developed their own policies regarding theseofferings.On September 4th,China banned investment in ICOs citing breaches of securities laws anddisruption to economic and financial order13, and moved to shutdown cryptocurrency exchanges also.13 In July, the U.S. Securitiesand Exchange Commission required companies to register ICOs in the same fashionas IPOs14. pursuance this ruling on September 29th, theSEC charged two companies with fraud and selling unregistered securities afterrunning successful ICOs that collected more than $300,000 USD14. full-blooded efforts have been made to legitimisecryptocurrency off erings by law firms such as Cooley in New York and otherswith vested interests in making ICOs work. Cooley attests that it has developeda simple treaty for future tokens (SAFT) framework that will allow tokensales to be compliant with US securities laws. This is important given thatseveral major ICOs had excluded US individuals from participating given thethen-standing issues with the SEC. If by lend oneselfing the SAFT framework the SEC issatisfied, then US investors would have access to more ICOs providing a major sourceof capital to them. The basic premise of the Simple Agreement of Future Tokens(SAFT) is that the cryptotoken fail the Howey test, a measure of whether afinancial instrument is in fact a security. In order for tokens to fail thetest and not be considered securities, they must be delivered to investors onlyafter a functioning product or service is in place. The network and the tokenmust be genuinely useful such that they are actually used on afunctional network, ac cording to Cooleys framework. To date ICOs havedelivered tokens to investors before the launch of the underlying currency,meaning that the only real function tokens could have use for would be intrading in secondary markets, blatantly classifying them as securities. In the case of Tezos, investorsbought into the project hoping that the Tezos platform would be builtsuccessfully, and that by owning the tokens, also yet to be created, they wouldbecome stakeholders able to shape the final platform. One particular casehighlights the blatant regulatory arbitrage which is plain for all to see, andwhich the founders of Tezos attempted to disguise by consistently referring to theirICO contributions as non-refundable donations, in order to make ambiguous thenature of the security they were offering. Tim Draper, one of the main venturecapital backers, when asked by Reuters how much he had donated replied Youmean how much I bought? A lot.InAustralia, ASIC released a decisive factsheet on ICOs a nd their position,stipulating that ICOs must be conducted in a manner that promotes investortrust and confidence, and complies with the relevant laws11. ASIChas also warned that the Corporations Act may apply to an ICO depending on therights that attach to the coin from the ICO itself, rights to underlying coinsor rights on tokens used in the ICO. Likewise, ASIC has alsomade it clear that if an ICO is conducted to fund a company, then the rights habituated to the coins issued by the ICO may fall within the definition of ashare. Where it appears that an issuer of an ICO is actually making an offer ofa share, the issuer will need to prepare a course catalog as for any other IPO11,which will allows investors the safeguard to withdraw their investment beforethe shares are issued should there be misleading or deceptive selective information inthe prospectus. Lastly it isworth noting that some ICOs have been described by their initiators as a formof crowd funding. In Australia, ASIC has made a clear distinction between crowdfunding using an ICO and crowd-sourced funding (CSF) that has been regulatedby the Corporations Act since 29th September 201711.Under the new laws, CSF will be a financial service where start-ups and smallbusinesses raise funds, generally from a large number of investors that investsmall amounts of capital. There will be specific rules for conducting CSF withfewer regulatory requirements than ICOs, while maintaining investor protectionmeasures. This is particularly of importance in the case ofTezos, where the developers sought donations to fund the development of theirnetwork, a deliberate misrepresentation which would now be both illegal andarguably unethical in Australia. 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