Crypto - The red pill or the blue pill

Welcome to back dear listeners to Bitesize Payments. Today, we delve into the world of cryptocurrencies. They are digital natives in a payments world that is mostly analogue, the technology behind them is genuinely impressive however they introduce new paradigms which to some cause’s issues.

Like many tools in the payment sphere, it’s not the tool per se that is the issue but, in its application, what its used for. For some, it represents an escape from societal or governmental oversight for some it’s just plan daft. So, a bit like Neo in the Matrix, are you ready to take the red pill or the blue pill? 

I'm not Morpheus, and I won't dive into conspiracy theories or philosophical debates, however hopefully I will guide you through their history, how they work and of course who does what.

So, shall we follow the white rabbit….

Payments Industry Insights

History of Payments

Payment System Explained

Corporate Payments Strategy

Payment Regulations Impact

ISO20022 Standard

Digital Payments Evolution

CBDC Advancements

Cryptocurrency in Payments

Financial Technology Education

Transcript

SPEAKER_00: 0:01

Welcome back dear listeners to Bite Size Payments. Today we're going to delve in the sometimes murky, crazy world of cryptocurrencies. However, they're digital natives in the payments world that frankly is mostly analog. The technology behind them, blockchain, is genuinely impressive. However, they introduced new paradigms, which as ever causes some issues. Like many tools in the payment sphere, it's not the tool per se that is the issue, but its application and what it's used for. For some, it represents an escape from society, governmental oversight, and for some, frankly, it's just plain daft. So a bit like Neo in the Matrix. Are you ready to take the blue pill or the red pill? I'm not Morpheus, and I won't dive into conspiracy theories or philosophical debates. Hopefully, however, I will guide you through their history. how they work and of course who does what. Okay, shall we follow the white rabbit? So recently, I've been listening to a history of rock music in 500 Songs, a podcast by Andrew Hickey, which I guess shows my age somewhat. But nevertheless, and by the way, it's a really great podcast. One of the things that Andrew says a lot is that there really isn't a first of anything in music, and that's rather like payments. The Knights Templar, for instance, introduced the form of tokenized payments, an early alternative to the then traditional methods that we discussed in earlier episodes. And while their system was actually based on trust and cryptocurrencies operate in a trust-less environment, the concept is quite similar. We could, of course, also refer back to shells, Cowie shells and beads that we talked about in the first episode. Or we could even look at Linden dollars from Second Life. I guess she's forgotten a little bit about Second Life. But again, they're tokenized forms of currency. But my point here is there really isn't a first of anything. Anyway, let's jump forward to 2009 when the first cryptocurrency, Bitcoin, was created by an anonymous person or group. of people under the name of Sakutoshi Nakamoto. Probably pronounced that really badly. I do apologize. Bitcoin is by far and away the most important crypto out there, but there are lots and lots, and I really mean lots and lots. As of August 2023, there were over 22,900 cryptocurrencies listed on CoinMarketCap. However, it is important to note that not all of these cryptocurrencies are either active or even valuable. Some of the cryptocurrencies have been abandoned and are no longer supported, while others are scams. Estimates vary, but about 80% are in fact scams. Either way, that's an awful lot of cryptocurrencies, some 4,000 plus. Total estimates of the value is about 1.2 trillion US dollars. Now, to put that into context, there are about, well, there are currently 186 fiat currencies in the world with approximately some 100 trillion US dollars in circulation. So that's not quite the same light for light, but it does give you a view of the scale here. The top cryptocurrencies make up 90% of the total cryptocurrency versus the top 100%. 10 fiat currencies, the dollar, et cetera, which make up 99.5% of the total reserves. So frankly, both are pretty concentrated. So how in fact do these markets work? And how does crypto work? Well, imagine acquiring a third party cryptocurrency using your dollars. I'll elaborate on the key players soon. With this cryptocurrency, you can make purchases globally sidestepping conventional fiat currencies like the dollar or the euro and of course the governments and regulators that regulate how those processes work. Should you or the merchant want to convert these now digital assets back to fiat currencies, you can exchange them of course for dollars or euros etc. You can or clearly retain your cryptocurrency, hoping that its value climbs, or of course employ it for a purchase or a transaction, whatever. Whenever you choose to liquidate your cryptocurrency holding, you can trade them back to fiat currencies like the dollar, etc. Now, cryptocurrency prices are driven by supply and demand. When a particular currency witnesses a surge in demand versus its supply, its price elevates. Conversely, when its supply surpasses its demand, its price drops. We'll delve into the transaction fees later. In my view, and to be fair, in many regulators' views, cryptocurrencies for this reason resemble more of an asset type behavior than a traditional currency. A significant consideration then is when you're crystallizing your holding, specifically the exchange rate you secured and when buying is a big issue. So, you know, for instance, if you're trying to exchange your Bitcoin to dollars and the cryptocurrency has fluctuated in the wrong direction, you will lose out your asset if actually buying. are worth less than you purchased them for. Now, of course, that can happen exactly the other way around. And for some, cryptocurrencies, therefore, are just investment opportunities. Many have profited while others have, frankly, lost everything. The potential to bypass controls and, of course, specifically to evade tax systems, combined with the notable market downturns and, in some cases, crashes, has garnered an awful lot of governmental scrutiny. Some nations like China and India have in fact prohibited them altogether, while countries like Canada and Turkey have set very strict regulations around them. On the other hand, places like Australia and the US have a more lenient perspective. It's clear that the regulatory stance on crypto is not stable yet and probably will remain for a while in flux. The crypto market operates in a decentralized, free from direct government or institutional oversight, if you will. This characteristic renders it more volatile than a traditional market, yet also offers investors more autonomy. That's either extraordinarily cool or very scary, depending on your point of view. So while my discussion primarily revolves around cryptocurrencies from a general perspective, it is worth noting that we can discuss payments from a retail point of view, everyday consumers like you and I, and we could also address it from a wholesale perspective. Although the underlying concepts remain the same, their utilization on trading floors... offer different advantages. Being digital natives, they can simplify the implementation, say, of smart contracts and other advanced features. So while there is no great difference underneath it all, the use cases as ever differ. Anyway, let's dive into more about the way they work and who the actors are. Now, given this is a different model, there are different actors here. There are the cryptocurrencies themselves, Bitcoin, the pioneer of the crypto world. It acts as a store of value, medium of exchange, and of course, a unit of account. Ethereum, the second largest cryptocurrency, is a platform that allows the creation and execution of smart contracts, a big plus on the trading floor, as I mentioned. It powers applications like decentralized finance, so-called DeFi, non-fungible tokens, NFTs, and gaming. This is almost the grown-up version of crypto, if you will. Tether is a stable coin pegged to the US dollar, and I will talk more about them later on. But they're the big three. Now, crypto miners. These are a little like high street banks. They effectively do the processing. Miners verify and secure the individual transactions on blockchains. Miners are verifying and securing the individual transactions on blockchains. They utilize powerful computers to do so and in return they are paid in cryptocurrency. Maintaining the blockchain's integrity and ensuring all the transactions are properly recorded and verified is a key asset of crypto. Examples of notable mining companies include Marathon Digital Holdings, Riot Blockchain, and Hut& Mining. Now, there's also currency exchanges. These are effectively the on and off ramps of platforms that enable the buying and selling of cryptocurrencies. Major exchanges by trading volumes include Beyonce, Coinbase Exchange, and FTX. Cryptocurrency exchanges also charge fees, typically in the range of 0.01% to 0.05% of the transaction amount. Now, we also need wallets, and wallet providers offer software solutions for storing cryptocurrencies. Wallets can be used to hold the currency for investment purposes or, of course, to buy things, including some really big merchants, including Microsoft and AT&T. And of course, wallet providers also charge fees, typically 0.2% to approximately 0.75% per TRAN. Examples of wallet providers, and there are several of them, include Coinbase Wallet, Exodus and Trust Wallet. Overall, the average Bitcoin transaction fee is currently around$3 per TRAN. However, and it is a big however, During periods of high congestion, Bitcoin transaction fees can reach literally hundreds of dollars per transaction. So let's try and approach cryptocurrencies from a different perspective, a different narrative, if you will. Imagine I introduce Polcoin. a new digital currency powered by the most advanced technology. To paraphrase Blackadder, the whizziest tech that ever was whizzy on a particular whizzy day, underpinning my pull coin. At its inception, I decided in my ICO, my initial coin offering, much like an IPO, one pull coin, a PC, is worth$2. People buy into the idea, storing PCs in their digital wallets. As its popularity grows, the value of PCs rise, reaching$4, and eventually soar up to the dizzy heights of$20. From an investment point of view, this is absolutely fantastic growth. Now, for transactions, if somebody is willing to exchange a coffee for, say, 0.025 of a pull coin, then in that world, Paul coins function very similar to fiat money. This transactional nature is very reminiscent of the bartering system that we previously discussed in episode one, I think. Now, as long as a seller recognizes the value of Paul coins, I can make purchases, even international ones. Here, we can identify two different primary use case for Paul coins. as an investment, hoping the value goes up, as a medium of exchange for goods and services. But let's consider a scenario where people suddenly realize, for whatever reason, that my coins, these pull coins, are in essence just a digital entry in a virtual ledger. What if they deem pull coins to be worthless? What if they deem that pull coins aren't as interesting or as valuable as they used to be. Now, if that sentiment spreads, the value will probably plummet, and potentially erasing all the investment that I've made of these coins. Now, you could argue, and you'd be right to argue, that traditional currencies have faced similar crises, with runs on currencies throughout history, and you'd be right. However, On, for instance, UK banknote, there is a statement, I promise to pay the bearer. This means that the note is worth its face value. And while modern money isn't backed by a tangible asset like gold, as we discussed a few weeks ago, the government guarantees its value. Now, this assurance is what effectively differentiates fiat money from cryptocurrencies. That guarantee, however, comes with strings attached. government oversight, regulation, and of course, controls. And of course, this brings us to the pivotal choice. Do we want to be inside of the security of the government-backed currency or the freedom, autonomy, and the anonymous nature and potentially the risks of cryptocurrencies? In other words, do you want the blue pill or do you want the red pill? There's a couple of things I want to discuss here because they seem at times incongruous. Which is really, how can these transactions be both so transparent and yet anonymous? Well, it's kind of a function of blockchain. Every transaction on a blockchain is recorded in a public ledger, accessible to anyone. This ledger offers a comprehensive history of all the transactions on that blockchain, ensuring transparency and preventing double spending, which is a fantastic asset of blockchain. Everyone can verify that a transaction has occurred and that the coin hasn't been used more than once. Now, so far so good. However, instead of Displaying a real name, transactions display digital addresses. For instance, when using Bitcoin, a transaction won't read, Paul Tamala sent one Bitcoin. Instead, it will show an alphanumeric string, which isn't directly linked to the user's real world identity. This makes the transaction pseudo-anonymous. Though each transaction is transparently recorded, the real world identity of the individual behind these digital addresses remains concealed. So they're both transparent and yet can be anonymous too. Early on in the podcast, I talked about Tether, a stable coin. So what are stable coins? Effectively, stable coins have a design principle that they have a consistent value in relation to a fiat currency, typically the dollar. This design allows them to have all the benefits of cryptocurrencies, being a digital native and all those good things, but they have the stability of being pegged to the dollar. And it's this balance that brings all the technology benefits and yet stability that means the stablecoins are really, really worth watching, keeping an eye on. One of the issues here, I guess, is it's a bit like electric cars. Some people go, yeah, I really want an electric car, electric car. I really want an electric car. It's very cool. It's where the technology is going, all that good stuff. And yet I want the real world example of having a hybrid. To some, that's complete Marmite. To others, it's just a sensible choice. We shall see. Well, there you go. Cryptocurrencies. Cryptocurrencies are... relatively new and for some extraordinarily controversial, especially from the perspective of a sovereign nation trying to protect its status quo in the hierarchy of the way that currencies and payments work. It's also true to say that that perspective also is what drives a lot of people to cryptocurrencies and the fact that they can circumvent these controls. Their association, however, with the dark web and the potential for misuse further complicates all of that narrative. Least we forget, though, the technology that they're based upon is truly innovative and allows us to bring a whole new set of financial paradigms to the market. And I think it really has prompted governments of the world to accelerate the development of CBDCs, central bank digital currencies, as a safer way of introducing digital technologies. Now, we're going to delve into CBDCs in an upcoming episode very soon. But when all is said and done, it might just come down to, you know, do you want to keep with the red pill or do you want to take the blue pill? Either way, whether you take the blue pill or the red pill, I'd still be grateful if you could tell a friend if you enjoyed the podcast. And if you have any questions, please don't forget you can email me at bytesetspayments at gmail.com. Cheers.