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PA OPINION

Should cryptocurrencies play a part in your future?

As someone who dabbled a little in Bitcoin soon after its launch but didn’t hold on to any, I’m probably one of the many people experiencing some pangs of regret at the lost opportunity. At the time of writing, Bitcoin’s value hovers just below US$17,500 following what can only be described as a meteoric rise in recent months.

Although acceptance of cryptocurrencies both within organisations and banking is growing, for many Bitcoin is far from a mainstream technology. Accepting and processing this and other cryptocurrencies is currently the exception rather than the norm. As I contemplate my failure (so far) to become a Bitcoin millionaire, here are some trends I see developing and how they present risks and opportunities.

HOW IT ALL STARTED

Today's cryptocurrencies can trace their origins back to E-Gold, which launched in 1996, and allowed the transfer of value between E-Gold accounts denominated in grams of gold or similar precious metals. E-Gold experienced many issues that cryptocurrencies experience today – hacking, theft, fraud, cybercrime – and was eventually suspended in 2009 due to legal issues.

At the time E-gold allowed transactions as small as one ten-thousandth of a gram of gold, making it the world's only viable micropayment system. What was lacking in E-gold was a blockchain to improve transparency and provide a consensus mechanism for validating transactions. Bitcoin actually achieved this by extending the gold analogy and making Bitcoin a limited resource – only 21 million bitcoins (minus 3 bitcence) can ever exist – and these are ‘discovered’ through ‘mining’ (solving of complex cryptographic problems using brute force computing power). There’s great speculation that the current upward trajectory in Bitcoin’s value is akin to a ‘gold rush’ and that some prospectors may end up being burned when the bubble bursts.

What makes them different to conventional currencies – and how that can be dangerous or powerful

Cryptocurrencies are different from conventional fiat currency however, and it’s these differences that create the opportunities that make them so attractive, while at the same time bringing risks.

THE RISKS

Technical failure

Risk associated with cryptocurrency goes beyond price volatility. Bitcoin is the poster boy for price volatility in cryptocurrency but serious issues have also arisen due to flaws in technical implementation.

The famous Mt Gox hack involved the theft of private wallet keys (then unencrypted). It ultimately led to the loss of US$460 million in cryptocurrency plus a further US$27.4 million from the company's bank accounts. More recently a programming error and the subsequent effort to rectify it by a panicked developer led to the freezing of US$280 million in Ether in affected wallets. Ether is the currency associated with the Ethereum Blockchain.

Ethereum has also suffered from price volatility. When a post appeared on 4Chan wrongly claiming that Vitalik Buterin – the creator of Ethereum – had died in a fatal car accident, the price of Ether fell from $317 to $286 in moments, before bottoming out at around $216.

There are also further risks associated with the speed and throughput of some cryptocurrency networks. For example, can the network be updated sufficiently quickly between transactions to prevent cryptocurrency being spent twice, the so-called double spend problem? The throughput problem has been again highlighted as a sudden craze for the CryptoKitties cat trading game on the Ethereum has slowed down transaction processing and created a huge backlog.

Make the artificial real. Artificial intelligence and automation.

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Lack of control

Cryptocurrencies create a different kind of economics that looks a little like the Wild West. The decentralised nature of cryptocurrencies makes them resistant to regulatory control and censorship. Once initiated, payments are impossible to stop. This alone makes cryptocurrency attractive to criminals as payments cannot be frozen on the grounds of money laundering or breeches of regulation.

The financial establishment is grappling with this quandary and its response is often contradictory. On the one hand Jamie Dimon, the Head of JP Morgan, describes Bitcoin as "a fraud that will blow up" and Bitcoin investors “stupid”. At the same time his company acts as an agent for buyers and sellers of Bitcoin XBT, an exchange-traded note designed to track the value of Bitcoins.

I think the current position is like the early internet era, where everyone knows that some order will be imposed if only because customers/users/the market will demand it. It’s just that no-one is yet entirely sure what that regulation will look like. 

Environmentally damaging

Bitcoin’s recent newsworthiness has also drawn attention to environmental costs of Bitcoin mining. It’s reported that the electricity required by the mining process now exceeds the total power requirements of 159 countries.

So cryptocurrencies are bad for the planet. Huge amounts of computing power are required to support the functioning of a cryptocurrency network. At some point the use of such huge volumes of power just to satisfy an arbitrary requirement of cryptocurrencies is likely to be challenged. Ideally, future cryptocurrencies should be designed with efficiency in mind – or at least be fit for purpose.

THE OPPORTUNITY

The other main differences between cryptocurrencies and conventional currencies hinge around the technical capabilities of the underlying Blockchain. Those include the ability to track and exchange any asset of value and the ability to execute smart contracts which essentially allows cryptocurrencies to enable micro-economic systems of value exchange. These capabilities unlock new opportunities that will be key to the future of cryptocurrencies.

Enabling a new and automated machine economy

One particular application for cryptocurrencies that’s attracting considerable attention is their potential for use as an essential commercial enabler of the Internet of Things (IoT). To realise its potential and fulfil many of the future scenarios being presented for it, the IoT will need a mechanism for managing value exchange and transfer in an underlying machine economy.

In this machine economy a wealth of connected devices will exchange value with each other to pay for services. For example, an individual sensor could make a tiny charge for supplying a reading and receive payment as a minuscule fraction of a Bitcoin or Ether.

Cryptocurrency could also provide the mechanism for new kinds of business arrangement. For example, an automated vehicle could operate under shared ownership by many people. Profits accrued from its services could be distributed amongst the owners in cryptocurrency according to the rules governing each person's stake. This could even go down to the level of micropayments that would be impractical to fulfil with conventional currency.

Combining with AI to form building blocks of the future economy

Given cryptocurrency’s capability to operate smart contracts – or execute business rules once specific conditions are met – this will allow for the creation of ‘decentralised autonomous organisations’ (DAOs). These DAOs exist as nothing more than a set of business rules encapsulated in smart contracts built upon Blockchains. Add AI into the mix and you can add an additional level of decision making complexity where the AI acts as an overseer for the set of smart contracts that form the DAO.

The addition of the currency factor completes the picture, enabling entirely new kinds of organisation that create value without any human intervention. And of course this would demand a complete rethink of many existing regulatory environments. For all kinds of organisations this could present an opportunity for radical automation of a wide range of business logic and processes.

WHAT'S NEXT

There’s currently a tremendous amount of innovation going on in both cryptocurrency and blockchain technologies that shows potential in helping to overcome some of the issues and challenges. In particular we await the inevitable response from the regulatory community that will ultimately determine the longer term fate of Bitcoin and other cryptocurrencies.

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