Regulation of Cryptocurrencies. Necessity and Approaches


Textbook, 2019
76 Pages

Excerpt

Table of Contents

List of Abbreviations

1 Introduction and Analysis of the Status Quo

2 Terminologies and Underlaying Information
2.1 Distinction of Classical Payment Methods
2.2 Terminological Distinction of Cryptocurrencies
2.3 Popular Cryptocurrencies and underlying Technologies
2.4 Key Intermediaries in the Bitcoin Ecosystem

3 Necessity of Regulation
3.1 Danger of Criminal Activities
3.2 Consumer Protection
3.3 Monetary Policy
3.4 Consideration of Counterarguments and Impediments

4 Regulatory approaches
4.1 Overview of Global Regulation Approaches
4.2 Central Bank issued Cryptocurrency
4.3 Prohibition or Restriction of Cryptocurrencies

5 Conclusions

Addendum

List of References

List of Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

1 Introduction and Analysis of the Status Quo

The last few decades are marked by the digitalization, the rise of the Internet and the smartphone revolution. New technologies created a permanently connected world with transcending borders and the internet as the backbone of our economy. Eventually, the technological progress affected society‘s payment methods and even the way we store our money. The emergence of Bitcoin in 2009 occurred at a time, in which numerous investors had lost trust in the established financial system. The liberal idea behind Bitcoin drove the interest of the people and led to a unique success story. The immense surge in Bitcoin’s price was followed by the emergence of thousands of cryptocurrencies, most of which were based on the distributed ledger technology. In the subsequent years, this technology has targeted not just online payment systems, but is striving to revolutionize whole industries. This new market has experienced an ongoing increase in popularity and market capitalization since it is creating unique opportunities, but also putting law enforcement at the forefront of new challenges. Despite of Bitcoin’s great potential, its history is marked by illicit and criminal activities and businesses. This raises the questions, which dangers and threats are still inherited by Bitcoin and other cryptocurrencies and whether appropriate regulatory measures could ease those concerns. How the governmental administration of cryptocurrencies and their regulation develops in the future will not just have direct impact on the success of Bitcoin and the likelihood that cryptocurrencies develop into a mature financial industry, but could also affect companies of competing payment systems like PayPal, credit card-issuing companies as well as financial institutions. The current regulation is mostly perceived as opaque among scholars and varies widely between governments around the world, while the timeliness of the topic creates an explicitly high degree of scientific relevance.

The objective of this literature review is, to comprehensively depict, based on current and relevant literature, initially the phenomenon of emerging cryptocurrencies, their underlying technologies and the consequences of their popularity for classical payment systems, in order to consider the necessity of governmental, regulatory measures afterwards and introduce the most reasonable and feasible options as well as their mode of operation for law enforcement. To create a context, a terminological categorization will be carried out below in chapter two, followed by the communication of basic knowledge about the underlying technology and an introduction of main businesses within the Bitcoin ecosystem. Subsequently, the acquired knowledge will be utilized, to analyze recent literature in chapter three, to enable a critical consideration regarding the necessity of stricter regulatory frameworks for cryptocurrencies, as well as barriers and constraints these new technologies impose for law enforcement. Chapter four will address recent publications regarding feasible approaches for the regulation of cryptocurrencies, under the consideration of previously discussed impediments. Finally, chapter five will provide a review of the work by summarizing the findings and allowing a suggestion for future developments as well as recommendations for actions regarding the conduction of governmental policies for the administration of cryptocurrencies.

This work is based on the latest, most cited and most relevant scientific research. The timeliness of the topic however leads to a limited amount of accessible scientific literature and therefore requires the observation of alternative sources to ensure an objective examination. Beside numerous contributions in eminent scientific journals for the discussion of the core topics, internet documents like the news portal Coindesk were utilized for the acquisition of information, whose integrity was thoroughly screened. The selection of references was adjusted to the objective of this thesis, to provide the best possible heuristic value.

2 Terminologies and Underlaying Information

To understand the issues and difficulties of regulating these newly emerging technologies and markets, it is crucial to possess a basic understanding of the underlying technologies, competing payment services and key players in the Bitcoin ecosystem. This chapter provides a broad information framework about terminologies and technologies in the context of cryptocurrencies. The first subchapter provides an introduction into classical payment methods and a distinction of digital payment systems. Furthermore, an analysis about the categorization of Bitcoin and other digital currencies in terms of money and currencies will be carried out. Finally, this chapter presents the most popular and important cryptocurrencies as well as key players and intermediates in the Bitcoin ecosystem.

2.1 Distinction of Classical Payment Methods

First, a terminological classification of established payment methods will be carried out to enable an economical categorization, but also a technological demarcation of cryptocurrencies afterwards. Common payment methods can be distinguished by non-digital and digital approaches. The non-digital payment methods are comprised of cash, debit payments, cash on delivery, and advance payments and transferals.

In the seventh century, the first coins were introduced in the kingdom of Lydia, followed by the first paper money in China in the eighth century.1 Since these early times, societies established diverse kinds of cash as an exchange medium to facilitate trade and accelerate the economic progress.2 The next step in the development of payment systems was paper money. People accepted paper money as a medium of exchange because of the implied promise that it was convertible into coins or a determined amount of precious metal.3 Eventually currency has evolved into fiat money, which is defined as paper currencies issued by governments which legally must be accepted for the payment of debts. Although coin and paper money does not fulfil an essential or vital purpose for survival, societies have agreed upon its value because it is scarce and provides value to its user, which is that it functions as a medium of exchange, unit of account and store of value.4 The first discussions evolved in recent years about the necessity of physical money. However, until today the payment with cash provides a high degree of anonymity, convenience as well as low costs for payments to every user.5

In the late 1950s the transition from a cash-based economy to electronic payment systems began.6 With the emerging banking industry in the 20th century the variety among payment methods increased and individuals got access to secure payment transactions through financial intermediaries. As a result, banking account-based payment options like direct debiting,7 cash on delivery,8 or common transferals9 emerged.

In the late twentieth century the digital revolution began and opened up the market for digital payment systems. In 2000, the SEPA10 project was born, which included the objective to transform the European forms of payment systems to a more efficient and safe technology-based system.11 A recent study has shown, that stakeholders of the SEPA project have saved about 21,9 billion Euros yearly due to higher processing efficiency and price convergence.12

Modern payment methods include payments via credit cards, PayPal or online transferals. In the context of this literature review, the digital payment methods are particularly relevant. Cryptocurrencies are a new option in the category of digital payment systems and are therefore a direct competitor to credit cards, PayPal transactions and other forms of online transferals. Therefore, we will take a closer look at the underlying operating modes, prospects and limitations of these systems.

The payment via Credit card is the most popular and widespread digital payment method. Credit cards are issued by banks and credit card institutions and are accepted as an official payment method almost everywhere in the world. The largest Credit card organizations are VISA, Mastercard, Diners Club and American Express. These companies profit from the use of credit cards through several kinds of fees, such as annual customer fees, service fees for the multinational use of their products or fees for the withdrawal of cash at an ATM. However, the charged amount for these services varies strongly by factors like the respectively cooperating institute, the kind of credit card or the geographical location of the client. The centralization within business platforms like the credit card system allows the credit card companies and banks to operate highly efficiently due to economy of scale. While VISA can handle peaks of up to 47000 transactions per second, they never use more than a third of this capacity even in peak episodes.13 Additionally, the strict regulations, audits and overviews facilitate the management of systemic risk and provide trust in the system. On the other hand, those regulations limit progress, which is why development between participants occurs rather slow compared to other industries. Furthermore, a common credit card transaction can take several business days to be executed, with results in inconvenience for the clients who need to wait for the delayed booking on their account. Credit card issuing institutes face risks that are typical for centralized systems. All parties are linked to the central ledger, so the participants face systematic- and counterparty risks.

PayPal is a company founded in 1998 by Peter Thiel and Max Levchin in California. The company is specialized on online payments and provides one of the worldwide most frequently used online payment methods. In 2018, PayPal has more than two hundred million customer accounts and is therefore an online payment service with a highly expanded infrastructure. The company’s goal is to simplify and democratize financial services.14 While credit card transactions usually take some time to be executed, a transaction from one PayPal account to another can occur instantly. The cost for a transaction is basically zero, but PayPal charges users for the reception of incoming payments. The money receiver can keep the money on his PayPal account and use it for future transactions, or transfer it to his bank account, using a standard SEPA transaction. Such a SEPA transaction however requires the user to pay a service fee and provide some patience, since the service usually takes several business days to be executed.

Addendum 1 visualizes PayPal’s overall transaction volume per quarter since the beginning of 2010.15 In 2017, PayPal executed about seven billion transactions with a significant increase of transactions in the last quarter. According to this data, PayPal executes not only 222 transactions per second on average but can also expect increasing transaction volumes in the upcoming years. Although PayPal is not registered as a bank, it is categorized as a money transmitter in the USA and is therefore subject to financial regulations which focus on the protection of consumers.16

The term online transferal refers to either electronic banking or mobile banking. While a payment via electronic banking uses a to the Internet connected computer, mobile banking payment transactions are based on the telecommunication networks. Unlike a common transferal, the online transferal is independent of the geographical location. The client can authorize the transaction when and wherever he or she wants. Safety and Security for this method is guaranteed through the PIN- and TAN- method. This technique enables users to verify their identity and therefore validate their transaction, to prevent misuse of the online transferal system. However, remittances, especially from one country to another, are usually expensive because financial institutions charge high transaction fees on the originally transferred amount.

Cryptocurrencies are a new player in the digital payment market that works without a financial intermediary or a trusted third party like credit card institutions or PayPal. Unlike common digital payment systems, cryptocurrencies work through the decentralized distributed ledger technology. In the following subchapters we will observe the terminological origins of the term cryptocurrency as well as the technological backgrounds, to provide an explicit and comprehensive understanding of this emerging technology and to create a frame which enables us to perform a comparison to established digital payment services.

2.2 Terminological Distinction of Cryptocurrencies

Although they differ in their meaning, the term cryptocurrency is often used synonymously with the terms digital currency or virtual currency. The term digital currency refers to every kind of electronic money, like money stored on PayPal- or bank accounts.17 The term digital currencies might therefore be misleading when perceived as an innovation that emerged through Bitcoin. Effectively, digital money has been around for quite some time; in fact 96% of the circulating money in the United Kingdom was digital in 2016.18 The definition of a virtual currency according to the European Central Bank, includes any currency that is a digital representation of value which can be used in some cases as an alternative to money, but is not issued by a central bank, credit institution or e-money institution.19 A virtual currency therefore is not backed by any government or private organization and is out of reach for money supply control or monetary policy. Some virtual currencies have been created to enable the exchange of virtual goods and services within online communities like gaming platforms or social networking sites.20 A cryptocurrency is both, a digital and a virtual currency, protected through cryptography.21 The most popular cryptocurrency is Bitcoin, which can therefore be described correctly as a digital currency, a virtual currency or a cryptocurrency. However, the assumption that every digital currency would be a cryptocurrency at the same time would be wrong and misleading.

Bitcoin is often referred to as digital money. However, in chapter four we will discuss that the legal definition of cryptocurrencies varies widely by different governments, central banks, experts and financial institutions and that cryptocurrencies therefore are treated and regulated differently. For now, an analysis about cryptocurrencies in the context of the economical view of money will be carried out in the context of the question, whether the term of digital money is an accurate description for cryptocurrencies like Bitcoin.

The term “money” from an economist’s point of view, refers to everything that is generally accepted as payment for goods, services or the repayment of debts.22 The three primary functions of money in an economy require it to work as a medium of exchange, as a unit of account and as a store of value.23 Common currencies, like paper bills and coins, fit into this definition and can therefore be clearly categorized as money. To be considered as a medium of exchange, a currency should be commonly used in an economy as payment for goods and services. Considering the increasing number of companies that are willing to accept Bitcoin as a legitimate payment method, cryptocurrencies meet this criterion up to a specific level. To fulfil the requirement of working as a unit of account, a currency needs to be able to measure value in an economy. However, Bitcoin underlies immense price fluctuation and the cryptocurrency markets are prone to bubble behavior.24 The graphical illustration in Addendum 2 shows the daily percentage changes of Bitcoin and adequate comparable media in US dollar prices in 2013 and visualizes the immense volatility of Bitcoin. Furthermore, Bitcoin can be traded for different prices at different exchange platforms without the opportunity of arbitrage profits, what adds to the negation of the question whether Bitcoin can be useful as a unit of account.25 The function as a store of value requires a currency to work as a repository of purchasing power over time. This function is not a unique subject to money, since any kind of asset can be used to store purchasing power. However, when the owner of a currency spends it after holding it for a certain amount of time, he expects to receive at least the same value the currency was worth when he acquired it. In these terms, cryptocurrencies like Bitcoin faced challenges like price manipulation, hacking attacks and theft in the past. Bitcoin cannot be stored in a bank, but must be held in digital wallet instead, which can be costly to maintain and a vulnerable target to attackers.26 Furthermore, Bitcoin’s exchange rates to the US dollar exhibit nearly no correlation at all, compared to the exchange rates of the US dollar and further famous currencies. Thus, Bitcoin can hardly be used as a tool for risk management and it is highly difficult to hedge against any risks that apply to Bitcoin itself.

Most scholars agree that cryptocurrencies clearly do not fulfil the three functions and therefore should not be considered as money from an economic point of view. Some scholars suggest, that Bitcoin and other cryptocurrencies should be considered instead as speculative investment vehicles.27 This economical approach differs, like stated above, from many legal definitions and statements of public authorities. Next, we will observe the history and characteristics of well-known cryptocurrencies, chosen based on their market capitalization and popularity. Furthermore, we will discuss the details of the blockchain technology in the context of Bitcoin, the most popular Cryptocurrency.

2.3 Popular Cryptocurrencies and underlying Technologies

In this subchapter, some leading cryptocurrencies, i.e. those with the largest market capitalizations, will be introduced along with the key features of their underlying technologies. Bitcoin, the most popular and widespread cryptocurrency in today’s market, will be subject to detailed observation. Subsequently we will compare some selected altcoins like Ethereum, Litecoin and Ripple. Finally, we will provide some general information about altcoins and initial coin offerings in the context of risks and regulation.

2.3.1 Bitcoin and the Blockchain Technology

Bitcoin is a general term used for several concepts and technologies that shape together the basis for a digital money ecosystem.28 Usually the term refers to units of the cryptocurrency called Bitcoin or the online communication protocol that facilitates the use of this particular cryptocurrency.29

To summarize, this subchapter provides essential information, which is crucial for building a basic understanding of the most popular cryptocurrency. Below, we will look at the history of Bitcoin, the focal points of the Blockchain technology, and a comparison of the main advantages as well as disadvantages of Bitcoin in relation to classical payment methods.

History of Bitcoin

While several centralized cryptocurrencies were proposed as early as the 1980s, Bitcoin was the first decentralized one to solve the problem of double spending and to gain popularity and acceptance within the financial market. Bitcoin’s first concept was published in November of 2008 by an unknown founder with the pseudonym Satoshi Nakamoto.30 Nakamoto combined several previous approaches to virtual currencies like “b-money” or “HashCash”, but also added new key innovations like the proof of work algorithm to create a decentralized digital payment system that works without the need for a trusted third party.31 The source code was publicly accessible for everyone and included the first applicable concept of a global, distributed ledger. The first software for the exchange of Bitcoins was published early in 2009, with the first official Bitcoin transaction occurring in January of 2009. In the following years, the early use of Bitcoin was characterized by illicit and criminal activities in places like the Silk Road.

The Silk Road was an illegal, online black market through the dark web which was launched in February 2011 by a man named Ross William Ulbricht. The platform was accessible through the Tor browser, which significantly differs by other internet browsers in terms of anonymity. The Tor browser automatically deletes privacy sensitive data and allows the users to browse certain websites without revealing their IP address. Users were not just able to anonymously buy illegal products like drugs, weapons and fake identity documents on the Silk Road, but also got access to services like murder-for-hire and several website hacking services. Every transaction through the Silk Road was executed with Bitcoins, due to their unique benefit of ensuring the participants’ anonymity. In October of 2013, the FBI successfully tracked down the origins of Silk Road, leading to the arrest of Ulbricht and the shutdown of the market place. Furthermore, the FBI confiscated the private keys to more than 173,991 Bitcoins in connection with the Silk Road case, which was equal to the value of seventy million US dollars, using that time’s exchange rate.32 The demise of Silk Road was followed by numerous imitators, including a similar website called “Silk Road 2.0” and about thirty competitors. It is therefore unclear, whether the take down of Silk Road confined the illicit use of Bitcoin. In 2017, the price for one Bitcoin reached an all-time high of 20,089 US dollars and a market capitalization of 188 billion US dollars.33 Today, Bitcoin is by far the most popular cryptocurrency. The number of companies that accept Bitcoins is constantly rising, which leads to an increasingly comprehensive infrastructure of the Bitcoin network and therefore high protection against manipulation or hacking attacks within the blockchain. Reports about Bitcoin are daily components of the mainstream media and professionals from multidisciplinary fields argue about the risks and benefits of the new technology. One of Bitcoin’s major innovations is its underlying blockchain technology, which enables the decentralization of transactions through a network of nodes instead of a trusted financial intermediary.

Blockchain Technology

The blockchain is a globally distributed ledger which enables the verification of a data transaction through a decentralized network. The allocation and security of data in the blockchain enables functions of a centrally organized information system to work as a decentralized system. That means, users of the blockchain can perform data transactions without the need of a trusted third party. Although the application area of this new technology is still limited, the blockchain technology could be used wherever an intermediary operates as a trusted third party to manage and verify transactions. When the blockchain technology was first published in 2009 as a technical concept for Bitcoin, its purpose was primarily to facilitate the creation of a decentralized, digital currency. With imitators following Bitcoin’s success, numerous new cryptocurrencies have gone public in the recent years, many of which were based on new, slightly adjusted variations of Bitcoin’s blockchain technology. At the same time, it was quickly acknowledged that the potential of the blockchain technology exceeds the application area of cryptocurrencies by far. Recent publications indicate that several, global companies intend to use the blockchain technology to support or improve their core business; these organizations span from industries like insurance,34 automobile,35 and many more.36

Closely related is the term of the distributed ledger technology, although DLT should not be used interchangeably with blockchain. Like visualized in Addendum 3, a distributed ledger is a decentralized electronic database that hold records about transactions and is spread about several nodes or computer devices throughout a network. The innovative feature of this technology is that the ledger is not controlled by a single authority like a centralized ledger, but by consensus within the whole network.37 A distributed ledger therefore enables the network to record ownership through a shared registry.38 However, not all distributed ledgers employ a chain of blocks, which is why the blockchain is only one of many possible formations of the distributed ledger technology.39 The blockchain data file is kept on all computers of the blockchain network, and every single transaction needs to be validated and saved by the consensus of majority. The blockchain is based on the peer to peer concept, which describes a computer to computer connection. In a peer to peer network, all computers are directly connected to each other, have equal rights and can send data files without a central server instance.

A main function in a blockchain is the mining process. The blockchain creates periodically new mathematical puzzles with a random component, which can only be solved by computational methods. Users can connect hardware to the blockchain and provide their computing power for the calculations of the blockchain. As an incentive to encourage users to participate in the bitcoin network and provide hardware units for verifying the validity of recent transactions, the system provides a reward to users that successfully solve this task, with newly minted Bitcoins.This mining process is crucial for the security of the blockchain because the mining nodes validate legit transactions and reject irregular transactions by reference to the blockchain’s consensus rules.40 Additionally, new units of the cryptocurrency are issued through the mining process, making miners crucial actors of the Bitcoin ecosystem. However, the supply of Bitcoins is limited to 21 million units, which will be reached by approximately year 2140. At this time the reward for solving the mining puzzle will be set to zero and Bitcoin mining will no longer be profitable.

Once a data transaction is validated by the miners in the network, it can’t be removed or changed. Addendum 4 shows, that only validated transactions get registered and saved, while fraudulent transactions get identified as invalid and are not integrated into the blockchain. These transactions get periodically grouped together into a “block” of transactions. The first block within a blockchain is called the genesis block.41 Approximately every ten minutes a new block is added to the system. Those blocks are stringed together to a linked sequence of blocks, creating a “blockchain”. Since these blocks and transactions are publicly accessible for everyone, every blockchain user can verify that past transactions did in fact occur. The blockchain itself is basically a logfile of previous transactions.42

The blockchain is based on fundamental concepts of cryptography, like the public-private key cryptography. Every user can design a public key and a directly linked private key. While the public key can be shared publicly and without hesitation to receive transactions, the private key works like a unique digital signature and needs to be kept secret to avoid the theft of Bitcoins. This cryptographical system accomplishes the functions of both, authentication and encryption. A message which is encrypted with a public key can only be decrypted with the associated private key. This concept allows every user to publish messages which can be confirmed as authentic and trustworthy. Since the public key is not connected to a user’s personal data but the transaction ledger is publicly accessible, blockchain based cryptocurrencies are both, anonymous and public.

Key Benefits and Disadvantages

Like stated before, cryptocurrencies like Bitcoin rely on the distributed ledger technology. Because of this technology’s decentralized nature, Bitcoin provides some unique benefits compared to common payment options. Firstly, all transactions are publicly available on the distributed ledger, which provides an extraordinary high level of transparency to its users. After the financial crisis in 2008-2009, a lot of people had lost their trust in financial institutions and the banking system. With the blockchain, there is no need to entrust a third party with verification since every transaction is validated by the consensus of the network.

Secondly, the algorithm’s encryption ensures statistical protection against cheating and fraudulent activities. The assurance and belief, that nobody can misuse this protocol through illicit or fraudulent activities, is ensured by the underlying cryptographic encoding technique in the blockchain technology. Like stated above, the blockchain is basically a list of previous data transactions. A user of the blockchain doesn’t just hold certain amounts of units, but also participates in a public transaction list, which shows that he or she received units in the past and that there was no prior transaction in which that user spent those units. To misuse this global, public ledger, a user would have to change the transaction history or get a fraudulent transaction verified by the network. While changing the history of validated transaction in the blockchain is statistically impossible, a pool of miners could theoretically be able to prevent new transactions from gaining confirmations or reverse transactions that were recently completed. The likelihood of such an event and the conceivable resulting damage will we discussed in chapter four. Additionally, a noteworthy difference between Bitcoin and established payment methods is the anonymity provided for individuals. Law-abiding people can benefit from a level of anonymity on the terms they want it. One could argue that this kind of privacy should not be diminished by the government.43 Another potential benefit of the blockchain, is that the decentralization allows economic or bureaucratic transactions of all kinds to be handled much cheaper than they can be through their centralized counterpart; for example, through a financial institution. Although transaction in the Bitcoin network should be free in theory, users usually need to pay transaction fees to the miners. These fees vary from one exchange to the other. Though, even under consideration of these fees, the transaction costs are significantly lower than transaction costs among Bitcoin’s counterparts.44

Finally, 2.5 billion adults in the world live without access to a bank account. Cryptocurrencies might have the capacity to give those people access to a global, financial system. Bitcoin knows no borders, provides cheap, fast and convenient transactions and every person’s cellphone works as a bank in their pocket with only the aid of a software application. In addition, the DLT has potential to function as a benefit to the economy and as an engine for future innovations.45 This young technology has already changed how many people think about money and financial institutions, and with some of the worlds largest companies adopting DLT’s key features, we might experience its impact on numerous areas of implication in the near future.

Conversely, besides the risk of a 51%-attack, the blockchain is facing several issues and limitations. A main concern about cryptocurrencies is the anonymity they provide for criminals and individuals with illicit intentions. The Silk Road-incidents clarified, that the near anonymity of cryptocurrencies constrains the scope of actions available to law enforcement significantly, and therefore makes it a highly attractive medium of exchange for criminals.46 The innovation of the DLT could be misused as a tool to commit crimes, due to a lack of clear regulation. The unclear and opaque global regulation however is another problem and a potential threat since further developments of regulatory approaches are rather uncertain. How global regulatory approaches by governments and financial institutions develop will most likely be one of the most crucial factors regarding the question of whether cryptocurrencies and the blockchain industry will become a mature financial services industry.47

Furthermore, the blockchain technology faces some technological constraints. A major problem of Bitcoin’s blockchain technology is the issue of scalability. The blockchain’s capacity is limited to ten transactions per second. Like stated earlier in this chapter, the centralized digital payment service PayPal processes on average about two hundred transactions per second, and VISA manages to process tens of thousands of transactions per second. Considering the million users currently in the global blockchain, and the objectives this technology seeks to achieve, the current scale of the Bitcoin blockchain is clearly insufficient to revolutionize the global money transfer system.48 Another issue is the immense high energy consumption of the Bitcoin network. All mining pools of the global Bitcoin network exceed an energy consumption of 42 terawatt hours per year, which is more than the energy consumption of the Republic of Ireland.49 Due to the increasing complexity of the puzzles in the mining process, the consumed power by the global Bitcoin mining pools will continue rising. Furthermore, the high demand for energy results in the fact, that most of the mining occurs in countries with low energy costs. Above 80% of all Bitcoin mining occurs in China.50 Calculations summarize, that the global Bitcoin mining electric consumption might exceed the amount of power consumption the world uses today as soon as February of 2020.51 This power consumption is so high, that it even became an ecological problem. The concept could even have an impact on climate change and therefore provoke additional, federal regulation. Moreover, the current Bitcoin price and the required energy for the mining process both are factors for the profitability of Bitcoin mining. If the energy consumption of the mining pools keeps rising at this high rate, the Bitcoin price needs to rise as well to keep Bitcoin mining profitable in the long term.52

Another issue is the extent of the system. The blockchain file, which needs to be downloaded and saved on every mining Node in the network, already exceeds the size of 160 Gigabyte.53 This constraint disqualifies most of personal smartphones and laptops from participating in the blockchain and prevents the network from expanding at a much faster rate. While the technology should be able to perform instant transactions in theory, transactions are not executed immediately in praxis. The average verification process of every payment requires only about 15 minutes within the blockchain,54 but this number necessitates the payment of an additional transaction fee. This fee is what negates Bitcoin’s benefit from being free. If a user transfers a payment without paying an additional transaction fee to the miners, the execution of the transaction can take hours or even days.

Lastly, scholars discuss the likelihood of cryptocurrencies being a threat to the economy. The price of cryptocurrencies is set by supply and demand, but the supply of a cryptocurrency depends on the underlying code and cannot be changed after the initial offering. Since Bitcoin’s supply is set to 21 million units, its price might be subject to deflation in the long term. Furthermore, Bitcoin’s high price volatility, the lack of concrete economic value and the findings that the cryptocurrency market is prone to bubble behavior concerns scholars and increases the need for consumer protection and concrete regulation policies.

2.3.2 Ethereum

Vitalik Buterin, the creator of Ethereum, was inspired by Bitcoin’s blockchain technology and wrote the Ethereum white paper in November of 2013.55 Ethereum was formally announced in January of 2014 by the Ethereum foundation, a Swiss nonprofit organization and officially went public in July of 2015.56 Only nine months after the launch, Ethereum’s built-in cryptocurrency Ether reached a market capitalization of 1 billion US Dollar.57

Just like Bitcoin, Ethereum is based on the Blockchain technology. However, Ethereum is not considered as a pure cryptocurrency, but rather a platform for decentralized applications, smart contracts and decentralized, autonomous applications.58 The founders see Ethereum as a medium to enable interactivity between millions of smart contracts in terms of exchanging information, creating new marketplaces or providing new types of services. Within the Ethereum blockchain system, smart contracts are written in an individual programming language called Solidity. Since Ethereum is publicly accessible, anyone can use Solidity to write and upload new programs or applications to the Ethereum blockchain.

Like stated above, one of Ethereum’s most distinctive characteristics is that it enables users to work with smart contracts within the blockchain. Smart contracts are computer protocols, which allow users to file transactions of money, property, and shares or other suitable units without being dependent on a trusted third party. Essentially, smart contracts are contracts able to execute themselves without needing banks, lawyers or notaries.59 If a defined event occurs, such as the reception of a set amount of ether tokens, the contract performs a defined action independently of any third party system. To use smart contracts within the Ethereum blockchain, save data files, execute transactions or run calculations, users pay fees in the form of Ether tokens. Ether is the actual cryptocurrency within the Ethereum network which is hard-coded into the system. Because of the technological complexities, the terms Ether and Ethereum are often used synonymously. Ether is currently the cryptocurrency with the second largest market capitalization after Bitcoin. In January of 2018, the price for one Ether token reached the all-time-high of 1457 US dollars. Ether’s market capitalization at this time peaked at 134 billion US dollars. Meanwhile, several companies and hundreds of applications have been designed based on Ethereum. Officially presented concepts and projects based on Ethereum include but are not limited to industries like the internet of things, peer-to-peer marketplaces, financial derivates trading, crowd funding platforms, cryptocurrencies and accounting and network security.

2.3.3 Altcoins

Altcoins like Ether are alternative cryptocurrencies, which went public after the success of Bitcoin. With over 1500 existing cryptocurrencies, there is a wide variety of altcoins available. Many of those coins are based on an advanced technology or claim to solve problems of competing coins. IOTA60 for example claims to be the third generation of blockchain, since it solves Bitcoin’s issue of scale and uses a blockchain-like technology named Tangle. Other coins focus on areas of application for very specific sectors and subsectors like financial exchange, digital voting or supply chain management.61

Founders who want the public to have access on their digital coin for the first time, can choose to launch an initial coin offering. An ICO is an option to raise capital for a coin through crowdfunding and avoiding strict regulations at the same time. However, in 2017 more than nine hundred new altcoins were launched through ICOs, of which more than half have already failed. With so many ICOs every month, many of the altcoins are a scam, or they just don’t offer any value. Many of these altcoins just copied Bitcoin’s system and changed a few parameters, like the block size or the average time between blocks.62 Another trap for investors are illicit pump-and-dump schemes. If an individual or group successfully launches an ICO, the chances are that the founders hold a large quantity of these coins. If the coin then gets traded on public exchange platforms or becomes accessible to a community, the demand for the coin increases and the founders are in the position to sell their tokens for a much higher price. New coins include the risk, that their founders have fraudulent intentions. In the case of such unethical behavior, a digital coin doesn’t even need to add any value or solve a problem. The chance to earn a lot of money within a short amount of time attracts not just entrepreneurs, but also criminals and scammers. If an investor considers investing into an asset like a young, digital coin, he or she should thoroughly analyze the value of the coin and critically question the motivation of the founders. However, not all alternative coins are based on fraud or illicit intentions. Some of the largest, most successful and popular altcoins are Litecoin and Ripple.

[...]


1 Halaburda/Sarvary (2016): 18.

2 Haines (1961): 1–28.

3 Mishkin (2016): 98.

4 Havrilesky (1973).

5 Górka (2016): 41.

6 Górka (2016): 2.

7 With a payment by the direct debiting system, the holder of an account issues a permission to the receiver of the transaction, to draw out a specified amount of money from their account. This permission occurs through a direct debit mandate, which is signed by the holder of the account and submitted to the executing financial institution. Because of the automation involved in the payment process, the direct debiting scheme is especially useful for repeating payments.

8 Another type of the traditional, non-digital payment methods is cash on delivery. In this process the payment occurs during the delivery of the product or service initially to the delivery service provider or the executing post office. The responsible institution charges a service fee and transfers the determined amount of money to the receiver of the payment.

9 When an account holder chooses the common transferal, he or she submits a payment order to his or her financial institution. The expenditure of time, as well as the service fee charged by the bank, depends on several factors like the geographical locations of the involved parties or the business policy of the involved bank. However, international transactions are usually more expensive than national or local transactions.

10 SEPA is a project in the eurozone, which aims to make cross-country transactions within member states equivalent to domestic transactions within single countries.

11 European Council (2000).

12 Pwc (2014).

13 Trillo (2013).

14 PayPal (2018b).

15 Statista (2018).

16 PayPal (2018a).

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18 Barrdear/Kumhof (2016): 4f.

19 European Central Bank (2015).

20 Peters/Chapelle/Panayi (2016): 242–246.

21 Boel (2016): 152f.

22 Mishkin (2016).

23 Mishkin (2016).

24 Cheah/Fry (2015).

25 Yermack (2015).

26 Yermack (2015): 33.

27 Bariviera et al. (2017).

28 Antonopoulos (2017): 1.

29 Boehme et al. (2015): 213.

30 Nakamoto (2008).

31 Antonopoulos (2017).

32 Trautman (2014): 96f.

33 Coinmarketcap (2018).

34 Heyen (2017).

35 Deutschenbaur (2018).

36 Mesropyan (2016).

37 Mills et al. (2016).

38 Santander (2015): 14.

39 Morabito (2016).

40 Antonopoulos (2017).

41 Kroll/Davey/Felten (2013): 5.

42 Antonopoulos (2017).

43 Swasdiphanich (2017): 20.

44 Guadamuz/Marsden (2015).

45 Guadamuz/Marsden (2015).

46 Swasdiphanich (2017): 19.

47 Swan (2015): 89.

48 Croman et al. (2016).

49 Bordo/Levin (2017): 7.

50 Blockchain (2018b).

51 Holthaus (2017).

52 Hern (2018).

53 Blockchain (2018a).

54 Blockchain (2018c).

55 Buterin (2014).

56 Tual (2015).

57 Coinmarketcap (2018).

58 Diedrich (2016).

59 Diedrich (2016).

60 IOTA is a cryptocurrency with a market capitalization of about four billion US dollars and therefore the tenth largest cryptocurrency in April 2018. IOTA claims to provide the necessary technology to enable free and feasible interoperability among millions of resources in reference to the Internet-of-Things-industry.

61 Kimura (2018).

62 Narayanan et al. (2016).

Excerpt out of 76 pages

Details

Title
Regulation of Cryptocurrencies. Necessity and Approaches
Author
Year
2019
Pages
76
Catalog Number
V452180
ISBN (eBook)
9783960954620
ISBN (Book)
9783960954637
Language
English
Tags
Cryptocurrency, Blockchain, Consumer protection, Global Regulatory Approaches
Quote paper
Daniel Werner (Author), 2019, Regulation of Cryptocurrencies. Necessity and Approaches, Munich, GRIN Verlag, https://www.grin.com/document/452180

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