Abstract

<aside> ✅ Cryptocurrency is recognized as a cheap, dependable and fast-paced method for transferring value across the Internet in a peer-to-­peer system. Other than a miniscule incompatibility as a result of a fork in 2013, the bitcoin network has been operating continuously and efficiently for over 8 years. Although there have been losses and thefts of cryptocurrencies belonging to individual holders as a result of numerous phishing and spoofing campaigns, the blockchain networks themselves have has never been successfully breached or impeded.

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Despite cryptocurrencies many technical achievements, it is far from reaching mainstream consumer or business adoption. Judging by the current trend in transaction volumes1, the slow growth of actual crypto usage shows no sign of changing in the foreseeable future. This is despite the availability of many easy­to­use wallets and the fact that bitcoin can now be spent online at many mainstream businesses such as Microsoft, Tesla and Starbucks.

There are many possible causes of crypto’s slow adoption, including: (1) the practical difficulty of purchasing crypto, (2) end­user satisfaction with existing payment systems (3) the volatility of crypto’s value relative to government­issued currencies, (4) a lack of support for crypto in the mainstream financial sector. (5) the perception that crypto is insecure, (6) questions over crypto’s legal status and (7) the irreversible and unforgiving nature of crypto transactions.

In the absence of end-­user adoption, many have suggested that cryptocurrency could help improve internal processes within traditional economic sectors, by lowering costs, reducing settlement times and eliminating intermediaries. One immediate theoretical possibility is using cryptocurrency as a currency and conduit for rapid inter­bank settlement. However the volatility of a tokens value relative to government ­issued currencies renders this unworkable in practice. A more promising direction is to use blockchain infrastructure to transact in assets other than crypto itself.

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Tokenization

At the heart of bitcoin lies the blockchain, a global decentralized ledger which stores the full history of all bitcoin transactions. The blockchain is verified and stored by every node in the bitcoin network, of which there are approximately 10,000 as of April 2021. The bitcoin protocol ensures that, barring temporary discrepancies, every node in the network has the same version of the blockchain, without requiring this consensus to be determined by a central authority. Another key feature of bitcoin is that nodes can join or leave the network at any time, without disrupting the functioning of other nodes or the ongoing processing of transactions.

New transactions can be created by any node and are propagated across the network in a peer-­to­peer fashion. Any node can take a set of these pending transactions and create (“mine”) a new block containing them together with a link to the previous block. The new block “confirms” the transactions and is also propagated across the network. To prevent minority control over mining, bitcoin uses “proof of work” to make it computationally difficult and expensive to create a new block. If a “fork” occurs, in which two competing blocks are mined almost simultaneously, proof of work also acts as a dispute resolution mechanism. Since blocks are hard to create, it is unlikely that both forks will grow at an identical speed. The protocol specifies that the fork with the greater amount of work is the correct one, so the network quickly regains a unified global consensus.

Along with bitcoin transactions, the blockchain can be used to store any digital data. While some view such uses as “bloating the blockchain”, bitcoin’s decentralized nature means that they cannot effectively be stopped. This led the developers of Bitcoin Core, the official bitcoin client, to introduce an official mechanism for adding arbitrary metadata to transactions in early 20143. This mechanism is used by services such as Proof of Existence and BlockSign to notarize the existence of a document by embedding a digital signature of that document inside a transaction. Other tools such as php­OP_RETURN enable larger pieces of data to be stored and retrieved from the blockchain, turning it into a general­purpose permanent decentralized data store.

Transaction metadata is used by several protocols, such as CoinSpark, Counterparty, Omni Layer and Open Assets, to support third party assets on the bitcoin blockchain. First, an issuing entity creates a new set of tokens representing an asset, by sending a transaction with some “asset genesis” metadata. As part of this process, the issuer can undertake a contractual obligation to allow these tokens to be exchanged for the equivalent real ­world asset at any time. Ownership of the tokens is freely transferred between holders using other transactions with “transfer” metadata, without requiring the approval of the issuer or any other authority. In effect, a token acts as a digital bearer bond, with the ownership of that bond determined by the data embedded in the bitcoin blockchain5. In the finance world, a token issued by an institution with a strong credit rating could be perceived by other institutions as a close approximation to the underlying asset.

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The Shortcomings of Cryptocurrency