Crypto-assets are products that have captured the attention of media, both experienced and inexperienced investors, financial regulators, and governments. But what are they? How can they impact our lives?
This section will help you to better understand the key fintech concepts, and the concerns that regulators may have with people investing their savings in them. Click on the terms below to learn more.
The term “fintech” is simply a merger of the words “financial” and “technology”. It refers to the use of technology, including computer programs, to deliver or improve banking and financial services.
There have been many traditional financial services that have drawn the attention of fintech developers. Mobile banking and software apps that let you buy insurance online, or that provide investment advice over your mobile phone, are a few examples. When crypto-assets are used to meet financial services needs, they are considered fintech as well.
Advances in technology can bring new solutions that forever change the way that people do things. New technologies, like crypto-assets, often bring new risks, and it usually takes some time to understand how best to protect consumers and the public from those risks without stopping progress.
Crypto-assets is a term that captures a wide range of products. Examples include cryptocurrencies, crypto-coins, exchange tokens, non-fungible tokens, security tokens, utility tokens, and virtual currencies. Common to all of these is their reliance on distributed ledger technology (DLT), like the blockchain, to track and record key details, such as the ownership history of the crypto-asset.
Examples of crypto-assets that you may have heard of include cryptocurrencies like Bitcoin, Ethereum, Ripple and Litecoin.
DISTRIBUTED LEDGER TECHNOLOGY AND BLOCKCHAIN
How distributed ledger technology (DLT) is defined varies. However, the key concept with DLT is that a number of participants on a network of computers use cryptography (secret coding) to control the generation of units of digital assets and to record and verify transactions. In the case of cryptocurrency, the DLT used is called the blockchain.
With DLT, transactions are recorded digitally across the users on the network and the collective records must all match to be accepted. This is one of the key innovations of DLT. There is no centralised government authority or middleman, such as a Central Bank, involved in the process. The network is the first and final authority.
The lack of a central government authority may appeal to different users for various reasons. However, in some cases, it also attracts people with criminal intentions. In fact, crypto-assets have become a popular payment method for some frauds and other crimes which could impact you. For example, they are often used to facilitate ransomware payments.
ARE CRYPTOCURRENCIES, CURRENCIES?
Although the usage and acceptance of many crypto-assets and ways to exchange them for “real” money are increasing, by no means should you expect to go to the grocery store with your cryptocurrency, or that your landlord or the local power company must accept it from you.
Because “currency” is in the name, many people think that a cryptocurrency is a “currency” like US dollars, or euros. US dollars and euros are known as “fiat currencies”. Fiat currencies are backed by the governments that issued them and are legal tender in the countries where they are issued – meaning that everyone in that country accepts them as a means of payment. Cryptocurrencies are not backed by an issuing government. They are not legal tender.
Cryptocurrencyprices are usually based on supply and demand, and they can have very large price swings as a result. This makes them a poor way to measure or store value.
There are developers working on cryptocurrencies that maintain stable prices. These cryptocurrencies, known as ‘stablecoins’, have prices that are connected to the prices of stable assets, such as US dollars or gold. Unfortunately, they are often complex and still subject to supply and demand forces that reduce the stability of their prices.
CRYPTO-COINS AND TOKENS
Cryptocurrencies, crypto-coins and crypto-tokens are very similar terms, whose meanings are still not universally defined. ‘Token’ is the term many experts and regulators use more and more frequently when discussing cryptocurrencies and crypto-coins.
“Tokens” can be divided into three categories, depending on their features:
1. Exchange tokens: intended for use as a means of exchange, not issued or backed by a central authority and used as a means of trade outside of the central payments and banking system
2. Security tokens: features of securities and may be regulated just like securities
3. Utility tokens: grant access to an existing or prospective product or service and do not qualify to be regulated like securities
HOW ARE THEY MARKETED AND SOLD?
When public companies need to raise capital, or a private company makes the decision to “go public”, they may sell shares of their company in an initial public offering (IPO). Similarly, developers looking to raise money for a project or new venture may use an initial token offering (ITO), where tokens are offered in exchange for money or other assets. ITOs are also known as an initial coin offerings (ICOs), token sales or a coin sales.
In well regulated capital markets, the promoter of an IPO must meet strict regulatory standards regarding the information they are required to share with the public about the investment. However, ITOs/ICOs are often unregulated, in which case the supporting documents of the ICO are not required to be reviewed by a regulatory body, or to meet the high standards for disclosure of material information as would be required for an IPO.
HOW DO PEOPLE TRADE THEM AFTER THE ITO/ICO?
Once an ITO/ICO is complete, tokens may be traded on a cryptocurrency exchange. A cryptocurrency exchange is an online platform that allows you to buy, sell or exchange cryptocurrencies for other cryptocurrencies, or for fiat currency. In many instances today, cryptocurrency exchanges are still unregulated. As a result, investors do not have the same protections as they would on regulated securities exchanges.
Cryptocurrency exchanges are also frequently the target of digital theft. Many have been hacked and suffered notable losses.
HOW ARE THEY STORED?
Tokens are stored in digital wallets, or e-wallets, that require a password for access. These passwords are often very long and complicated, to reduce the chance of theft or hacking. However, if an investor loses his or her password or the wallet is hacked, the investor could permanently lose access to the wallet’s contents.
E-Wallets can be hot or cold. Hot wallets are online and connected to the Internet, so the user can access them to do transactions. However, as they are online, hackers may be able to access them too. To combat theft by hacking, some investors put their tokens into cold wallets. Cold wallets are stored offline and are away from exchanges. People who invest in cryptocurrencies usually have both cold and hot wallets.