As far as the finance industry is concerned 2017 can safely be called the Year of Cryptocurrency. The popularity of these FinTech products has skyrocketed even overshadowing other important subjects such as the fresh Basel III guidelines or the coming into force of MiFID II.
In short, three indicators are representative of the ‘cryptocurrency mania’, i.e. price, market capitalisation and trading volume. which have rocketed in 2017.
Without delving too deeply into what drives these performances and whether coins have an intrinsic value or not, or whether it is indeed a bubble, it is convenient to make a general presentation of the entire e-coin business ecosystem. Two observations are needed though.
First, e-coins are not money, nor financial instruments. The common understanding, especially in the media, comes from the general term ‘cryptocurrency’, giving the impression that bitcoin is a sort of a virtual currency. However, the situation is now different since e-coins don’t fulfil the essential criteria or functions of money, neither the definition of financial instruments (transferable securities or units of collective investment undertakings) under MiFID II.
Second, there is a certain risk in acquiring e-coins, but it is uncertain whether it is a high or a low risk. No assumption can be validly made in relation to the sustainability of e-coins other than that it is highly dependable on whether this concept will be picked-up and integrated into our daily lives, just like internet websites, or whether it’s just a trend that will slowly fade.
The Cryptocurrency phenomenon relies on two fundamental concepts: the coin and the transfer system. Payment systems (the ‘blockchains’) facilitate transfers of value in coins instead of fiat currency or securities between members, transfers which are processed based on cryptography and mathematical decoding algorithms.
The first mechanism of this type was Bitcoin, following which 3,000 others were developed. It can safely be assumed that the initial purpose was to create a money-transfer system that escaped “institutionalisation” (and, thus, supervision and regulation) and which was not only incorruptible, but completely transparent and founded on the good faith of the community. Launched at the peak of the 2008 sub-prime crisis, some authors argue that blockchain got off to a very popular start because it offered an alternative to the sector that was believed to have caused the crash of the U.S. economy.
Concisely, a user downloads the core computer software, which connects him to the blockchain community. He can then exchange fiat currency for e-coins and order a transaction. The transaction can be ‘mined’ (validated) by any participant, after which the e-coins or tokens are transferred to the receiver and the transaction is added to the global public ledger.
At the beginning, it was used as a payment system. The first commercial transaction was made to pay for two Papa John’s pizzas for roughly 13,000 bitcoins. Later on, some saw the potential in the concept – both because it brings many benefits and because the software is open source – and started to invest in it. By 2014 however, it is argued that more than 80% of transactions were speculative.
Replicas or ‘altcoins’ were created soon after and bitcoin saw its first competitors. Platforms that facilitate exchanges between e-coins, fiat currency and altcoins were also developed, originating what today is called a Digital Coin Exchange (DCE).
Then, finance professionals joined the system. Brokers started to offer services, investment firms started to trade in cryptocurrency and organise Initial Coin Offerings, trade platforms multiplied, IT companies developed software to facilitate mining pools, bitcoin ATMs were created, e-coin banks were launched, more providers of goods and services began to accept payments in e-coins, newly developed payment platforms organised parallel blockhains, cryptocurrency journalism took off, statistics websites grew in popularity, cold wallet deposits were created, and the first coin-based financial instruments were launched (late 2017), i.e. bitcoin futures and options.
And this is just a fraction of the community. E-coins have created an entire business ecosystem, replicating almost all available models in commerce and finance.