Solutions need to solve problems By Andrew Tottenham, Managing Director, Tottenham & Co November 4, 2020 at 7:02 pm Three years ago, I wrote an article, “Gambling on the Blockchain,” about blockchain technology and cryptocurrencies. Three years later, most of what I wrote has stood the tests of time. Today, there is still a lot of hype around blockchain and cryptocurrency technology. PayPal recently announced that it will accept cryptocurrencies. But I stand by what I wrote, that blockchain technology has a significant place in our society, though its use in gambling and the current cryptocurrencies are a solution trying to find a problem. The gist of the article was that blockchain technology has its place and could be very powerful for confirming the veracity of ownership or record, but as a solution to replace fiat currencies or to verify gambling transactions, it is not so useful. There are also inherent security risks, but more about that later. After the article was published, I received numerous responses arguing that cryptocurrencies would replace fiat currencies. They fell into three broad themes: Nobody trusts currencies backed by governments; the technology is better; and cryptocurrencies provide privacy. These arguments, whilst they may be correct, do not mean that they will or should be accepted in the real world in their current form. And none argued for blockchain as a means to verify and guarantee gambling transactions. When it comes to trust, do we have confidence in “real-world money” and the systems used to govern its storage and transfer? Obviously, we do. Normally, and certainly in the days of the pandemic, we are quite happy to tap a card on a reader to pay for a coffee, a meal, some groceries and the like. When the transactions get larger, further layers of security are required, such as PINs, verification codes, etc. And when they are very large, other security, escrow accounts and the like, comes into play. Nobody really likes retail banks. We take most of what they do for granted, get upset with the fees they charge and only really interact when things go wrong. But we do, on the whole, trust banks to receive our money, look after it and pay it out only when we request them to. It helps that governments have required insurance to be put in place, so that if a bank goes bankrupt, not all of their customers’ money is at risk. Crypto requires people to hold money in a “wallet” that is only accessible using a private key, a series of digits. If you lose or forget the private key, you are out of luck and if it gets stolen, the same applies. Remember, whoever holds the private key holds the Bitcoin and once it is out of your account, you have no way to get it back. Transferring cryptocurrency requires an exchange and people need to trust exchanges to do what they say they will, just as we do with banks. Some exchanges have been hacked and last year, $350 million was stolen from four exchanges. This is small by comparison to bank fraud, but banks will refund money if they determine it was taken fraudulently. Also, it does not build confidence when some exchanges have been charged with money laundering and fraud. For example, the U.S. government has filed civil and criminal charges against one of the world’s largest cryptocurrency exchanges, BitMEX, and four of its top executives. Governments or the “independent” boards they have put in place to determine and implement monetary policy do not want to lose control of the money supply. It is too important to allow the Bitcoin algorithm to determine the amount of money in circulation. How would governments raise money, especially when they are currently creating it like it is going out of style? Is “better technology” a reason why cryptocurrency should be adopted? “More sophisticated” or “more clever” would be better descriptions. Those of us old enough to remember Betamax and VHS know that “better” is no reason at all. Betamax was easily better, but that was an argument over content and VHS won. Much better technologies give a more accurate representation of music than the compressed-file format, mp3. Yet mp3 and its successors rule the day. The “better” technology is confined to a niche audience. There is always trade-off between convenience and price. People used to think that the largest TV screen with the most pixels was the thing to have. Some still do. But many are quite happy to watch films, read books and get news on mobile phones and tablets. It is really a question of usefulness rather than “better”. Cryptocurrencies’ values against fiat currencies are highly volatile. Many people I talk to who own cryptocurrencies do so as an investment; they talk about how much money they have made. But like gambling, few talk about their losses! And none talks about using it as a means for transactions. As a payment mechanism, it is not convenient, so it is just not that useful. Most people earn their money in real-world currencies and have real-world bills to pay. Paying with a cryptocurrency requires exchanging their hard-earned money for crypto or the seller of the goods or services to take the risk on the exchange rate and they too have real-world bills to pay. The exchanges rates vary considerably and if you earn your money in real-word currency, you don’t know from one day to the next how much something will cost you. If cryptocurrencies do become in widespread use, the exchange rate volatility should calm down. But isn’t it easier to pay with a credit or debit card? One of the arguments put forward in support of crypto is that if anonymity is a concern for law enforcement, the exchanges could verify the identity of account holders and the people party to the transactions. Because every transaction includes the account address of the parties involved, albeit in encrypted form, it would not be impossible to determine where the money was going. Who would police the exchanges to make sure they are carrying out the Know Your Customer protocols, so that nobody could be anonymous? Sounds very like the Commodity Futures Trading Commission (CFTC) in the U.S. and in the UK the Prudential Regulation Authority or the Financial Conduct Authority. In fact, the civil action taken against BitMEX was done so by the CFTC. Currently, most crypto transactions are anonymous. The technology allows for value to be moved around without showing who owns it, although there is a permanent record of the transaction, albeit with no names attached to the accounts. But if some of the records are out of the reach of regulators or law enforcement, it is an ideal vehicle for money laundering. Proceeds of crime can be and are easily laundered which is why it is a darling of the dark web. The U.S. government reaction to cryptocurrencies is similar to that of online gambling: If we cannot control and suppress online gambling, we will control the money going in and coming out. In 2006, the Unlawful Internet Gambling Enforcement Act, or UIGEA, made facilitating transactions for illegal online gambling an illegal act. The banks immediately tightened up their policing of transactions and U.S.-facing gambling sites found it difficult — not impossible, but difficult and expensive — to do business there. U.S. citizens are not supposed to trade on offshore crypto exchanges. Meanwhile, exchanges resident in the U.S. must carry out full Know Your Customer checks. Anonymous transactions are a thing of the past on those exchanges that are regulated. The U.S. Department of Justice is taking aim at the cryptocurrency industry. And finally, the U.S. Internal Revenue Service is interested. On the front page of U.S. citizens’ annual tax declaration, it now asks, “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” The next step is having to provide the details. Those who were hoping that crypto would provide privacy will be disappointed.