Since the inception of Bitcoin in 2009, cryptocurrencies (digital or virtual currencies) have become increasingly popular.
According to the Financial Conduct Authority (FCA), around 2.3 million adults in the UK owned crypto assets in 2020, up from 1.9 million in the previous year.
As a result, the number of exchanges where consumers can buy and trade crypto has increased, though the market remains dominated by established exchanges, such as Binance and Coinbase, the largest two exchanges by daily trading volume.
According to a survey conducted by the FCA, only 5% of British crypto holders who bought it online did so exclusively on UK-based exchanges, while 83% used solely non-UK based ones.
Considering the low number of crypto holders in the UK, this represents a significant opportunity for UK-based exchanges to increase their market share.
Centralised exchanges, like Binance, are expected to have recorded over US$14 trillion (£10.2 trillion) in trading volume during 2021, up an estimated 689% on the previous year, according to The Block Research.
This growth is likely due to people spending more time online, an increase in celebrity involvement, higher interest in non-fungible tokens (NFTs), a rise in use cases and spikes in the value of cryptocurrencies.
Blockchain technology
Bitcoin is built upon blockchain technology. A blockchain is a database whereby information is stored electronically in blocks that are linked together using cryptography. In the case of Bitcoin, it is a decentralised blockchain, which is immutable. This means that when a transaction is executed, it is irreversible and can be viewed by anyone. Another characteristic of a decentralised blockchain is that no single person or group can take control and all users of the network share and retain control.
NFTs are another blockchain-based technology that have increased in popularity, particularly during 2021. An NFT can be almost anything digital, including pictures, music and videos, though the majority of NFTs have taken the form of digital artwork.
Collections such as Bored Ape Yacht Club and CryptoPunks have gained notoriety, with celebrities such as Eminem, Serena Williams and Jimmy Fallon owing NFTs from these collections. So far, the most expensive CryptoPunk collectable sold for US$11.75 million (£8.59 million).
In the crypto-sphere, the Ethereum blockchain is the most popular for NFTs, accounting for over 90% of the NFT volume during 2021, according to crypto-based venture fund 1Confirmation.
Although Ethereum is popular in the NFT scene, other networks boast higher numbers of daily transactions. For example, 3.9 million transactions were recorded on the Hedera Hashgraph network on 10 January 2022, compared with just 1.2 million on the Ethereum network. Additionally, as Hedera is a third-generation crypto technology and uses the hashgraph consensus mechanism, it can achieve significantly improved performance at a lower cost.
Hedera has a number of well-known partners, such as IBM, PwC, and Deloitte, and is governed by 39 council members to ensure decentralisation. At the time of writing, council members include EDF Energy, LG, Google, IBM, Boeing, London School of Economics and Tata Communications. This wide range of companies and organisations reflects the versatility of blockchain technology.
One case study currently listed by Hedera is Dropp, a payment services solution provider. Blockchain technology offers a high level of security, fast transaction speeds and cheap transaction fees, which makes it a perfect solution for payment services, as no minimum transaction amount is required.
Another case study listed is Australia-based Datahash, a full-service supply chain solution that ensures the authenticity of agricultural products. This platform offers a solution to wine fraud, which costs US$3 billion (£2.2 billion) a year, according to independent expert Maureen Downey. From vine to bottle, each step in the supply chain is monitored and recorded on the blockchain with a signature and timestamp at each stage. This allows all participants in the supply chain to view and verify at each stage, increasing trust and ensuring authenticity.
While Datahash currently uses this process in wine and dairy production, this process could be applied to other commodities, such as the production of precious metals, to ensure materials are sourced ethically.
Similarly, Infinite by Suku is a digital identity issuance and management platform aimed at creating NFTs that represent the authenticity of both physical and digital goods. This aims to tackle the issue of counterfeit goods in the marketplace and increase trust between buyers and sellers. While this use case is focused on the sale of trainers and other apparel, it could be used in auctions and other secondary markets to prove authenticity.
Disruptive uses
While crypto technology is only in its infancy, the number of possible use cases is rapidly rising. NFT technology could prove a major disruptor for many industries, particularly music production.
When an NFT is created, the number of ‘copies’ is pre-set, and royalties can be set by the creator. If an artist releases a song or album as an NFT, they would be able to fix the supply, and would earn royalties each time one of their NFTs were traded through smart contracts stored within the blockchain. Essentially, this would cut out record labels.
In January 2022, rapper Nas announced he would be selling the royalty rights to two of his songs as NFTs and in March 2021, Kings of Leon was the first band to launch an NFT album, generating over US$2 million (£1.5 million) in sales.
With reference to art work, NFTs would allow artists to benefit more from their creations, as they would be able to continue to earn royalties each and every time their art was traded, not just the first time they sold it.
In March 2021, artist Beeple sold an NFT for US$69.3 million (£50.7 million), making it the most expensive NFT sold to a single buyer. In December 2021, an NFT created by artist Pak sold for US$91.8 million (£67.1 million), though this was bought collectively by just under 30,000 collectors.
Furthermore, since an NFT can be used as a proof of ownership, there is a huge potential for almost anything requiring a contract or proof of ownership to become an NFT or to be verified on the blockchain, such as the deed to real estate or proof of ownership for vehicles. In the future, this has the potential to be a major disruptor to the real estate industry, though currently, the regulatory environment surrounding crypto technology requires development.
NFT technology also poses a threat to computer game publishing , as NFTs can be used in ‘play to earn’ games. One example is Gods Unchained, a card- and strategy-based NFT game. Crypto-based casinos also exist, both in online platforms and in the metaverse, an online virtual reality environment. For instance, Decentral Games operates free-to-play online casinos whereby players must own NFTs to be eligible to play. This has the potential to disrupt the Online Gambling Services and Casinos industries.
Risky investment
Despite the benefits and use cases of crypto and NFT technology, these investments are still considered high risk by the FCA. The FCA banned the sale of crypto-derivatives to retail customers in October 2020 and issued a warning to retail investors about the risks associated with crypto asset-related investments in January 2021. The FCA even issued a formal warning about Binance Markets Ltd in June 2021, banning it from operating in the UK, which resulted in many banks stopping customers from making payments to crypto trading platforms.
As the current regulatory environment is behind the curve, almost anyone can set up a basic crypto asset and scam the consumers purchasing it.
Blockchain analysis firm Chainalysis reports that US$14 billion (£10.2 billion) in cryptocurrency was taken in hacks and scams over 2021, with the majority of this coming from decentralised finance protocols.
In September 2021, Chair of the Securities and Exchange Commission Gary Gensler described cryptocurrency markets as the ‘Wild West’ due to its uncertainty and volatility . In the previous month, Gensler called cryptocurrency investments ‘rife with fraud, scams and abuse’.
Consequently, despite the benefits and opportunities offered by crypto in both consumer and commercial markets, crypto assets still pose a significant degree of risk in the current regulatory environment.
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