by Lucas Ewing
In the waning months of 2017, it was difficult to ignore the events surrounding bitcoin and a handful of other cryptocurrencies. During what many called a “bubble,” trading volume in cryptocurrencies skyrocketed, with bitcoin leading the pack. At its height, a single bitcoin could be traded for about $20,000—nearly 25 times its value just one year prior. While other cryptocurrencies fetched a much lower dollar value, they followed the same trajectory. The price of crypto has fallen substantially since its apex in December, but the price remains many times greater than this time last year.
During this crypto-craze, many economists and financiers have warned against investing in crypto, claiming that the recent events represent a speculative bubble and that cryptos have no socially beneficial value. While the rapid rise and fall in the price of crypto does bear the typical signs of a bubble, there may be more value to be found in these new technologies than mere speculation; blockchain and decentralized networks have the potential to create new legal frameworks and enforcement.
In this post, I offer an explanation for why cryptocurrencies may not be in ‘a bubble.’ Specifically, two factors may cause the value of cryptocurrencies to remain stable: increased transparency and reduced need for third-party enforcement.
Fraud and Transparency
The major development that ushered in the crypto revolution and crypto’s subsequent popularity was the invention of the blockchain. In a now-famous white paper, Satoshi Nakamoto proposed a solution to the problem of double spending by floating the idea of tying a currency to a public ledger containing every transaction and the wallet address of every existing coin. To use this currency, a user must possess a ledger that matches every other ledger in the user base. By ensuring that every user agrees on the location of every bitcoin, it is both impossible for any single user to double dip on a transaction and unnecessary to maintain a centralized intermediary. While large scale thefts are still possible, was revolutionary in that it helped garner the trust of its user base without relying on a centralized authority. By changing the architecture of the network, Nakamoto eliminated the need for coercive enforcement in this area. The benefits of this development are made manifest from the fact that a user’s coins are not beholden to a third party, and that users do not have to support the costs of an enforcer, as no enforcement is needed.
The blockchain, with its inherently transparent nature, spawned further development on top of it. Innovators began to think, “if we can ensure strictly monetary transactions on a decentralized network, maybe we can do the same for more complicated transactions.”
Every cryptocurrency is backed up by a public ledger (i.e., the blockchain), which contains an exhaustive history of every coin that exists and every time that coin has changed hands between users. The ledger is populated by a list of wallet addresses (crypto coins are stored in users’ wallets), which are encoded by a randomly generated string of letters and numbers. Accordingly, users can permanently encode any string of letters into the blockchain by presenting it as a (fake) wallet address. For example, a user can enter a transfer of .000001 BTC to the address “15gHNr4TCKmhHDEG31L2XFNvpnEcnPSQvd.” That “transfer” never goes through because the wallet address is not valid (wallet addresses are randomly generated when a user acquires a wallet, so the odds of this string correlating to a real user’s wallet are infinitesimally low), but the ledger encodes this address as a hex code (334E656C736F6E2D4D616E64656C612E6A70673F). In this example, the hex code is translated to Unicode, and reads as “3Nelson-Mandela.jpg”. Now you have successfully encoded a picture of Nelson Mandela into every bitcoin user’s ledger for the entire future of the bitcoin community.
In the same way, two users can encode the terms of a contract directly into the blockchain where payment is only transferred upon fulfillment of those terms. Alternatively, under what some have dubbed a “smart legal contract,” the legal terms are outlined in a real-world contract, and only the enforcement mechanism is coded into the blockchain. Again, by using the blockchain, there is no need for a third party to enforce the contract.
In addition, the blockchain has numerous other advantages. First, certain parties may derive value from the fact that the blockchain allows contracting parties to remain largely anonymous—they are only identified by their wallet addresses. Second, blockchain technology could allow users to enter into contracts with a machine. For example, the blockchain could permit a self-driving car to receive payments from passengers or pay for its own fuel. Third, the blockchain may facilitate the creation of unique organizational structures; entities like OpenBazaar already run on the blockchain. OpenBazaar is similar to Ebay, but because it runs on the blockchain, there is no corporation at the center that processes transactions. Instead, sellers transact directly with buyers. Last, the prospect of smart contracts is so alluring that programmers have designed cryptocurrencies with the express goal of facilitating commercial agreements using blockchain technology. Ethereum is the most well-known of these, and although it is only 2 years old, it has quickly garnered popular support with a market cap second only to that of bitcoin. The Canadian government even announced on January 20 that its National Research Council will begin publishing funding and grant information on the Ethereum blockchain. One of the tenets of democracy is transparency for its citizens, and democratic institutions are starting to take note of how blockchain technology can promote that goal.
Along with Cardano and NEO (5th and 8th largest market caps, respectively), the newest and most popular cryptocurrencies are those that focus on the prospect of smart contracts and are designed to facilitate their use. It is clear from market behavior that investors find value in crypto, not necessarily as a store of value, but as an advanced medium of exchange that represents an improvement on services like Paypal or Venmo.
It is hard to argue that the recent trends in crypto are not a bubble, but it is equally difficult to argue that crypto does not have value. Blockchain technology allows a cryptocurrency’s user base to assess, approve, and enforce transactions. By relying on the community, crypto eliminates the need for middle-men, and creates the potential for smart contracts, which replace law with code. As such, crypto creates value by reducing fraud and eliminating the costs of intermediaries.
One positive result of the recent “bubble” is that it increased financial backing for innovators and programmers who are interested in improving the original bitcoin technology. A slew of altcoins (cryptos that are not bitcoin) have recently arisen, claiming faster and cheaper transactions, better privacy, and more tailored purposes than traditional currency. Certainly, the bullish prices are not likely to last, but claims that crypto has no value may be overblown.
*Disclaimer: The Colorado Technology Law Journal Blog contains the personal opinions of its authors and hosts, and do not necessarily reflect the official position of CTLJ.