The Rise of a Fossil Fuel Backed Cryptocurrency?

One of the most important things to remember about a digital currency is that it is just a way of transferring ownership and assets electronically. In fact, for those who are scrambling to understand both cryptocurrency and blockchain, this idea is the first, and unfortunately all too often, the only port of call. That said, it is a decent place to start.

Cryptocurrency uses a decentralized digital communications “protocol” called blockchain to facilitate value transfer extremely efficiently. As a result, the largest banks and governments are now taking it seriously. There are also multiple ideas being developed about how this technology should be used, and what types of assets can be valued and transferred, which has also attracted the interest of the largest energy companies and telcos.

It was inevitable, then, that someone would come up with a way to align the world’s existing fossil fuel reserves with a form of cryptocurrency, enabling a new form of digital currency backed by energy as collateral, rather than gold or any other kind of asset.

In today’s global economy, the US dollar acts as a global currency because that is what barrels of oil are priced in and have been since 1971. It is also why some OPEC states, such as Venezuela, have tried to change the “oil-currency” from dollars to euros. The impact of the current setup is that U.S. monetary policy can have a huge influence on the rest of the world.

This is no doubt one of the reasons, beyond the implications of Brexit and England’s search for a new place in the world, that inspired the London-based entrepreneurs behind Bilur, and helped them attract funding.

Bilur, as described in industry press in early May, is a “new Ethereum-based cryptocurrency that wants to compete with Bitcoin.”

According to founder Ignacio Ozcariz, the CEO of RFinTech, the company behind Bilur, he hopes to create an oil-based cryptocurrency. In his words “[c]rude oil and its derivatives … have been running [the world] during the last wave of the industrial revolution. All of them are primarily energy vectors that, jointly, with the flow of energy in the form of electricity, have driven the unstoppable 20th-century technological revolution. So why not consider energy as the new monetary standard, as it is the base for the technological world.”

This is already a key issue at the heart of existing cryptocurrencies like Bitcoin and Ethereum. Many people support the use and development of these cryptocurrencies because they are theoretically beyond the control of government. In order to control a cryptocurrency, a government would need to invest substantial energy, time, money and programmers in order to fundamentally change the rules of the system. And this illustrates the key issue clearly. Cryptocurrency and blockchain cannot be divorced from a concept of energy as currency. It takes energy to allow the computations to occur. This system cost is then priced into all cyber currency transactions. It is like a minimal processing fee, or ATM charge, for accessing the system.

Energy backed cryptocurrency is entering a new phase because of the debate about global warming. Bilur’s value is tied to oil, but solar is already a considerable player in many parts of the world. That includes in OPEC countries that are struggling to wean their economies off fossil fuel (starting with Saudi Arabia). It also includes India, China and Germany. Connected to blockchain technology, solar energy can be monetized efficiently. This is a field that is taking off, particularly in Europe and China. As a result, a solar-backed cryptocurrency would make a lot of sense. Rather than selling “carbon credits” to allow firms to emit pollution, a “clean currency” might be a better solution for both consumers and investors.

What Does This All Mean?

Regardless of the feasibility of a fossil-fuel backed or gold backed cyber currency (there is a high profile effort afoot in the UK to create a gold-backed UK Royal Mind Gold token), these examples illustrate one thing: cryptocurrency creates a new platform for the next phase of value exchange in a tech-driven globally-connected world.

The ability to generate, transfer, swap and monetize “energy” will be very valuable in the world we are entering. This is also known loosely as the “shared” or “peer-to-peer” economy. There will be multiple attempts to create new currencies. There already have been. Many of those new cryptocurrencies will be backed by an asset in the real world in order to give them a tangible value. However, as with Bilur, the idea that such endeavours are based on ether serves to put a dollar value on “energy/computing time” already. This is because most holders of ether buy them in dollars, and energy or calculated computations of machine time are the basis for Ethereum in the first place.

It is easy to understand why this will be so important. Blockchain connected devices are powered by energy. That energy has to be paid for, and calculating what that energy is worth is going to be the first, most basic discussion. Why? Well, you cannot hook up a block of gold or a barrel of oil to a digital network and get it to work. You can, however, hook up an electric car, washing machine, mobile phone, or solar charging device.

With shifting global currents, unstable national governments, and economic flows of capital between different parts of an increasingly globalised world, it is clear that initiatives to create a new global currency (or several of them) will continue to attract attention, and venture funding.

Here is what investors, market commentators and regulators need to remember. The value of Bilur is tied to oil. Despite Trump’s call to return to a world driven by fossil fuel, however, energy markets and cryptocurrencies based on them are meeting a new age. Questions about valuation and worth of assets – taking into account negative externalities like carbon emissions and the energy cost of accessing the system with them – will dominate market formation, rules and the digital networks upon which all will depend.

Marguerite Arnold is the founder of MedPayRx, a blockchain healthcare startup in Frankfurt. She is also an author, journalist and has just obtained her EMBA from the Frankfurt School of Finance and Management.

Image: Pexels

Investing In Cryptocurrency

Cryptocurrencies are digital assets or “tokens” – akin to the idea of money – specifically designed to take advantage of the architecture of the Internet. Unlike traditional currency they have value not because of the guarantee of a financial institution or government. Instead, they have value for three reasons: their ability to be accurately “confirmed” by the computers on a particular network, the value that is placed (or misplaced) on them by the market, and as a consistent way to measure the price of goods within a blockchain network.

Cryptocurrency versus traditional currency

In some ways, cryptocurrency works very similarly to a traditional currency or a precious metal like gold. The worth of the US dollar, for example, as a means of exchange, is valued not only in term of what a dollar can buy in real terms, but also by its relative worth against other currencies.

A key difference, however, between traditional currency and cryptocurrency, despite Bitcoin’s recognition as an “asset” by the IRS and as an accepted currency by the EU, is that the supply of cryptocurrency is not controlled by a central bank, but rather reflects the actions and perceptions of many independent individuals across a large number of jurisdictions. This has the potential to upend basic models of political economy of the last century (if not the last several hundred years of Western history).

Bitcoins, for example, are mined at a predetermined rate each time a user of the network discovers a new block (currently 12.5 bitcoins are created approximately every ten minutes) and the number of bitcoins generated per block decreases over time. Ultimately, the total number of bitcoins in existence is never supposed to exceed 21 million.

The real impact of Bitcoin beyond the hype is that it has the potential to diminish the need for central banks. It also has the potential to reduce the role of financial intermediaries like retail banks. Cryptocurrency was designed as a form of electronic cash to allow individuals to transact without going through a financial institution. This is likely to have a profound impact on the global financial system, financial markets, and the banking industry.

When it comes to buying other kinds of cryptocurrency, such as Ether, which was not created as a traditional “currency” but rather to pay for computations along the Ethereum network, the investment analysis becomes more complicated. In a very real sense, the “value” of Ether is more like the cost of a barrel of oil, a watt of electricity or any other mineral that must be “mined” or processed in some way, and then used to make a piece of machinery function – in this case a computer.

Cryptocurrencies are not immune from market forces or monetary policy, starting with the fact that you still need traditional currency to buy them. Ultimately, the buying power and inherent value of a cryptocurrency will be affected by the real economy including by things like inflation, exchange rates, global electricity prices, and the speed of the computing networks through which the cryptocurrency is created, traded and transferred. In the case of Bitcoin, for example, a market price is created against traditional currencies like the US dollar and renminbi because the main buyers of Bitcoin do so in dollars and yuan. To the extent that the value of these traditional currencies continue to fall with inflation, the price of Bitcoin will continue to rise over time.

Investment risks

The value of cryptocurrencies are not controlled the same way that fiat currencies are, for example by a decision of a central bank to increase the money supply. However, the cost of the resources that are used to create, price and transfer cryptocurrency may still be controlled on a national basis.

Potential investors should carefully consider the risks of cryptocurrency investing, some of which are listed below:

  1. Lack of Adoption: There are many cryptocurrencies in existence. The more people that use a particular cryptocurrency, the more likely it is that other people will be willing to use it also. In short, this means that cryptocurrencies benefit from “network effects”. Investors need to be aware that if a cryptocurrency fails to gain critical mass, or if it is superseded by a technically superior or more popular cryptocurrency, then its value may decline rapidly.
  2. Market Volatility: Potential investors in bitcoin would be wise to tread cautiously given the high levels of volatility in bitcoin’s market price over the last few years. This means that even if you are correct about the long term direction of bitcoin’s market price, you could still lose money in the short run. As John Maynard Keynes noted “the market can remain irrational longer than you can remain solvent.” Potential investors should keep in mind that purchasing bitcoin with the hope of achieving short term capital gains is a form of high risk speculation, similar to gambling. Professional traders manage this kind of market risk by following the “2% rule”; a trading practice which suggests that an investor should never commit more than 2% of her total capital to any one trade. Further, manipulations of the price and supply of bitcoin have occurred regularly.
  3. Security Risk: Cryptocurrency is digital, and so there are risks posed by hackers, malware, or system failures. For example, anyone who has the private key to a bitcoin account can transfer bitcoins in that account to any other account. This poses a significant risk since all bitcoin transactions are permanent and irreversible. Many experts recommend storing bitcoin in a digital wallet that is not connected to the Internet.
  4. Increased Regulation: Cryptocurrency could be a competitor to traditional currency, and may be used for black market transactions, capital flight or tax evasion. There is also no reason why a government could not move to control the supply of a cryptocurrency in the future either by passing legislating, buying up enough of it to change the rules, or by incentivising programmers to change them.
  5. Lack of Liquidity: Liquidity refers to how easy it is to quickly convert an asset into cash without a significant drop in the market price. The more difficult it is to buy and sell a cryptocurrency, the greater the risk for an investor if they need to sell in a hurry. Bitcoin can be traded on various bitcoin exchanges, which makes it easier to buy and sell, however it has still not achieved mainstream adoption.

So, where should you invest?

The question of what cryptocurrency to invest in is a loaded one. It depends what one’s goals are. If the aim in buying cryptocurrency is to use it to buy specific goods and services, or to transfer money from one place to another, then the purpose is very different from someone who is merely trying to make money by speculating in the short term volatility of a cryptocurrency’s market price.

As the above discussion indicates, there are many issues to consider. For that reason, investing in a cryptocurrency is a far more complicated decision than investing in other kinds of assets – and the risks of the same are also not yet fully and widely understood. Tread cautiously.

Marguerite Arnold is an entrepreneur, author and third semester EMBA candidate at the Frankfurt School of Finance and Management.

Image: Pexel

What Is Cryptocurrency?

While “Bitcoin” has become a household word over the past several years, the concept of what cryptocurrency actually is goes far beyond traditional concepts of “money”.

First invented by the individual or group of people known as Satoshi Nakamoto in 2009, the original concept was to create a decentralized automated cash machine (in very simplified form) that would allow anyone to send assets of value to any other person whereby those assets would not need to pass through or be controlled by any financial intermediary. In other words, it was an attempt to build another kind of currency uncontrolled by any central bank or government. Further, such transactions would be recorded by the computers connected to the network so that they could be verified by anyone who had access to it.

When seen as “money” cryptocurrencies pose a very real challenge to the role of central banks in that they essentially establish a new way for value to be created and transferred – globally.

How many cryptocurrencies are there?

At this point, there are too many to count.

Cryptocurrency is given value both by its creation (or mining) and by the other tools that are used to store, access, transfer, trade and transact with it. For example, Bitcoin, which is the oldest form of digital currency, is now traded on exchanges. Its reflected value is usually calculated either against the dollar or the yuan (which most people use to “buy” Bitcoins).

However, it is also not quite that simple. The inherent monetary value of Bitcoin as expressed in traditional currency terms is also impacted by how many people want to hold Bitcoins at a certain point in time (for whatever reason) and further by how many people are using Bitcoin for some other purpose (for example, transferring Bitcoin to another place or using it to buy another asset).

That said, the way that institutional entities (such as the IRS in the United States or the European Union) recognize Bitcoin as a form of “asset” is very much reflected in their understanding of cryptocurrencies as a form of “cash” or monetary asset, valued by reference to local currency. In other words, the inherent value of Bitcoin as understood from the perspective of agencies and governments who recognize and use fiat currency is to treat Bitcoin’s value as an asset understood in terms of local fiat currency – as if Bitcoin’s entire “value” was like dollars, gold or oil.

The two most widely recognized forms of cryptocurrency that are commoditized currently are Bitcoin, which is the oldest and most recognized form of cryptocurrency, and Ether – the “gas” as it were that makes the Ethereum network tick.

What is the inherent “asset value” of Cryptocurrency?

The short answer is that there isn’t one. It can be the value assigned to the currency by what is paid to acquire it, what kind of other asset worth it can be used to buy, how much it costs to create or “mine” such currency, or the perception of its worth based on its scarcity or expected future value.

Ether, as much as it is beginning to be traded, was not envisioned as a “currency” but rather a way to pay for computer processing power to effect another transaction along the Ethereum network. “Digital tokens”, of which Ether is an example, can be priced by the amount of electricity and computing time necessary to either create them or to perform a specific function along the network (such as recording a transaction). In other words, “cryptocurrency” is the juice which allows connected devices to do what they were programmed to do.

It remains to be seen how cryptocurrencies will affect national economies – in fact, the concept of what a traditional economy is could easily be upended (which is the fear of the central banks). Regulation of cryptocurrencies is still beyond the reach, if not ability, of traditional economic controls. This is part of the allure of cryptocurrency. What its ultimate asset value will be, however, is still very much an unknown and incalculable concept.

Marguerite Arnold is an entrepreneur, author and third semester EMBA candidate at the Frankfurt School of Finance and Management.

What Is Blockchain? A Beginner’s Guide

The year 2017, for everything else it may or may not be, is already heralded as “The Year of Blockchain.” But what exactly is “blockchain” – and why is it slated to be the debutante of the ball across multiple industries?

Essentially blockchain is a way of connecting distributed databases to each other. In other words, it connects databases on machines that are not otherwise connected to each other in one firm or location. Further, it is also a way for these databases to “talk” to each other – to issue and receive commands and data in both encrypted and hashed form to accomplish functions or tasks. Blockchain is, in effect, a new kind of database, which writes “ledger entries” in different locations, but which can then be accessed by the network of computers to confirm that transactions did occur and reconcile these transactions.

It creates what is widely known as a “trustless” network – in other words, it removes the need for trusted third parties like banks or financial institutions to “enter” or reconcile entries, however this is a bit of a misnomer. The role that was formerly played by trusted third parties is now being played by the blockchain network itself. The “trust” that is implied is that the network is stable and the code – or protocols – of the network can in fact function as they are intended to. While blockchain may remove the need for trusted third party institutions, some of the newer blockchains (including Ripple) are based on the idea of “trusted” or “authorized” parties transferring data to one another. This allows a preselected group of “trusted parties” – in this case banks – to lower transactions costs, reduce the chance of fraud and remain competitive while creating in effect a private network.

The most revolutionary aspect of blockchain is that it moves the role of verification (of a task, payment or other action) from a single entity (such as a government or corporation) to multiple computers along its network. While a government or corporate entity (or even single person with enough wealth and power) could conceivably buy the majority of Bitcoins on the Bitcoin network and then hire programmers to change the rules of the network according to its own mandate, this is currently seen as a remote possibility.

The medium of exchange in the world of blockchain is cryptocurrency – tokens that have some value determined either by (a) direct market forces as in the case of Bitcoin or Ether, or (b) by the cost of the computing power required to produce them – in which case they is known as either a “tokens” or “altcoins”.

The workhorse of blockchain is the “smart contract” – which is just another way of saying that after a token has been “paid” for a particular purpose, then a certain action or transaction is triggered. For example, if Jane wants to send Bob five Bitcoins, she can utilize the Bitcoin network to do so (as long as she and Bob both have “wallets” connected to the network) and further, a record of that transaction will be recorded in all the computers in the network. If Jane is expecting to receive, in exchange for those five Bitcoins, ten shares of Bob’s company stock, he will be required to send her the digital token assuring her that the shares have been transferred to her before he can accept the five Bitcoins.

According to Nick Szabo, a cryptographer and “father” of smart contracts, an idea which he explored in a paper published in 1998, smart contracts are “a set of promises agreed to in a meeting of the minds [which] is the traditional way to formalize a relationship.”

Said another way, smart contracts work within the protocols (or algorithms) created to link the chain of databases together, to execute how such computers communicate with each other.

There are many different use cases for this kind of technology – although it has made its first impact in the world of finance. According to the Chamber of Digital Commerce, which has just published a report “Smart Contracts: 12 Use Cases for Business and Beyond” the industries (beyond finance) which are likely to see rapid deployment of the technology in the near future range from a further development of the concept in the financial industry to insurance and the healthcare industry.

What deployment of blockchain technology really means in the immediate future, is that the world will become more interconnected, that manual processes in many industries will be automated, and that the “costs” associated with these transactions will fall dramatically.

That said, it is far too early to predict what the adoption of blockchain will accomplish – just as it was essentially impossible to see where and how the Internet would change the nature of communication and community.

Suffice it to say, however, that by 2020, the world will already be a very different place because of blockchain’s deployment. By 2025, according to top consultants like Deloitte [pdf], the banking industry (at a minimum) will be profoundly disrupted.

Marguerite Arnold is an entrepreneur, author and third semester EMBA candidate at the Frankfurt School of Finance and Management.