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Understanding Cryptocurrencies and Non-Fungible Tokens

Posted in Crypto Asset Compliance on May 16, 2024
Cryptocurrencies And Non-Fungible Tokens

Cryptocurrencies and non-fungible tokens (NFTs) are two innovative and emerging technologies that have made waves in the digital world. While both of these technologies are often discussed in the same breath, they have some fundamental differences that set them apart. In this essay, we will discuss the basics of cryptocurrencies and NFTs, their similarities and differences, and the potential implications of their growing popularity.

The cryptocurrency market has changed significantly over the last few years. Two of the most notable developments are the massive growth of the number of so-called private tokens issued on existing platforms to raise funds and the emergence of so-called stable coins. These trends have caused various regulatory authorities, standard-setting bodies, and industry professionals to shift their focus and expand their vocabulary from the term cryptocurrencies to the broader term of crypto assets.

Cryptocurrencies or coins, such as Bitcoin and Litecoin, are those crypto assets that are designed or intended to perform the roles of currency, which means to function as a medium of exchange, a store of value, and a unit of account. They are intended to constitute a peer-to-peer alternative to government-issued legal tender.

Cryptocurrencies can be characterized in numerous different ways and we will look at two of them. In particular, we will look at private versus sovereign coins and stable or backed versus non-stable coins.

Cryptocurrencies And Non-Fungible Tokens

Understanding Cryptocurrencies and Non-Fungible Tokens

The Private versus sovereign coins. The emergence and growing popularity of cryptocurrencies and their underlying technology have inspired various central banks to investigate whether it would make sense for them to issue their digital currencies, for wholesale purposes, or as a complement for physical banknotes and coins. These digital currencies are commonly referred to as central bank digital currencies or CBDC.

Simply put, a CBDC is a digital asset or a digitalized instrument issued by a central bank for payment and settlement, in either retail or wholesale transactions. Because it is issued by a central bank and represents a liability for that bank, it is considered a sovereign coin.

On contrary, non-central bank digital currencies that are decentralized can be described as private coins.

The Stable coins versus non-stable coins. The first wave of cryptocurrencies, which began with Bitcoin and hundreds of subsequent Bitcoin clones, are de-facto considered by their users as something of value. They do not represent any underlying asset, claim, or liability, making them prone to high price volatility. They are what could be called traditional non-backed cryptocurrencies.

The highly volatile nature of traditional non-backed cryptocurrencies makes it very hard for them to truly perform the roles of currency and to become more widely adopted as such.

Several cryptocurrency advocates have recognized that the severe price volatility of the first wave of cryptocurrencies is indeed a major hurdle for their acceptance as a means of payment and store of value. They have tried to address the issue at hand by introducing so-called stable coins.

Simply put, a stablecoin is a variant or subcategory of cryptocurrencies typically pegged or linked to the price of another asset or a pool of assets, designed to maintain a stable value. Like traditional non-backed cryptocurrencies, stablecoins are intended to perform the roles of currency.

Traditional non-backed cryptocurrencies are generally decentralized and do not have an identifiable issuer or at least not an institution that can easily be held accountable by or to the coin’s users. Stablecoins on the other hand, typically represent a claim on a specific issuer or underlying assets or funds, or some other right or interest. They are, in other words, backed by something and not just perceived to be something of value. Examples of stablecoins that are already in circulation are Tether, Multi-collateral DAI, and Gemini Dollar, among several others.

And then, there are Token. Tokens, on the other hand, are those crypto assets that offer their holders certain economic or consumption rights. Broadly speaking, they are digital representations of interests or rights to access certain assets, products, or services. Tokens are typically issued on an existing platform or blockchain to either raise capital for new entrepreneurial projects or to fund start-ups or the development of new innovative services.

There is currently more than one category of cryptocurrencies, there is also more than one category of tokens. Tokens can take on different forms with diverse features. Since their conception, different approaches have been developed to classify and define them. Generally speaking, most regulatory authorities tend to distinguish so-called investment or security tokens from so-called utility tokens.

Cryptocurrencies And Non-Fungible Tokens

What is investment Tokes. Investment tokens, which are sometimes also referred to as security tokens or asset tokens, are those tokens that typically provide their holder’s rights in the form of ownership rights or entitlements that are similar to dividends.

Investment tokens are generally issued for capital raising, for example through an initial coin offering, and show similarities to traditional debt and equity instruments.

Secondly, there are Utility Tokens. Utility tokens are those tokens that grant their holders access to a specific application, product or service often provided through a blockchain-type infrastructure. They typically only provide access to a product or service developed by the token issuer and are not accepted as a means of payment for other products or services.

Some examples of utility tokens include Golem and Filecoin, which both facilitate access to a specific service: Golem grants access to computing power and Filecoin to data storage.

Like investment tokens, utility tokens are also issued to collect financial resources, usually to fund the development of the issuer’s application, product, or service. However, unlike investment tokens, their main purpose is not to generate future cash flows for investors, but to grant access to the issuer’s application, product, or service, and at the same time create a user base.

Besides cryptocurrencies and tokes, there are also hybrids. While it is theoretically feasible to draw a clear dividing line between cryptocurrencies and tokens, and, diving deeper into the latter category, investment and utility tokens, in practice it is not always easy to fit a crypto asset into one or the other category.

This is because crypto-assets can exhibit features of more than one category. Cryptoassets that embody such a combination are commonly referred to as hybrids and raise particular regulatory challenges. An example of a hybrid token, more specifically an investment-utility hybrid, is Crypterium, which is used to pay transaction fees when using the services provided by the issuer, gives the right to discounts for future services, and gives a right to revenues.

Before we finish this video, I want to briefly note that this taxonomy is not carved in stone. This is, after all, a snapshot of what is out there now. The crypto market continues to evolve, so what holds today, may require an update in the future. Now if you have any further questions, please let me know. Otherwise, thanks for watching, and see you in the next video.

NFTs

NFT stands for Non-fungible token. Non-fungible” more or less means that it’s unique and can’t be replaced with something else. For example, a bitcoin is fungible which means trade one for another bitcoin, and you will have the same thing. FATF describes NFTs as “digital assets that are unique, rather than interchangeable, and that are in practice used as collectibles rather than as payment or investment instruments.” 

As per FATF, digital assets that are unique, rather than interchangeable, and that are in practice used as collectibles rather than as payment or investment instruments, can be referred to as non-fungible tokens (NFT) or crypto-collectibles. It is important to consider the nature of the NFT and its function in practice and not what terminology or marketing terms are used. Some NFTs that on their face do not appear to constitute VAs may fall under the VA definition if they are to be used for payment or investment purposes in practice. 

Other NFTs are digital representations of other financial assets already covered by the FATF Standards. Such assets are therefore excluded from the FATF definition of VA but would be covered by the FATF Standards as that type of financial asset. Given that the VA space is rapidly evolving, the functional approach is particularly relevant in the context of NFTs and other similar digital assets. Countries should therefore consider the application of the FATF Standards to NFTs on a case-by-case basis. 

NFTs are unique cryptographic tokens that exist on a blockchain and cannot be replicated. NFTs can represent real-world items like artwork and real estate. “Tokenizing” these real-world tangible assets makes buying, selling, and trading them more efficient while reducing the probability of fraud. NFTs can also function to represent individuals’ identities, property rights, and more.

Non-fungible tokens (NFTs) are cryptographic assets on a blockchain with unique identification codes and metadata that distinguish them from each other. Unlike cryptocurrencies, they cannot be traded or exchanged at equivalency. This differs from fungible tokens like cryptocurrencies, which are identical to each other and, therefore, can serve as a medium for commercial transactions.

Cryptocurrencies And Non-Fungible Tokens

The distinct construction of each NFT has the potential for several use cases. For example, they are an ideal vehicle to digitally represent physical assets like property and artwork. Because they are based on blockchains, NFTs can also work to remove intermediaries and connect artists with audiences or for identity management. NFTs can remove intermediaries, simplify transactions, and create new markets.

Much of the current market for NFTs is centered around the collectibles, such as digital artwork, sports cards, and rarities. Perhaps the most hyped space is NBA Top Shot, a place to collect non-fungible tokenized NBA moments in digital card form. Some of these cards have sold for millions of dollars.

NFTs shift the crypto paradigm by making each token unique and irreplaceable, thereby making it impossible for one non-fungible token to be equal to another. They are digital representations of assets and have been likened to digital passports because each token contains a unique, non-transferable identity to distinguish it from other tokens. They are also extensible, meaning you can combine one NFT with another to “breed” a third, unique NFT.

Final Thoughts

Cryptocurrencies and NFTs are two emerging technologies that have the potential to revolutionize the way we think about finance, art, and digital ownership. While they have some similarities, they are fundamentally different in terms of their purpose and use cases. As these technologies continue to evolve, it will be interesting to see how they are adopted and integrated into our daily lives.