Exploring crypto assets, from understanding the distinction between cryptocurrencies and tokens to recognizing their inherent risks, is an essential journey for any individual or institution eager to participate in this rapidly evolving digital financial landscape.
The crypto 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 crypto assets.
A crypto asset can simply be described as a type of private asset that depends primarily on cryptography and DLT or similar technology as part of their perceived or inherent value. This includes consecutive types of crypto assets, namely virtual currencies, and tokens.
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.
Exploring Crypto Assets
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 to 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. Since it is issued by a central bank – and hence is a central bank liability – it could be described as a sovereign coin.
On the contrary, non-central bank digital currencies that are decentralized can be described as private coins.
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.
Just like 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.
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.
A well-known example of an investment token is Banker’s BNK token, which grants its holder a right to a weekly commitment to be paid out in the cryptocurrency Ether.
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 tokens, 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. Crypto assets 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.
Inherent Risks in Dealing with Cryptocurrencies
Various risks are inherent in dealing with cryptocurrencies, such as financial crime risks. Financial crime is generally defined as any activity that involves fraudulent or dishonest behavior for personal financial gain. Financial crime refers to all crimes committed by an individual or a group of individuals that involve taking money or other property that belongs to someone else, to obtain a financial or professional gain. The two most significant types of financial crime are money laundering and the financing of terrorism.
Financial crime is a significant ongoing challenge for institutions and individuals. As regulators and financial authorities introduce new strategies to detect and prevent financial crime, criminals develop more sophisticated methodologies to evade legal scrutiny and commit offenses, including fraud, money laundering, and the financing of terrorism. Financial institutions are also expected to participate in the fight against financial crime, by ensuring compliance with the regulations that authorities put in place at the risk of potentially severe penalties.
Financial crime ranges from basic theft or fraud committed by single individuals to large-scale, global schemes masterminded by organized criminal syndicates. Financial crime is commonly considered as covering the following offenses:
- fraud
- money laundering
- terrorist financing
- bribery and corruption
- insider trading
- cybercrime
Prevention of financial crime is a law enforcement priority in jurisdictions around the world. Below are the most significant types of financial crimes:
Fraud
The term ‘fraud’ usually includes activities such as theft, corruption, embezzlement, money laundering, bribery, insider trading, and extortion. All fraud activities are illegal and person or persons involved in these activities are categorized as criminals. In other words, using deception to dishonestly make a personal gain for oneself and/or create a loss for another is Fraud.
Fraud usually is an intentional act or series of acts which is perpetrated by human beings using trickery, and cunning using two types of misrepresentations which are a suggestion of falsehood or suppression of truth. It is primarily the responsibility of management to establish systems and controls, to prevent or detect fraud, errors, and weaknesses in internal controls.
Money Laundering
Simply spoken, the term money laundering describes the activity of concealing or disguising the identity of illegally obtained proceeds. This activity has the goal of making the illegally obtained proceeds appear to have originated from legitimate sources.
The precise definition of money laundering varies slightly in each country where it is recognized in criminal law, and it varies according to relevant organizations and standard-setting bodies, which are covered later on.
Money laundering is the processing of criminal proceeds to disguise their illegal origin. The money laundering process enables criminals to enjoy profits and funds without jeopardizing their source. When a criminal activity generates substantial profits, the individual or group involved must find a way to control the funds without attracting attention to the underlying activity or the persons involved. Criminals do this by disguising the sources, changing the form, or moving the funds to a place where they are less likely to attract attention.
Terrorism Financing
The financing of terrorism involves the provision of funds to individuals and groups to commit terrorist acts. Terrorism financing resembles money laundering in the sense that it often requires criminals to conceal the transfer of funds within the legitimate financial system.
Terrorists may use high-profile people in the country, to support them in their terrorist activities and for private gain. Terrorists may use public officials, who may abuse the authority of their public office for personal gain, which interferes with democracy and the rule of law. Corruption also may be committed by private individuals who abuse their positions for personal gain, which can hinder fair market operations and distort competition.
Terrorist financing is the provision or collection of funds with the intention that they should be used to carry out acts that support terrorists or terrorist organizations or to commit acts of terrorism. Terrorist financing includes the financing or aiding, abetting, and facilitating of terrorist acts, and terrorists and terrorist organizations. It is a collection of funds, by any means, directly or indirectly, intending to be used, in full or in part, to carry out terrorist activities.
Cyber Crime
Cybercrime is a crime that involves misuse or unauthorized access of systems, data, and information. Cybercrime such as cyberattack results in the loss of critical data and information, which causes financial losses, and reputational damages.
Cybercrime is performed by a hacker, who through malicious codes, viruses, or penetration techniques gains access to the system and information of an organization, and steals such information for ransom money or to blackmail the management to perform a particular action. The computer may have been used in the commission of a crime, or it may be the target. Cybercrime may harm someone’s security and financial health. There are many concerns surrounding cybercrime when confidential information is intercepted or disclosed, lawfully or otherwise. Internationally, both governmental and non-state actors engage in cybercrimes.
Final Thoughts
The ever-evolving world of crypto assets, spanning cryptocurrencies, tokens, and hybrid forms, has undoubtedly transformed the financial landscape. Understanding these digital assets, from private and sovereign coins to investment and utility tokens, is crucial for any investor or enthusiast. However, one must also remain vigilant about the inherent risks such as financial crime, money laundering, and cybercrime. As the market grows and matures, staying updated and educated about these dynamic assets will be paramount for navigating this complex, yet promising, financial frontier.
