Why Digital Assets will revolutionise the financial world
I won’t go into detail about what blockchain is and why it’s arguably one of the most groundbreaking innovations of the last century (if you still don’t know what it is please see here, here or here and buy this… if anything you’ll be able to hold your own at dinner parties).
What I am far more interested in regards the latest, and arguably the more promising application of blockchain technology: digital assets.
First things first
The issue with blockchain is that people immediately associate it with Bitcoin, which in turn seems to create a mental block which most find insurmountable.
So before I get to digital assets, let me attempt to explain that while it is important (and fascinating) to understand what Bitcoin is, it is largely irrelevant when it comes to why it now has any value. That’s because, conceptually, we struggle to truly understand what currencies are or why we’re happy to use a piece of paper as means of exchange. So please bear with me as I condense everything I know about currencies into two paragraphs to try and help you get passed this, so we can focus on what’s more interesting.
Pounds, dollars or even gold have value only in our common imagination. Their worth is not inherent in the chemical or digital structure of the metal, paper or code they are made in, nor their colour or shape. Money isn’t a material reality — it is a mental construct. We are willing to accept it as payment for services, time and/or effort simply because we trust explicitly the figments of our collective minds. We tell ourselves it has value because someone else is willing to attribute a value to it, and they only value it because someone else attributes a value to it and so on and so forth. We trust that someone will be willing to exchange something for the “currency” we in turn receive for something else. If there was no collective trust, the medium used as a means of exchange (whatever form it takes) would not be considered a currency.
Trust, therefore, is the raw material from which all money, including Bitcoin and other cryptocurrencies, is minted*. Whether you think Bitcoin is a silly fad or the future is up to how much trust you put in others and the general ecosystem. Nothing more. If enough people believe in it and are prepared to exchange goods and services for it, so will you.
But back to the matter at hand.
Digital assets are a more recent development in the use of blockchain technology. Up to this point, coins (or tokens) have only really had value in our collective minds, since they represent nothing real.
Enter coloured-coins.
Digital Asset 1.0: The Coloured-Coin Protocol
Coloured-coins were the first foray into digital assets. Created partly to overcome the collective imagination problem of getting everyone to believe that something had value. Issuers of coins decided to “colour-in” a specific Bitcoin with a real-world underlying asset (e.g. gold, shares, dollars etc).
The issuer of this coin then guarantees to hand over the underlying real-world asset to the person who returns that specific coin. The value of the coin is nothing more than a proxy for the real-world underlying asset. No need for collective imagination since we can all look up the price of e.g. gold!
What this means is that (for example) the Bank of England could issue a colored coin in the same way as it prints paper money; it would take a fraction of a Bitcoin and then insert the ‘’I Owe You’’ statement you find on a regular bank note, for the sum of say £5. The holder of this coloured-coin could then walk into a bank and exchange it for a £5 note if they wanted to, or alternatively spend it online or in a shop.
The same mechanism can be used for any other financial claim such as shares or even home ownership. Colored coins are different in nature than cryptocurrencies, because they have a specific issuer and are backed by a real financial asset.
The only issue with coloured-coins is that they are nothing more than a digital representation on the blockchain of an asset that exists and is traded in the real world. The underlying asset does not itself reside on the blockchain, and is therefore not governed by its rules.
Take a coloured-coin backed by e.g. 100 BP shares traded on the London Stock Exchange. The issue is that these shares have been issued in the real world and are therefore subject to, and governed by, whatever central authority oversaw their original creation and issuance (in this instance HMRC and the FCA). When it came time to hand over your coloured-coin in exchange for the BP shares you were guaranteed, that central authority who would validate the change in ownership could simply dispute it (for whatever reason) and you would not be the legal owner of the shares. Tough luck.
While this is not an issue in developed countries, as long as you comply with regulations and laws; in less “lawful” areas of the world where private property is often confiscated you can imagine the issues this might represent.
Digital Assets 2.0: the Asset Coin Protocol?
Asset-coins on the other hand are coins that represent a claim on an underlying asset or service whose existence resides exclusively on the blockchain.
Conceptually and legally this is more challenging for existing real-world financial assets, as legal ownership (as well as its rules defining transfer etc) are firmly rooted with central authorities and is likely to remain the case for the foreseeable future.
However, for the emerging consumer-to-consumer market, smart contracts, voting rights, subscriptions, vouchers/coupons and even smart property this could have very interesting applications and ramifications.
Let us take a simple example: concert/event tickets. Most of us at some point in our lives will have bought a ticket off someone (either the internet or through a friend). We typically receive a PDF, printed ticket or even a screenshot. The problem is we have no way of knowing whether the seller has already sold this ticket to others, whether it was his to sell or if its a fake.
If Coldplay where to issue concert tickets in the form of a digital asset coin (“Coldplay Ticket Coin”), where each coin represented a ticket, anyone wanting to sell it on would have to transfer/sell that digital asset coin via the blockchain (since it was created on the blockchain in the first instance), meaning the holder could never duplicate it (i.e. sell it to many people) and it would be very easy to check who actually owned that ticket and if they had the right to sell it.
Coldplay could even limit the re-sell price of their tickets (hardwired into the code) to ensure people weren’t having to pay £1,000’s to see them live (a big problem with the current market is that people buy tickets simply to re-sell them at a hugely inflated price, meaning that concerts are increasingly out of reach for most people).
Implications and Conclusions
While the idea of a “synthetic” exposure to a real world financial asset is nothing new (derivatives have been around for decades), the use of blockchain /distributed ledger technologies means that finally, we have the means of democratising and de-cenrtalising the issuance, trading and management of financial (and non-financial) assets and services, in a way that is safe, secure, legally binding and more importantly cost effective.
The initial issuance of financial assets will likely remain the responsibility of central authorisites for the time being, but nothing now prevents a number of non-traditional players from issuing coloured-coins backed by a single, several or a basket of real world assets which can be traded and even redeemed for “cash” far quicker and easily than it would take me to sell my BP shares to a third party (the recent plethora of Initial Coin Offerings (ICOs) is testament to how quickly the market has been to embrace this technology**).
If done properly, the use of digital assets via the bockchain could herald an era of increased transparency, openness and auditability pivotal to a fairer and more open economy; as well as offering access to a generation locked out of the investment and financial markets.
Please feel free to share your thoughts or make comments below — I’d love to hear your thoughts and opinions on the topic
@conradholmboe
#DigitalAssets #Bitcoin #DistributedLedgerTechnology #Blockchain
* Source: the Ascent of Money, Sapiens — recommended reading for anyone wanting to understand money)
**but also why it needs regulation
