Category: Cryptocurrencies

NFTs – Are they just a balloon?

In an economy, the standard categorization of assets is divisible and non-divisible. We could categorize all FIAT currencies, gold, land, etc., into divisible assets – everything we could divide into smaller chunks. On the other hand, a non-divisible asset is an asset that we can not divide legally – for example; we can not cut a piece from a painting and sell only it. The same is true for apartments, buildings, collectibles, etc. A unique number or id usually identifies both types of assets, but assets of non-divisible kinds sometimes could only have one copy.

We can see many parallels if we return to the crypto world and translate between the previous paragraph and the different tokens offered by the various crypto exchanges. In crypto, we call all divisible tokens “fungible”. Examples of such tokens are bitcoins, etheriums, and any other cryptocurrency. To verify transactions over the set of these tokens, we use the nature of how blockchain networks work. Every transaction is cryptographically signed, and one transaction keeps the metadata for the tokens transfer between two or more wallets. Usually, in this metadata, we store the unique id of the divisible token (when we split the token, we typically generate a new id/number for every part of the split).

You can see how financial people distinguish the fungible and non-fungible tokens/assets on the diagram. The non-fungible is usually a unique piece of art or collectible

The programming logic used to implement the described set of features is called a smart contract, and it could be described as a daemon program (for people who are not aware of the terminology, this is a service program running in the background), which operations could be stored into the ledger storage and are cryptographically signed. So essentially, when we transfer tokens, we call this program and its API.

Let’s return to NFTs now. Essentially, NFT means non-fungible token and is a non-divisible asset by its logic. Every NFT has a unique ID similar to the standard tokens and could be transferred between owners. There is a slight difference that we can not divide them, and currently, the protocol does not support multiple owners of the same NFT. Additionally, unlike standard tokens, NFTs could be emitted only by manual intervention but not auto-generated by the protocol itself as rewards.

A more profound analysis of the described behavior could give us the insights that NFS was designed to replace the standard legal contract by enabling the parties to upload their deal’s metadata into the blockchain. And thus to probably avoid the use of notary or at least to digitalize their work.

But how does this transfer to digital arts and collectibles? Usually, digital art is a digital file in some format (most of the time, we speak about images, but this could be a whole game model into a video game, for example). And copying a digital file is one of the basic operations we are taught when using computers. And here comes the help from cryptography – we could easily calculate a hash of the file, generate a random id for it, and sign them from the issuer name. This way, an artist could upload their file multiple times and offer a unique NFT for every file copy.

In conclusion – NFTs’ way of working is quite promising. With some will coming from governments around the World, it could easily automize and speed up the performance of different legal frameworks. Additionally, it would increase the visibility and clarity of how they work. At the same time – unfortunately, the way use it, aka selling pictures of cats and game models, is a little bit speculative. Unfortunately, it inherits some of the disadvantages of traditional fungible tokens, especially the problem with the emission of new assets into the network.

Smart Contracts: Mission Possible

In the last article for 2021, I shall touch on one of the exciting topics in technology for the last decade. For sure, with its novel approach, blockchain technology managed to change and shape our technical landscape during that period. These days crypto is brutally adopted, and many people use cryptocurrencies every day. Additionally, we could see the mass adoption of NFT and how it changed the art industry. We saw many platforms making ICO as a replacement for IPO. All of these would not be possible without blockchain.

But what is blockchain? Essentially, blockchain is an append-only database system in which every transaction is cryptographically signed. Your digital identity is presented by a pair of public/private keys. The algorithms use these keys to encrypt/decrypt and sign/verify the data coming into and out of the database. These same keys are used to identify your wallet in the standard crypto-currencies world. However, a traditional key/value database system is not enough for real-world usage, which is why almost all blockchain networks now offer smart contracts. 

Every smart contract is a programming object with a lifecycle happening in the blockchain network. Additionally, every interaction with it is recorded and cryptographically signed with the same set of public/private keys used for your digital wallet. With such capabilities and a way for sending money, the blockchain networks offer pretty exciting opportunities:

You can see a standard workflow of using a smart contract on the diagram. The seller and buyer provide data to the code deployed in the blockchain, and it is executed to fulfill the contract
  • Replacement of standard contracts: In one ideal World, crypto would dominate people’s legal operations. It has all the tools for doing that, and many platforms, including IBM’s Hyperledger, offer such capabilities. Instead of signing on paper, people use digital signatures, and the system’s distributed nature ensures that no malicious modification can happen.
  • E-voting: Many people believe that we could replace the standard paper-based voting system entirely with the progress of zero-knowledge proof protocols. Indeed, the technology is promising and could offer genuine authenticity during the voting experience in the future. However, its current state (aka not supporting actual programming language experience) is hardly helpful for anything other than checking a simple boolean expression.
  • Decentralized Economy: In our current capitalism-based world, the parties issuing the money control the market. With the rise of crypto, that’s no longer true because now everyone can start issuing tokens and dictating how the market operates. And this is extremely helpful for smaller communities, which can detach themselves from the centralized issuing authority.

In conclusion, blockchain is quite existing technology, but unfortunately, it is still not mature enough for mass adoption. The main concern is that it is still possible to track the money transfers and identify the real people behind the public/private key pairs despite being anonymous. The same is true for smart contracts and e-voting – for sure, no one is going to be happy if people have access to her/his real estate’s notarial act or know for whom he/she voted. 

How cryptocurrencies can help small communities?

One of the things I like the most about the cryptocurrencies model is that it gives an alternative. An alternative to the standard financial model, where you have a centralized certification authority and issuer, which issues new coins, banknotes, or whatever is the name of the payment object for the payment system. One big problem with that system is that it leads to centralization and naturally converts the places with issuer rights (aka central banks) into cosmopolitan districts. The traditional banking system gives them much more economic power than the smaller and more rural communities.

In comparison with cryptocurrencies, everyone can open a bank. We even can choose whether to have a distributed or centralized issuing model. In Bitcoin, for example, the issuing model is a distributed one, and this choice regularly leads to significant fluctuations in the exchange rates with the standard fiat-based currencies. Additionally, there is a cap on the number of Bitcoins, which can be issued, and this way, there is no realistic option for fighting inflation or even speculations. Having that in mind, I think we could agree that the Bitcoin model is far from ideal and could only play a digital alternative for gold, which automatically means that Bitcoin is not a currency in the traditional sense.

On the diagram, you can see a standard blockchain architecture, where the ledger is distributed, leading to distributed transaction signing and verification

Let’s analyze what will happen with the other model of a centralized issuer and no cap for issuing new coins. Still, it is essential to note that the transaction verification will remain distributed, such as in Bitcoin, but we will centralize only the issuing part. For sure, the model will need a legal way to inject itself into the standard fiat financial model and play nicely with it. At the same time, if we want to increase the local communities’ economic power, we shall need a solid local legal government-based entity doing the coin generation. And such a legal entity is the local area municipality.

Such an idea will effectively transform every municipality into a local central bank issuing new coins based on the economic stats for the metropolitan area governed by it. Additionally, at the moment, all the taxes are sent to the centralized bank. Once per year, the government decides how to distribute these taxes to all different city areas’ budgets. As an alternative, with the proposed model, we could choose to receive 30% of our income in the local municipality cryptocurrency and even pay our taxes on this 30% to the local municipality-based bank. Furthermore, the municipality could use this money to plan its budget.

In conclusion, cryptocurrencies can give us quite interesting financial alternatives. For sure, the exchange rates system between the different local municipality-based currencies will be an exciting problem to solve. However, we should keep in mind that we are already solving this problem globally, and we could take inspiration from how it is already solved. Some smaller cities and towns already tried issuing their cryptocurrencies. But, without the local taxes part, such endeavors are not economically viable and will not lead to any mass scale change.

The fail of ICO as a financial alternative to traditional stock exchanges

The killer of IPO, the new fintech revolution, the path to decentralization – all of these were the nicknames of ICO. But, what is an ICO? The initial coin offering (ICO) is a financial mechanism for a company to raise new capital. Usually, the reason for that event is to fund new services or business opportunities. Sometimes is to provide an alternative for financing early-stage digital innovations through crypto-assets.

Failure of ICO

Unfortunately, an initial coin offering is not always successful in attracting enough traction and investment. According to official research, around 800 cryptocurrencies are declared dead since 2018. It is a considerable decline in trust in ICO. 

Some examples of initial coin offering failures;

  • Swiss coin: Swisscoin was designed for a broad audience and the needs of small investors and traders. Using Swisscoin was to build up a payment system in which soon over a billion people will participate. However, it failed, and there is no traction for the last three years.
  • Enigma: Enigma is a decentralized data marketplace protocol and cryptocurrency created by a team of Massachusetts Institute of Technology graduates and researchers and incubated at MIT Media Lab. The Enigma protocol is a second-layer, off-chain network that aims to solve scalability and privacy issues on the blockchain. However, they got hacked.
  • The DAO:  The DAO was a decentralized autonomous organization (DAO) launched in 2016 on the Ethereum blockchain. After raising $150 million worth of ether (ETH) through a token sale, The DAO was hacked due to vulnerabilities in its codebase. The Ethereum blockchain was eventually hard forked to restore the stolen funds. However, not all parties agreed with this decision, which resulted in the network splitting into two distinct blockchains: Ethereum and Ethereum Classic.
To participate in ICO, people must have crypto wallets. After the initial coin offering, the coin is usually transferred to your wallet. You can use them to pay for something as soon as someone is ready to take your tokens.

Is the presence of an IPO the reason for the failure of ICO?

Yes! The main reason behind the failure of ICO is IPO. Most investors trust IPO instead of ICO. Companies do not back Bitcoin and Ethereum, so they are more community-based, which is entirely another financial mechanism. In the case of IPO and ICO, we usually speak about investors. Primarily, ICO deals with early investors who are interested in investing in new projects. However, most investors think that ICO is less reliable than IPO because of two reasons:

  • No regulation: To list your company on the stock exchange and make an IPO, your company must endure an exceptionally detailed and harsh financial audit. With ICO, this is not the case. There is no regulation, and you have to believe in the company owners’ words and vision.
  • No attachments: In case of company bankruptcy, there are legal attachments between the shareholders and the company owners with IPO. With ICO, this is not the case. If the currency is dead, there are no legal consequences.

In conclusion, I am personally a big fan of cryptocurrencies as technology. However, from the financial point of view, they are a little bit of a nightmare. Without regulation and centralized authority, you can not control inflation. And unfortunately, a community-based cryptocurrency will most probably end the same way as Bitcoin and Ethereum are behaving at the moment.