By Forrest Cookson
With the passage of the Genius Act by the United States Congress, the world of cryptocurrencies has entered an entirely new phase.
This article briefly examines the significance of this pivotal development, delving into the evolution of digital finance and the profound implications of this legislation.
Money, as it is commonly understood, refers to banknotes and deposits kept in financial institutions. We use it for daily transactions and as a dependable store of value. However, over recent decades, a progressively larger share of economic life has moved online, with financial exchanges increasingly conducted electronically.
The existing system, with its financial intermediaries like banks and stock exchanges and its regulators such as central banks and securities commissions, ensures probity and stability. Yet, it has grown increasingly vulnerable to illicit activities, including money laundering, terrorist financing, and the concealment of ill-gotten gains.
The advent of the blockchain, a computer protocol that enables secure, decentralised record-keeping, fundamentally transformed this landscape. With blockchain technology, it became possible to record and track transactions without the need for an intermediary.
The protocol enables market participants to automatically verify that their transaction is both complete and secure. This innovation led directly to the introduction of Bitcoin, a new type of financial asset created through this computer programme and sold to interested parties. The asset was designed to be impervious to theft and counterfeiting.
The Rise of Bitcoin
We must distinguish between the creation, or ‘mining’, of Bitcoin and its subsequent sale. The mining process represents the supply. Once created, a Bitcoin could be purchased using conventional currencies, such as US dollars, on dedicated markets. Crucially, no interest is paid on a Bitcoin.
There are two main things a Bitcoin owner can do with their asset. The first is to sell it. The value of the coin is determined by supply and demand, and as more people purchase Bitcoins, its value increases. A holder can then sell their Bitcoin for dollars to someone who wants to acquire one. A small number of enterprises allow Bitcoin to be used for purchases, for example, a few businesses will let you buy a Tesla vehicle with Bitcoin, but for the most part, Bitcoins are held with the expectation that their value will increase.
The advent of the blockchain, a computer protocol that enables secure, decentralised record-keeping, fundamentally transformed this landscape. With blockchain technology, it became possible to record and track transactions without the need for an intermediary.
The introduction of cryptocurrencies and now the establishment of this authorised link that simplifies trading are leading the world’s financial system into a realm of great uncertainty. The recently published annual economic report from the Bank for International Settlements paints a very gloomy picture of the rapid expansion of stablecoins and the increased transactions via cryptocurrencies.
Indeed, over the last few years that this market has been in operation, Bitcoin’s value has risen significantly, exhibiting a clear upward trend despite periods of volatility.
Essentially, there are two major uses for Bitcoin. The first is pure speculation: a buyer acquires a Bitcoin at the market price, holds onto it, and, if they are fortunate, sells it three years later for a significant profit. These gains are typically not taxed, which makes them even more appealing. This strategy has proven successful so far, though, of course, there is no guarantee that the upward trend will continue. Billions of dollars have been invested in Bitcoins for this very purpose.
This behaviour is akin to how some people buy gold; there is no interest payment, but there is an expectation that its value will increase, allowing it to be sold for a profit later. This is precisely the mindset of Bitcoin holders.
The second primary use of Bitcoin is to manage money obtained illegally, allowing individuals to hide funds from the authorities. It is simple to move the asset to another location where the proceeds can be laundered, transforming it into usable money. Anyone with the technical know-how can create their own token or coin and hope that people will purchase it. With no overarching regulatory authority for Bitcoin, it remains a dangerous and highly speculative asset for investors.
Central Bank Digital Currencies and Stablecoins
The widespread proliferation of digital currencies has prompted two distinct approaches to their regulation. One path, particularly favoured in Europe, is the exploration of a digital currency issued and regulated by a central bank. The amount of money created through such a token would be firmly under the central bank’s control. The other approach, adopted in the United States, is to leave it to the private sector, albeit with a loose regulatory framework.
Out of this came the concept of a stablecoin. A stablecoin’s value is pegged to a conventional currency, for instance, one stablecoin might equal one US dollar, and is backed by that currency or a liquid, low-risk security like a US Treasury bill. Let’s assume a stablecoin issuer, let’s call them “Colored Coins,” sells coins worth £1,000 to the public. The issuer would then take the proceeds and invest them in low-risk securities, such as 90-day US government bonds. The return on these securities would be retained by the issuer, as they do not pay anything to the holder of the stablecoin. The business model for the supplier is clear.
So why would anyone purchase a stablecoin? Unlike Bitcoin, there is little to no speculative effect, and major earnings are not expected. However, stablecoins are immensely useful for various activities. They can be used to buy and sell land, for instance, or for straightforward currency transfers. They could even replace credit cards, as there would be no charge to the merchant, potentially leading to lower prices for goods.
Furthermore, stablecoins make it simple to transfer funds between countries without the constraints of foreign exchange regulations or capital controls. While the stablecoin pays no return to the holder, it makes a multitude of transactions much simpler to execute.
As the stablecoin market matures, issuers may find a way to pay a small return to holders to attract more business. For example, they could make small loans, providing coins to a borrower who would sell them and buy back extra coins in the future to repay the loan with interest.
In fact, there has been a great demand for stablecoins. Currently, more than 175 companies are issuing them, though the majority are issued by just two firms. The market capitalisation of issued stablecoins is currently around $200 billion, with major US banks projecting this figure could rise to $4 trillion by 2030.
The steady increase in sales over the last four years demonstrates this clear demand. The coins can be redeemed for their value and are backed by a low-risk reserve. The issuers of these coins generate a healthy return from the interest earned on the securities that serve as their reserves.
The Genius Act and Its Consequences
The recent passage of the Genius Act in the US establishes the ground rules for stablecoins, making many of these transactions straightforward to carry out. The regulatory requirements are deliberately light. The process for starting a stablecoin is now well-defined and will become increasingly easier as more experience is gained. As noted earlier, this could spell the end for the credit card system. It could also make the US dollar a de facto worldwide currency for major transactions.
This action by the United States has been met with considerable controversy. Some argue that it will increase the dominance of the dollar in the world economy and undermine the monetary policy of countries outside the US. It will also serve to fuel informal financial systems. There is particular concern in Europe about the impact on the Euro and the European Central Bank’s ability to maintain a consistent monetary policy.
Many central bankers worry about the threats to financial stability, believing that the US is leading the world into uncharted financial territory. While President Donald Trump’s trade policies may reduce the US balance of payments deficit, they will not diminish the global demand for the US dollar as an asset. The stablecoin may be designed to fill this gap.
All of this rests on the invention of the blockchain, which allows for the public verification and strong security of these digital assets, all while undermining the existing regulation of the financial system. The market consistently finds a way around attempts to establish regulations.
The introduction of cryptocurrencies and now the establishment of this authorised link that simplifies trading are leading the world’s financial system into a realm of great uncertainty. The recently published annual economic report from the Bank for International Settlements paints a very gloomy picture of the rapid expansion of stablecoins and the increased transactions via cryptocurrencies.
For a nation like Bangladesh, which is grappling with a collapsed banking system and stubborn inflation, the implications of cryptocurrencies are not yet clear. As mentioned earlier, this is certain to support and expand the informal credit markets that are prevalent there.
These markets are often neglected in discussions of the financial system, but they play a major role in the economy. The expansion of cryptocurrencies will provide increased foreign support for these informal systems, and the problems for the Bangladesh Bank will only grow.
In economic history, great progress often arises from the breaking up of a monopoly. The shift from the railway to the private car and truck improved the transport system. Transmission lines brought electricity everywhere, decentralising manufacturing. Splitting apart the traditional financial system will probably bring great positive changes. Until July of this year, there was no real formal regulatory framework for these coins.
So, what exactly is going on? Why are people buying these coins and what are they doing with them? For the most part, these coins are involved in cross-border transactions, which have averaged $250 billion per quarter over the past three years. This means the coins are moving back and forth from one country to another and are presumably a mechanism for a significant volume of foreign exchange transactions.
