Understanding blockchain and crypto-currencies is going to be fundamental for financial services companies and with 2024 set to be pivotal year in this market, could dictate who will be the winners and losers in the years ahead, explains Duncan Moir, senior investment manager, Alternatives, abrdn
It’s common for some corporate leaders to speak with great excitement about the impact blockchain, and other forms of distributed ledger technology (DLT), can have on their businesses, yet in the same breath with disdain for cryptocurrencies, equating them to speculation, fraud, and pictures of spaced-out monkeys.
Indeed, several events over the last few years have augmented this narrative, including large-scale fraud at FTX, collapse of several lenders and hedge funds, as well as pump-and-dump schemes. However, these sorts of acts are not exclusive to cryptocurrencies, and have been perhaps just as prevalent in traditional finance over the years. As the digital landscape continues to evolve, it’s critical for enterprises to recognise the intrinsic link between cryptocurrencies and blockchain.
Cryptocurrencies are central to the functioning of most public blockchains (public blockchains are those that can be used broadly by anyone, although they are not all built equal and differ in governance approach, with varying levels of “enterprise attractiveness”). They are the payment mechanism for use of the respective blockchain and provide an incentive for both innovation of the technology and to those that help secure the networks.
The prominence of Bitcoin, the primary long-term use case of which is as a store of value, has led to a belief that cryptocurrencies have no real intrinsic value and are only traded by speculators. This is reinforced by volatile price movements, meme coins (such as Dogecoin) and social media-led rocket emojis and “to the moon!” proclamations.
In reality, most cryptocurrencies have a much less exciting, but extremely important purpose. Many large corporations (e.g. Visa, PayPal, SocGen, EDF to name a few) already use public blockchains today, and when they do so, they make payments (sometimes referred to as “gas” fees), either directly or indirectly in the native cryptocurrency of that blockchain. Payments are distributed amongst the individuals or entities that help to operate and govern the blockchain network.
One such group that receive payments are those running ‘nodes’ (think, loosely, ‘computers’) that validate transactions on the network to make technology updates, ensure fair ordering, and prevent malicious activity.
Proof-of-stake blockchains (the most prevalent) are secured through decentralisation of these nodes, who “stake” their cryptocurrency as their right to operate the network. The more nodes, with more evenly distributed stakes, the more secure the network as it reduces the ability to “attack” the network from a node. The cryptocurrency payment is therefore a mechanism to secure a public blockchain network by incentivising node operation.
Individuals who own the cryptocurrency but do not want to run a node (which in some cases can be complex) may stake their cryptocurrency to an existing node, receiving a portion of that node’s reward payment, and further enhancing security.
Of course, blockchains that do not require payments in cryptocurrencies, but instead are paid for in fiat (or at least digital fiat if we want to maintain the operational efficiencies of blockchain) are possible. Private blockchains are a good example of this and are more akin to software-as-a-service models. However, there is fundamental benefit of cryptocurrencies that is not easily replaced here, and that is the incentive they create to innovate.
Many blockchains have a finite, or at least controlled, supply of cryptocurrency. As a particular blockchain sees greater adoption, there will be increased demand for its cryptocurrency to pay for the use, which should place upward pressure on the value of that cryptocurrency. This creates an incentive for blockchain entrepreneurs and developers, who are typically remunerated in the native cryptocurrency, to innovate further and give their blockchain a competitive advantage over others.
Without cryptocurrencies, you create no real incentive for entrepreneurs to build innovative blockchain technology. You create no incentive for groups to operate blockchain networks and ensure its security.
Yes, as stated previously cryptocurrency-free “private” blockchains exist and have been used successfully by several companies to create operational efficiencies. But it’s unlikely that true innovation can come from the use of these. The real prize for most businesses will come from developing on public blockchains, which offer the ability to scale products and services through access to a wide, global audience.
The traditional corporate world needs to progress their understanding of blockchain technology and cryptocurrencies beyond the headlines. In financial services, where this rhetoric is most common, corporate leaders that fail to evolve will be left behind by the more advanced financial institutions, who are already on a path to public blockchain adoption. Fortunately, there is still time to close the gap but, with 2024 set to be a big year for blockchain adoption, they should make the most of the opportunity now.
