Blockchain – Brave New World or Not?

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Robert Kay

The launch of Bitcoin in 2009 was marked by very little interest beyond a small number of computer focused libertarians. However, its ability to act as a means of transferring value globally while remaining outside the regulation and scrutiny of traditional payment mechanisms was bound to find real world use cases. These began by being focused on users seeking to avoid scrutiny of their payments and what they were buying and selling. But slowly and surely the story was taken into more mainstream discussion and thence to a period of excessive enthusiasm for what was presented as a new way of doing practically anything. Having languished at less than $1,000 for most of its existence, the price of Bitcoin peaked at $20,000 in December 2018. It then entered the expected slough of investor despond as it failed to get back to that level until almost exactly two years later. Regulatory intrusion, most specifically by the SEC, was one reason for the loss of enthusiasm, as were a series of government backed initiatives to properly review the phenomenon of cryptocurrencies and use of distributed ledger technology.

Though it may not have felt like it to the most bullish enthusiasts, the process of properly looking at cryptocurrencies professionally was not a bad thing. In 2021, the subject once again entered the mainstream with new acronyms from DAO’s to NFT’s involving ERC-20 tokens and terminology like DeFi and CeFi. Once again focus was on the wonders of decentralization offering freedom from tired outmoded centralized structures. With Bitcoin now at more than $40,000 (having peaked at more than $60,000) it is clear that a lot of money has been made, and lost. The announcement of a lawsuit by ‘investors’ against a group of high-profile social media influencers (including Kim Kardashian) will no doubt be the precursor of others, as losers seek to recover some of the money they have lost from whoever they think they can.

Who can be pursued, for what supposed crimes and in which jurisdictions, seems destined to be a major talking point in future. Some of the 14,000+ of start-up businesses that have issued tokens to both individuals and institutions will inevitably prove to be worthless, fraudulent or both. In trying to determine what cases might be possible it is important to identify whether any of these decentralized ideas are genuinely new, and hence requiring specific legislation, or are rather old ideas wrapped in new, technologically sophisticated, clothes.

While there are many elements to consider and a lot of different approaches that could be taken, this article will focus on non-fungible tokens (NFTs). Initially these were issued as a way to raise money by founders wishing to undertake a wide variety of new businesses. Their apparent, and for a while real, advantage was that they were issued directly to buyers without any kind of oversight or review by anyone. This was seen as ‘democratisation’ of a venture capital process previously dominated by wealthy individuals and institutional investors. Regulators, most forcefully the SEC, decided that tokens, which basically involved participation in the value of business enterprises, are securities.

Once again, the apparent setback was in fact a benefit as it made it somewhat, but not that much, harder to separate fools from their money. The fact that the ‘rag pull’ (issuing tokens and then disappearing) is still a regular event in these markets, suggests that effective regulation still has some way to go. This is not surprising given the genuinely global nature of token issuers and individual buyers. While there remains a fringe element arguing that not all NFTs should be seen as securities, for most individuals and institutions the position is clear.

Compared with the traditional venture capital world, the key difference between tokens and shares is the fact that tokens can be and are traded from the outset. Given the volatile nature of the value of the underlying businesses, the trading activity is ripe for exploitation. It should be expected that all of the techniques used to manipulate regular share trading in listed markets such as the LSE will be copied in the new world. The case against social media influencers noted above is a classic ‘pump and dump’ case in the eyes of those initiating it. Insider trading is also thought to be rife in these markets, though with so much commentary taking place away from mainstream arenas, that may be hard to prove. All of that is before the opportunities for market abuse such as ramping, spoofing, front running, wash trading etc. are considered.

Legal actions seem inevitable as investors, issuers and traders (individual and institutional) seek fairness. The need for custodians, registrars and other protective ‘centralising’ intermediaries may be determined by lawmakers and politicians in response to individual losses. Or perhaps not. Many individual investors seem to treat token investments much like gambling; taking part for the sake of being involved and accepting the losses as the price to get the enjoyment from participating in a social event. A democratisation of Royal Ascot rather than venture capital. Given the breadth of potential jurisdiction issues, not to mention different definitions of the supposed ‘crimes’, may make it all too hard especially if no one wants to admit to their losses.

Should legal cases be brought, what will probably be lacking is disinterested independent knowledge. Cryptocurrencies evoke strong views, whether in favour or against, and a growing number of individuals and institutions are now direct participants in these markets, in many instances making good returns. The party may have some time to run.