If the sudden demise in the price of Bitcoin — from almost US$20,000 in late 2017 to about $3,600 in early January 2019, erasing some $200 billion in market value — becomes the measure of the extent to which cryptocurrencies and other blockchain manifestations will fulfill their oft-vaunted potential, the future doesn’t augur well for the technology.
“Bitcoin was conceived as a peer-to-peer technology aimed at facilitating direct currency transactions without government intervention,” says Robert Dawkins, a partner in Borden Ladner Gervais LLP’s Vancouver office. “It has not realized that dream, nor do I think that it ever will.”
Quite apart from its wide fluctuations in value, which is not a characteristic investors are fond of in assessing currencies, Bitcoin has so far not been able to shake off the simple reality that the technology is slow.
“You’re not going to get the public to buy coffee with Bitcoin if it takes 45 minutes to pay for it,” Dawkins says.
However that may be, jumping from the conclusion that Bitcoin will never replace our financial payment system to a doomsday scenario for blockchain’s future may be as hasty as the drop in the price of Bitcoin was sudden.
That’s because blockchain comes in many incarnations and applies to the world as we know it; it’s also a new application of an old technology.
“The layer that blockchain adds is called hashing, the process that ensures the blockchain’s integrity,” Dawkins explains. “Otherwise, you’re just talking about storage blocks.”
Interestingly, blockchain’s most telling inroads so far have been in the financial services industry, which originally perceived the technology as a threat to their status as intermediaries in the financial process.
“Blockchain is increasingly being used in new and innovative ways for banking purposes,” says Dawkins’ partner Ross McGowan.
Since 2015, banking and financial services companies around the world — including Commonwealth Bank of Australia, BMO, Société Générale, State Street, CIBC, RBC, TD Bank, Mitsubishi UFJ Financial Group, BNY Mellon, Wells Fargo, Mizuho Bank, Nordea Group, ING Group, UniCredit, Commerzbank, and Macquarie Group — have been investing in blockchain. Most recently, in November 2018, a dozen banks that included HSBC, BNP Paribas and Standard Chartered launched eTrade Connect, a new blockchain trade finance platform, aimed at reducing the time needed to approve international trade loan applications from 36 to four hours.
In the US, Intercontinental Exchange, the parent of the New York Stock Exchange, is awaiting approval from the Commodity Futures Trading Commission for its cryptoasset exchange, Bakkt, which is designed to let customers buy, sell, store and spend cryptocurrencies. Meanwhile, in February 2018, the Canadian Securities Exchange announced the introduction of a securities clearing and settlement platform built on blockchain. The platform — an intersection of digital assets with traditional financial products — will allow companies to issue conventional equity and debt through tokenized securities.
Otherwise, blockchain technology has already been applied to medical records, land registry holdings, digital identity and diamond sales, and even law firms have hopped on the bandwagon. Fasken Martineau DuMoulin LLP, for example, is a founding member of the Global Legal Blockchain Consortium, a non-profit organization aimed at setting operating and governance standards for the adoption of the technology in the profession. And Gowling WLG (Canada) LLP has formed a strategic alliance with Toronto-based Decentral Inc., in an alliance intended to “optimize the many commercial and legal applications of blockchain technology.”
Still, given the number of investors who have been wiped out by Bitcoin’s wild ride, legitimate questions are being asked whether investment in blockchain technology and cryptocurrency is now beyond potential backers’ risk appetites.
For his part, Dawkins believes that Bitcoin is too big to fail.
“It’s true that integrating Bitcoin into our economy is hideously complex,” he says. “But there’s so much money in it already that if it falls away, the consequences would be enormous.”
Michael Gokturk, CEO of Einstein Exchange, a Vancouver-based platform for digital currency exchange that boasts one of the world’s largest trading volumes, says the absence of regulation has much to do with the rise and fall of Bitcoin.
“There was a point where it was a lot easier to finance a start-up cryptocurrency or blockchain project than to invest in a project that was regulated,” he says. “But so much money was raised that the regulators started squirming, and with that came a fear of regulation that affected the market.”
Gokturk, who pointedly recalls the days when Amazon was trading at $1.50, maintains that the “great blockchain projects will survive and the 80% that are weak will die.” Still, he concedes that blockchain innovation has had a significant setback.
“A lot of people are saying, ‘I dabbled, I lost and I’m out,’” he says. “So my belief is that we’re now three to five years away from seeing a new burst of innovation.”
Burst aside, however, there are clear signs that the blockchain phenomenon is steadily marching onward.
Dawkins, for example, sees Ethereum’s technology, fuelled by tokens called “ether,” as far more interesting than Bitcoin.
“Ether has great potential because it is intended to support a whole business ecosystem, rather than just functioning as a cryptocurrency,” Dawkins says.
By way of explanation, Ethereum is a public, distributed ledger, blockchain-based operating system that generates ether, a cryptocurrency that can be transferred between accounts on the blockchain and used to pay for the computational resources needed to run a particular application or program. Put another way, ether is the currency in which someone using or accessing the Ethereum blockchain pays for its processing power.
Among Ethereum’s most promising features is its smart contract functionality, which can reduce the cost of paper-intensive transactions significantly. Here’s how Don and Alex Tapscott, co-authors of Blockchain Revolution: How the Technology Behind Bitcoin Is Changing Money, Business, and the World, describe the technology:
“Smart contracts are a form of a program that gives certain conditions and outcomes to money. If there is a transaction between two people, this program can be used to help verify the product or service and whether or not it was fulfilled. Once it has been verified, it can then be transferred to the person’s account.”
Mark Walport, the United Kingdom’s Government Chief Scientific Adviser until 2017, has said that smart contracts can provide “cryptographic certainty that [an] agreement has been honoured in the ledgers, databases or accounts of all parties.”
From this perspective, the applications seem endless. According to Timothy Hill, technology policy adviser at the Law Society of England and Wales, smart contracts “could be used to declare wills, transfer property or create self-executing contracts.”
The fact that Bitcoin may not replace banks, cash, credit cards and the like, then, may be disappointing to some and affect its value deleteriously in the short and medium term, but it is not necessarily fatal to its prospects.
“It’s still very early days,” says Usman Sheikh in Gowling WLG's Toronto office, and national head of the firm’s Blockchain and Smart Contract Group. “It’s important to remember that the internet also didn’t appear in one moment, but only after many years of development.”
Indeed, the evidence available suggests that a solid foundation for blockchain’s emergence continues to exist. As Osler, Hoskin & Harcourt LLP points out in the firm’s 2018 Legal Year in Review:
“Despite the dramatic market swing and the decline of the [initial coin offering], institutional interest in the major cryptoassets, particularly bitcoin, continues to grow, albeit cautiously. We view this as consistent with expanded regulatory oversight of cryptoassets, and we anticipate that institutions will increasingly enter the space as regulators clarify their positions with respect to cryptoassets.”
Here, Osler points to the “many announcements by companies hoping to provide the infrastructure necessary to serve” this institutional interest. The firm cites companies such as Coinbase and BitGo that have developed “cryptoasset custody solutions organized as regulated trust companies” that are intended to satisfy regulatory requirements applicable to institutional investors dealing in cryptoassets. Major financial intermediaries such as Fidelity and ICE are also planning cryptoasset trading platforms aimed at institutional investors.
Osler’s conclusion is that Canadian financial institutions, which remain concerned about money laundering and fraud, are cautious about dealing with cryptoassets businesses “but they are increasingly willing to provide commercial banking to trading platforms, over-the-counter brokers and other cryptoasset businesses that demonstrate strong compliance programs.”
There’s an irony here: as much as regulatory vacuums may have sparked Bitcoin euphoria, things have reached the stage where regulatory uncertainty is holding back blockchain development.
To be sure, securities regulators, particularly in the US, have stepped up enforcement. In June, to combat money laundering, the federal Department of Finance issued draft regulations for virtual currencies under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act. As testimony to the snail’s pace of cryptocurrency regulation, however, final regulations may not be published until 2020.
Perhaps the regulators who lag furthest behind are the tax authorities. Nonetheless, signs of progress emerged with the creation of the initiative known as the Joint Chiefs of Global Tax Enforcement in July, in which tax authorities from Canada, the US, the UK, Australia, France and the Netherlands agreed to collaborate to reduce the threat that cryptoassets pose to national revenue streams.
Meanwhile, something resembling chaos reigns.
“There’s a great deal of confusion among tax authorities as to how to categorize cryptocurrencies and ... apply tax law to them,” says Alexandre Dufresne, a tax partner at Spiegel Sohmer Inc. in Montréal. “Are they currencies or are they securities assets for which the tax consequences are different?”
Dufresne’s view is that, so far, the Canada Revenue Agency (CRA) has got it wrong.
“Let’s say you own Bitcoin and sell it as an investment,” he posits. “CRA would say that’s a barter transaction that attracts sales tax, but to me that makes no sense at all, mostly because you’re not paying someone to buy goods or services.”
As Dufresne points out, a wheat commodity trade does not attract sales tax even though the buying and selling of wheat is what underlies the transaction.
But, Dufresne adds, the CRA’s confusion is not surprising.
“They’re dealing with a new technology that has worldwide implications and is a great disruptor,” he says. “For governments to pinpoint exactly where that fits is not an easy task.”
It won’t be much easier for investors and lenders, either. At least not for a while. But, one way or another, it seems, blockchain is coming. Be on the lookout, or you may miss the boat.