Understanding the Basics of the Cryptoasset Market

January 25, 2019

Cryptoassets represent a seismic shift in the financial markets and, in recent years, have grown in popularity. The technological advancements  behind cryptoassets have come a long way and have the potential to disrupt the financial system as we know it. Central banks and other financial institutions can play a key role in shaping this landscape. However, this global phenomenon is creating confusion on multiple levels i.e. how individual cryptoassets differ from one another and the role of the major participants in the cryptoasset ecosystem. With the buzz around bitcoin, altcoins, cryptocurrencies and tokens, a whole new financial ecosystem has been created. This blogs looks at the taxonomy of cryptoassets, market participants and the current capital market landscape.

Introducing Cryptoassets

Cryptoassets are digital assets which use cryptographic techniques to generate a medium of exchange of financial transactions. Cryptocurrencies, utility coins, security tokens are all different types of cryptoassets. A cryptocurrency is a digital or virtual currency. The currency is encrypted (secured) using cryptography to secure financial transactions, create additional units, and verify the transfer of assets.  In contrast to fiat currency and central banking systems, many cryptocurrencies are decentralized systems based on blockchain technology.

Mining Cryptoassets


Taxonomy of Cryptoassets

Cryptoassets are a superset of cryptocurrencies. The most widely known cryptocurrency is Bitcoin. Altcoins and crypto tokens are subset categories of cryptocurrency. Litecoin, Bitcoin Cash and Dogecoin are common examples of altcoins. Crypto tokens are special cryptoassets tokens that reside on their own blockchains and represent an asset or utility [1]


Bitcoin and altcoins are virtual currencies that have dedicated blockchains and are primarily used as a medium for digital payments. Crypto tokens, however, operate on top of a blockchain that acts as a medium for creation and execution of decentralized apps and smart contracts, and are used to facilitate transactions. In the following subsections, we briefly introduce virtual currency products (including Bitcoin and Ether), utility tokens, security tokens, and stablecoins.

Convertible Virtual Currency Products

Bitcoin was created as a reward for payment processing using cryptography, , known as mining, in which participants offer their computing power to verify and record payments into a public ledger.  With a goal of building decentralized applications, Vitalik Buterin proposed the development of a new platform with a more general scripting language for application development. This led to the origination of Ethereum, a decentralized platform that runs smart contracts, and Ether, a form of payment made by clients of the platform. Read more on Blockchain technologies in our whitepaper [2].

Utility Tokens

Utility tokens is a digital token of cryptocurrency issued to fund the development of an ecosystem in which the utility token, at a later date, can be used to purchase goods or services offered by the issuer. For example, by creating utility tokens, a startup can sell ‘digital coupons’ for the service it is developing.  

Digital Security

Digital Security are considered an investment contract. They are subject to securities regulations and offer an array of possible applications as financial instruments. The main use-case for these type of tokens is the ability to offer a digital representation of shares of a company’s stock in anticipation of future profits e.g. in the form of dividends. These differ from utility tokens which are offered by a start-up to its client for the purpose of financing the client's future purchases.

Stablecoins

Stablecoin is a subset of cryptoassets backed by a real-world asset(s) e.g. dollar, gold, bitcoin, hybrid assets, etc.  Stablecoins are price-stabilized and mirror the volatility profiles of reference assets. They incorporate Bitcoin or Ether features: programmability (e.g., smart contract integration), efficiency (e.g., low-to-zero transaction fees, fast settlement times), fungibility and open or permissionless access.[3]-[4]. Stablecoins also provide a liquidity solution for cryptoasset exchanges as most exchanges can't accept dollar or euro or other fiat deposits.  There are two main types of stablecoins: algorithmic and asset-backed. 

Major Cryptoasset Participants

Major Cryptoasset Participants

There are four major cryptoasset participants today, namely exchanges, banks, miners, and custodians.  

Exchanges

A cryptoasset exchange allows participants to trade cryptoassets. It provides an online matching platform for supply and demand.  There are currently over 210 exchanges listed, most of which are centralized meaning there is a trusted middleman to handle the trades.  Based on volume and estimated revenues, the top three cryptoasset exchanges are centralized cryptoasset exchanges (CEXs), such as Binance, Huobi, and OKEX.

Miners

Like mining for gold, Cryptoassets are mined by individuals and companies using computers to process transactions and earn a cryptoasset reward.  This is a very resource-intensive process, requiring heavy computing power to satisfy security conditions (rooted in cryptography) and ensure that all network participants agree the blockchain is accurate

Banks

The opportunities for banks to utilize blockchain technologies could have far-reaching implications.  However, direct cryptoasset trading is relatively limited for banks.  Areas in which banks could potentially leverage blockchain technologies include payments, clearing, settlement, KYC and AML processes, and trade finance amongst others.

Custodians

Cryptoasset custody solutions provide storage and security services. They incorporate a combination of hot storage (with a connection to the Internet), cold storage (disconnected from the Internet), and vault storage (a combination of both). Coinbase and Fidelity Investments are two firms currently offering or designing these custody services.

A cryptoasset ecosystem, composed of a diverse set of actors, builds interfaces between public blockchains, traditional finance, and various economic sectors. These services add significant value to cryptoassets as they provide the means for public blockchains and their native currencies to be used in  the broader economy [5].


The next blog in this series looks at the various cryptoasset marketplaces.

[1] Token, https://en.bitcoinwiki.org/wiki/Token

[2] Quantifi, Noble and OKCoin ‘Blockchain Technologies in Financial Markets’ https://www.quantifisolutions.com/whitepapers

[3] “The State of Stablecoins,” https://www.blockchain.com/research

[4] Oscar Williams-Grut, “The crypto world is going wild for 'stablecoins' — here's everything you need to know about them,” Business Insider, Sep 30, 2018. 

[5] Garrick Hileman and Michel Rauchs, “Global Cryptoasset Benchmarking Study,” Cambridge Centre for Alternative Finance, 2017