Asset-backed cryptocurrency — a blockchain regulatory mechanism

A law to ensure only that amount of cryptocurrency can be in circulation by a company for which it has sufficient backing of physical assets should be formed

by NIDA KHAN

Blockchain came into the limelight with a promise of providing transparency and immutability in a decentralised peer-to-peer network by ensuring transactions between entities in a trustless environment.

The decentralised nature appealed to the masses a lot, who — even though they could not fully grasp the complex technicalities associated with the new technology — welcomed it as an innovation that could free them of financial institutions, and maybe even government interference.

The glare surrounding the hype of blockchain faded last year with the prices of leading cryptocurrencies like BTC from bitcoin and ETH from ethereum falling down to a low, where investors were forced to rethink on their decisions to buy them in the first place.

The average citizens who invested in cryptocurrencies are waiting for a breakthrough to see the prices soaring again to resell them.

The beginning of 2019 rocked the blockchain world by the news that the founder of Canadian crypto exchange QuadrigaCX died in December 2018, blocking access to nearly US$144 million (RM588.96 million) in BTC and other cryptos. He was the sole authority in possession of the passwords of the company’s cold wallets to which the funds of the company were transferred to. Cryptocurrencies can be kept in two types of digital wallets — hot and cold.

Hot wallets remain connected to the Internet and are susceptible to attacks by hackers, so the preferred and more secure choice of storage is a cold wallet.

A cold wallet is stored on a platform like a USB device, that is not connected to the Internet. When a transaction needs to be conducted, the USB is connected to the computer to facilitate it.

The choice of cold storage in the case of QuadrigaCX was understandable, but when we talk about the decentralised nature of blockchain, we think about authority and power not being confined to a single person.

In a centralised infrastructure, power and authority rests with a single entity — but a decentralised platform implies that multiple users have power over the platform.

The position of the CEO of QuadrigaCX being the sole authority managing the funds of the crypto exchange does not comply with the spirit of decentralisation in blockchain.

Regulatory Concerns

The enumerated incident brings out two vulnerabilities in any blockchain-based initiative that are of concern from a regulatory perspective.

The primary is that the decentralised nature of blockchain should be maintained in all blockchain-based ventures.

If the crypto exchange was maintained by multiple owners instead of one, honouring the spirit of decentralisation in blockchain, then this would have solved the predicament by allowing multiple people to be aware of the password to access the funds. Furthermore, the digital nature of any blockchain wallet always exposes it to the risk of a cryptocurrency being lost through loss of the password protecting the wallet. There is a necessity of some degree of physical assets to be coupled with the digital assets, so that in scenarios where the password of a digital wallet is absent, the funds can be recovered by means of the physical assets backing the cryptocurrency in circulation.

A law to ensure only that amount of cryptocurrency can be in circulation by a company for which it has sufficient backing of physical assets should be formed.

It should also be ensured that when a blockchain firm is launched, the ownership and authority are truly decentralised. This would protect users from many spurious ventures and scams that are possible in the digital age when they use blockchain.

If the funds of QuadrigaCX were asset-backed — and it was ensured that at any moment of time, the funds in custody of QuadrigaCX were backed by assets in ownership of the founder — then even after his death, the government could distribute it according to the transaction records of various clients.

Asset-backed

When the finance world witnessed the worst recession of the times, it was mainly due to the fact that money was being created out of thin air for lending. If the lent out money was backed by assets, this would have controlled both the lending and borrowing.

Asset-backed investments bring stability to money in exchange and prevent any harmful activities for the economy.

There is an emergent need to at least back the cryptocurrencies with assets to ensure that a similar recession does not happen in the digital economy.

A spate of incidents similar to the one outlined above in outcome, where funds were lost, brings forth a necessity for the governments to bring about new laws and policies governing blockchain transactions and companies.

Cryptocurrencies and digital money are the future of the digital world and their usage will prove to be very beneficial for the economy, but only if sufficient measures are in place to ensure safe digital financial transactions.

Fiat money that is in circulation is in the control of central banks, and hence, the supply is regulated.

Asset-backed cryptocurrencies can ensure similar regulations on the supply of any cryptocurrency and can work to make blockchain usage a mainstream reality, circumventing some threats associated with blockchain-based transactions.

  • Nida Khan is a developer of two pioneering Islamic financial technology tools, and is currently pursuing an industrial doctorate degree on blockchain and data analytics for traceability in finance at the University of Luxembourg. The views expressed are of the writer and do not necessarily reflect the stand of the newspaper’s owners and editorial board.