Cryptocurrency and blockchain: hitting the real world, and some real-world problems
May 2019 | EXPERT BRIEFING | BANKING & FINANCE
Conferences and webinars devoted to cryptocurrency or blockchain are becoming increasingly common. Depending on an attendee’s attitude toward technology and, arguably, to new modes of finance, these events may seem like the wonders of tomorrow or like some unfortunate example of technology-run-amok. However, this intersection of the worlds of technology, finance and law has hit a milestone in a seemingly mundane transaction: the sale of shares in a series of real estate partnerships to purchasers paying not in dollars, euros or yen, but in cryptocurrency.
For the benefit of those less-than-totally knowledgeable about the world of cryptocurrency and blockchain, cryptocurrencies, the most well-known of which are Bitcoin and Ethereum, are digitally generated and stored units of exchange. Unlike conventional currencies, they are not issued by a government. To protect the value of each unit of cryptocurrency, the issuance of new units is governed by complex algorithms. Persons executing the computer operations needed to generate these new units of currency are known as ‘miners’ and each new unit of currency is time stamped, and its existence and location stored in records, known as ‘blocks’, on a network of computers. The storing of these blocks on such a large number of computers reinforces the security of the underlying records, as the network is highly resistant to efforts to improperly modify any individual record. So, for example, one cannot alter the number of bitcoins in a particular account, as one would need the entire network of computers to accept the modification; a highly unlikely event. This continuously-growing, mutually-reinforcing ledger of verified blocks, distributed across an entire network, and thus known as a ‘distributed ledger’, is collectively referred to as a blockchain.
One difficulty with cryptocurrencies, from the perspective of investors, has been finding assets, particularly large-scale assets, where this new form of value is accepted as payment. As a result, for many, if not the majority, of investors, investments in bitcoin and its ilk have essentially treated the currencies as commodities rather than as units of exchange. In this sense, cryptocurrencies have been what dollars are to currency traders. Currency traders are primarily interested in the value of dollars relative to other currencies; they are only incidentally interested in the use of dollars to buy goods or services, for example. Similarly, bitcoin investors have largely been in the business of betting on the value of their bitcoins relative to dollars or any other fiat currencies.
For many years, investors looking to use cryptocurrencies to make more conventional investments in ordinary, real-world assets, had relatively few places to turn. Why would someone making a large-scale investment in ‘ordinary’ assets want to use cryptocurrency in lieu of a national currency? For persons in nations with weak or unstable currencies, cryptocurrencies offer a more stable alternative, since while demand for these currencies may fluctuate, supply is essentially fixed. No one can ‘print’ a new batch of Bitcoins. Further, even for those who have routine access to stable currencies, cryptocurrency transactions are self-clearing, without a need for an intermediate entity, such as a bank. This is an inherent feature of cryptocurrency residing on a blockchain: once such a transaction is completed, it is automatically and immutably stored as a block on the chain. The transaction cannot be completed without sufficient funds, and the blockchain is indifferent to the location or nationality of the buyer or seller.
Given the advantages of cryptocurrency, it was only a matter of time before such large-scale investment began to appear. In February, FinTech firm Inveniam Capital Partners led the first sale of a series of securitised real estate investments, allowing investors to purchase using cryptocurrencies stored on a blockchain. The sales in question were, in some sense, unremarkable: investors were being offered shares in the purchase of a We Work office building in Miami, in a housing development in southwest Florida, in student housing in Fargo, North Dakota and in a water pipeline, also in North Dakota. While one could invest in dollars if one chose to, one could also invest using cryptocurrency, acquiring ‘security tokens’ reflecting the amount of the investment. These security tokens are themselves stored in blockchain form. The value of the cryptocurrency relative to dollars was fixed, with a minimum investment of $500,000 worth of currency. This new form of investment presents a mix of issues both familiar, such as an offering of shares in a real estate investment, and novel, namely, dealing with a unit of exchange with little history, be it legal, financial or otherwise.
From the perspective of a litigator, one issue jumps out – the difficulty of assessing the costs of failure. In any investment, there are risks that an investor assumes: that an underlying investment will be unprofitable, that a partnership will become untenable, that a disgruntled investor will sue. Ultimately, these risks are implicitly factored into the price of the investment itself. However, what will happen when the unit of investment itself, the currency, is new, and its values and risks not yet clarified by experience, regulation and, particularly in the US, litigation? In an investment where cryptocurrencies are invested along with national currencies, who bears the risk of changes in relative value of currencies? Particularly in these relatively early days of cryptocurrencies, where there are thousands of competing currencies, who bears the risk of demand for a particular unit of exchange falling so far that its value approaches zero? Time will tell, but the business community will expect answers faster than the data can be gathered.