If you don’t know much about cryptocurrency, a lot of noise you hear is about its market volatility. And while there are many inaccurate and hysterical reportings of the challenges that face cryptocurrency, the incredible volatility of such assets is unobjectionable.
Given that there are over 2000 cryptocurrencies being traded and used today it can be difficult to judge the value of many of these. Adding value is what asset-backed tokens aim to do.
This article discusses the merits and potential of asset-backed tokens, also referred to as stablecoins.
The Future of Asset-Backed Tokens
Asset-backed tokens have a wide range of potential for increasing access to investments and encouraging those with lower income to invest fractionally.
Using blockchain and automated smart-contracts access to valuable assets can be increased because not only are the assets borderless, but it is now cheaper and safer to invest. In the past, unless you had access to lawyers and financial advisors, not to mention investment capital, it was not possible to participate in many valuable investments.
Asset-backed tokens can help fractional and trustless participation in investments such as shared real estate ventures and ownership or intellectual property and royalty payments.
Because the blockchain is immutable and public, and have applied smart contracts, ownership, and due diligence are not only more accessible but has improved accuracy.
STOs Replacing IPOs
Asset-backed tokens function in a very similar way to IPOs. STOs are used to fund new projects and give investors an opportunity to invest early. Therefore, asset-backed tokens offer a percentage of digital ownership of an immutable, liquid and trustless representation of company debt or equity. With the application of blockchain, the process more efficient and more accessible than ever. Increased access has the potential to significantly grow the STO market.
Asset-Backed Tokens for Commodities
Security tokens take real-world commodities and make them digitally tradable. It is entirely conceivable that present third-party custodians for valuable assets such as oil, natural gas, wheat, or sugar, commodities can be effectively tokenized.
Current auditors who verify the security and trustworthiness of custodial storage could use blockchain to facilitate these commodities. Blockchain’s immutable public record can be used to create more confidence in the current market.
Bitcoin is hailed as “digital gold,” as it has many of the same valuable qualities. But if auditors and custodians are coordinated with blockchain, it also has the ability to increase fractional ownership of actual gold bars.
Non-Fungible Hard Assets
Tokenization could make shared ownership of non-fungible assets a reality. One of the benefits of the immutable record of blockchain is the ease of shared ownership. Asset-backed tokens can represent non-fungible assets, which are things like collectibles. Each digital token is unique which creates digital scarcity.
Moreover, smart contracts can be used to create joint ownership of artworks or art collections while they are stored in museums. So, the artwork can still be displayed publicly, but the asset will be maintained cryptographically on a blockchain.
Soft Assets which are Non-Fungible
Soft assets include things like intellectual property and digital asset collectibles. As it stands, IP assets, like as copyright licences, trademarks, patents and royalties from music and media rights have low liquidity and currently. This is because they lack a secondary marketplace to trade on their value. This means that it will be possible to increase the liquidity of music and works of art.
Digital collectibles are things like CryptoKitties, which are examples of asset-backed tokens that generate value and scarcity. With tokenized ownership, it is conceivable that there be an increase in the value of digital collectibles for gaming, which are currently managed with central databases. Blockchain and tokenization make it much easier to prove ownership of digital items like these.
Stable Coins v. Security Tokens
Stable coins are linked to fiat currencies and so they are a kind of stable asset-backed token. Those who hold these stable coins participate in fiat reserves. This is so that the token retains a stable ratio based on the fiat currency. Security tokens are different from stable coins. Security tokens represent another currency rather than an asset like gold or oil.
Volatility and Cryptocurrency
But even amid the volatility cryptocurrencies continue to prove their value in real life and as regularly traded assets. One reason for the success is the technology that cryptocurrencies rely on; blockchain and hard cryptography. Blockchain is unassailably amazing and is creating new markets on a daily bases.
Nevertheless, volatility brings with it some very real problems for investors and for the growth of real-world applications.
Volatility is exactly what stable coins, or asset-backed coins, are attempting to fix.
The original cryptocurrency, Bitcoin, was designed as a non-fiat currency, or to be its own gold standard. That means that Bitcoin is valuable only as a currency of exchange, and because of its scarcity, it remains valuable. But Bitcoin is not backed by a national currency nor is it an actual precious metal.
What makes an altcoin valuable?
However, this is not the case for all cryptocurrencies. The problem is not necessarily because they are not valuable, but because their value needs to come from somewhere else. Bitcoin has the unique advantage of being the first effective digital currency. And applies a design that is secure, but has the downside scalability issues. This is primarily because Bitcoin is computationally very difficult and therefore very energetically expensive and time-consuming.
But valuable cryptocurrency like Ether and successful ICOs are not so different from holding shares in Apple. It’s shares are valuable because Apple is a valuable company. But if Apple were to stop producing amazing products the shares also lose their value.
The idea of asset-backed tokens is to manage some of the inherent volatility of the cryptocurrency market. A “stable coin” is a coin that is backed by a physical asset, such as gold or fiat currency, like the British Pound. However, despite being backed by another asset, these coins are not governed by central banks.
Asset backing offers more potential for stability because its value is less speculative. This is because the value is the result of a physical asset, and not merely perceived value or use for transactions, like Bitcoin.
Different Kinds of Cryptocurrencies
Geoffery Char describes 4 main kinds of cryptocurrencies:
- Alternative Payment Coins, for example, the original completely digital currency Bitcoin.
- Utility tokens or Native Tokens, these are often necessary to use a platform. Ethereum’s Ether began as a utility token.
- Stablecoins, which are fixed against a cryptocurrency, fiat money, or an exchange-traded commodity like gold.
- Security tokens, which is a digital form of a traditional security, and so it has a different regulatory structure than other cryptocurrencies, and may not be decentralized at all.
Utility tokens play an important role in the development of new blockchain based companies. They, along with native tokens, function in a similar way to IPOs. An ICOs (Initial Coin Offerings) is typically used to crowdsource funding for new projects, while also letting early investors in at a discounted rate.
Ethereum holds the record for the most successful ICO in history for the sale of Ether. However, the problem with ICOs is that sorting out the quality projects from out-right scams can be tricky. And utility tokens typically only have value or utility on its own platform.
Ether is an exception to the rule, but Ethereum is an exceptional case. Most projects are not going to be able to come close to their success. As such, most native tokens can only be used on their own platform.
The basic idea of a utility token is very useful and can be very beneficial for early investors. The catch is that the company behind the token needs to be valuable as well. As a rule, utility tokens do not have any real-world assets to back the projects. A utility token is used on a specific platform. So if the platform is successful then the token will continue to prove its value. But if it does not, then it is very possible that the token become meaningless.
A partial solution to the risks associated with ICOs are IEOs. IEOs are the same in principle to ICOs but are also backed by large contributions from the host exchange. So with an IEO, the exchange assumes more of the risk than the individual investors.
Because this is a real concern for the investors and companies, the U.S. Securities and Exchange Commission (SEC) has been creating more restrictions for ICOs. This is because as ICOs try to provide secured fundamental value, they are becoming more and more like a typical security.
Security token offerings (STO) have real-world value, backed by externally valued assets. Asset-backed and security tokens are designed to offer secure, rapid and minimal cost trading of traditional assets which rely on blockchain. This increases liquidity as the value of a token is not limited to its value on the native platform. Security tokens are more like traditional assets which mean they have more liquidity. An asset has increased liquidity when it is easy to sell.
As a comparison to traditional investments, bonds and stocks are assets with high liquidity. These are contrasted to vehicles, real estate, jewelry, art, and collectibles. The second kind of asset is valuable, but do not have a high trading volume, which basically means they rely on a niche market. And while cryptocurrencies are increasing in popularity they can in many ways still be likened to a niche market.
Recently Japan has accepted Bitcoin as legal currency, many countries now acknowledge Bitcoin as a taxable asset. And in places like China, Korea and Venezuela with unstable governments, there is a premium on the value of Bitcoin as it becomes more valuable as these fiat currencies struggle.
Of all the cryptocurrencies, Bitcoin is the currency that has the steadiest rates of adoption. There are several reasons for Bitcoin’s success as a utility token. Bitcoin has the advantage of being the first successful digital currency to work on blockchain technology. It uses hard cryptography and the SHA-256 hash, eliminating the double-spend problem.
The problem of instability
However, for all utility cryptocurrencies, the challenge of instability remains a prominent issue. The issue is that even though these are valuable assets, it makes it difficult to use these coins for their original design, which is to work like digital cash. This is because of their volatility, which meant that their value is likely to change by that end of the day.
Bitcoin has proven its lasting power, as well as the value of investing in it as a tradable asset. Still, at the time of writing this, over the last 12 months, Bitcoin’s value increased by nearly 100%. And over the past 4 weeks, Bitcoin has risen from around $8000 to $11 500, peaking around $14 000.
While this kind of growth is great for investors, it makes paying for a coffee unappealing. As a consequence of this flux, cryptocurrencies like Bitcoin are often considered “speculative assets” as their value is pretty indeterminate and unpredictable at this time.
It is important to remember that Satoshi’s design was to make a currency that worked like universal cash. Moreover, Bitcoin is meant to work as its own gold standard, which means that the value of Bitcoin is in the value of holding and exchanging it. Tying its value to another currency or precious commodity was not part of the original design.
Bitcoin and Ethereum
Bitcoin alone has been the most successful of all cryptocurrencies to function as it was designed. Even Ether has to prove its value via Ethereum’s projects. Having value come from multiple places is not a bad thing, we cannot have more than one thing that we called gold; if that were the case, it would lose all meaning and value.
What has a great deal of potential are utility tokens that support quality projects and companies, as well as asset-backed cryptocurrencies. Just as Apple stocks are valuable because the company is valuable, so can utility tokens and asset-backed tokens garner a similar kind of value and have an important role to play in the market.
Addressing Volatility with Real-World Value
As an effort to partially resolve the issue of serious volatility in the crypto-market, we have seen an increase in asset-backed, or stable coins. These coins use corollary assets in order to maintain a stable value. These can be commodities like precious metals, fiat currency or even real estate.
The crucial difference between an asset-backed coin is that its value is tied to a real-world tangible asset. Therefore, its value is not purely digital, which puts asset-backed coins into their own category of cryptocurrency.
Increasingly asset-backed coins are becoming more and more popular. When it comes to asset-backed coins, they can be either centralized or decentralized.
Valuable cryptocurrencies and ICOs like Bitcoin and Ether were designed as purely digital commodities. This makes good sense because both currencies have established a value-adding product. For Bitcoin, it is a secure digital currency, while Ether started as an ICO and native token, it is now one of the most valuable traded cryptocurrency.
Examples of Tokens that are pursuing the asset-backed route:
Tether is infamous in the crypto and securities world, as it is surrounded by controversy for failing to comply with audits. Initially, it claimed to be backed by USD, however, now it claims to be backed by its own reserves. It is also a centralized token and therefore does not have much to do with the original design and ethos of cryptocurrency.
Maker’s stable coin is the Dai. It is decentralized as well as backed by ETH. Its value is pegged against the USD. that means that each Dai is worth 1 USD. And their system relies on smart-contract automation.
Havven’s stable coin provides stability by building a system that is backed with two coins. The first coin is called Nomins which is the stable coin, which is used for everyday transactions. The second is reserve tokens, which are called Havvens. Each transaction has a fee. The fees are then redistributed to the Havven token holders who are rewarded for maintaining the system.
Digix has its own approach that is particularly interesting. It has built a cryptocurrency that is allied with third-parities to tie the value of the coin to physical commodities.
Digix’s asset-backed plan is to use a third-party verification of physical commodities. The information is then stored on a public Ethereum blockchain in order to maintain a record of the physical asset. Combining physical assets with blockchain technology is part of their effort to develop what they call “proof of protocol.”
Proof of Provenance (PoP)
Proof of Provenance (PoP) is a supply chain tracking system. The protocol is designed to improve the tracking, auditing, and transparency of asset-backed tokens. The lack of transparency is one of the many criticisms that have been launched against Tether. So, these can be seen as steps towards an improved marriage of cryptocurrency and physical assets.
Digix will track all deposits and audits of the gold they hold on the public Ethereum blockchain (a distributed ledger) and IPFS (a distributed database). All of their supply chain information is to be available to the public to maintain authenticity. Therefore the design demands that there will never be gold tokens issued without first going through the PoP protocol.
Asset-backed tokens are definitely a bit of a detour from the original ethos of the cryptocurrency community. The crypto-world is predicated on a trustless ethos. It relies on technology rather than altruism. But it is possible that asset-backed tokens will create new confidence in the crypto-market, and increase the usability of cryptocurrency for basic transactions.
The Cost of Cryptocurrency
While no one can accurately foretell the future of cryptocurrencies it is very likely that Bitcoin is here to stay. It is possible that Bitcoin will replace all other fiat currency for a truly digital and borderless world. However, it is far more likely that cryptocurrency will have a more modest outcome.
As cryptocurrencies continue to prove their worth and utility, is it entirely likely that quality cryptocurrencies such as Bitcoin will remain a well-traded asset. But the others that follow have to prove their value in other ways. Perhaps it will be the development of more high-quality projects that lead to valuable ICOs and native tokens, or more utility token such as Ether.
The challenges that Bitcoin faces are usability, transaction cost and of course, volatility. The cost of each transaction is highly volatile. Currently, there is not enough data available to accurately explain the fluctuations.
Currently, transactions are purely market-driven, which means that supply and demand control the cost that miners charge. Although miner’s transaction rewards is a part of the design, it adds to the volatility of the price.
Moreover, the energetic cost of mining and sending Bitcoin transactions is predicted to be unsustainable. Due to the complexity, which makes the digital secure, Bitcoin transactions and mining are energetically expensive.
Budish, an economic theorist, argues that if the mining difficulty were lowered, the probability of a 51% attack would increase. If the computational cost is decreased attackers have more opportunity to take over the hash power.
To prevent this kind of attack from happening Bitcoin transaction must remain costly. If this is the case it will mean that using Bitcoin for everyday purchases will never be economically feasible. So, it is more likely that Bitcoin will remain valuable, but will not be able to overcome the scalability issues it faces to replace fiat currency.
Determining the Value of Cryptocurrency
Let’s return to asset-backed tokens and the overall concern for cryptocurrency’s volatility.
Predicting the value of cryptocurrencies is incredibly difficult simply due to the lack of long term the data available. HedgeTrade‘s platform is designed specifically to counter this problem. There is little doubt that cryptocurrencies will remain valuable as technology continues to improve.
However, cryptocurrencies do not behave like traditional assets. Cryptocurrencies are not public companies with earnings and expenses that can be investigated and reported on easily.
Take Apple, to figure out the value of Apple we can look at its financials and determine its book value. The book value is the worth of the company’s if they were liquidated. And, given Apple’s past success, the market has confidence in Apple projects, and so the value continues to rise.
As cryptocurrencies continue to develop, it is important to carefully consider the following qualities: market volatility, scalability, security and privacy, and centralized v. decentralized.
Stability and Liquidity
The strongest argument for asset-backed tokens is that they have the potential to bring more market stability and liquidity. If cryptocurrencies have more stability then their usability can be increased.
If these tokens have more stability, meaning they have steady growth, rather than grandiose spikes and drops, it will make regular usage and scalability more probable.
And, if tokens are backed by physical assets, then they might also be more liquid. Assets have more liquidity when they are easy to sell. Assets that are easier to sell are things like precious metals and successful companies like Amazon and Apple. This is because the value is much more evident, and therefore the asset is easy to sell. Real estate is less liquidity because although it is valuable, you need to find the right buyer. And the property is much more expensive, and therefore moves more slowly.
The most novel use cases for asset-backed tokens are therefore emerging from tokenomic models which are backed by limited liquidity assets. Example of the application of tokenomics include derivatives, private equity, real estate, collectibles, and other assets. Using blockchain and digital ownership makes the potential market borderless.