Module 3: Capability and Use Cases

Cryptographic Currency Capabilities and Use cases

This module discusses the characteristics embodied in cryptocurrency. A representative selection of cryptocurrency uses are drawn from industry briefs, government reports, academic resources, and expert interviews. They range from human trafficking to cross-border remunerations to disaster recovery and sanctions avoidance. Collectively, these uses can be distilled into the following general use categories, although multiple permutations and interconnected examples exist. Categorizing use cases as positive or negative is complicated because those definitions depend on who is using cryptocurrency and for what purpose. For this discussion, positive use results in benefits to an individual or group, although it may not apply to all; a negative use centers around the exploitation of others.

Characteristics

Characteristics are the foundational elements of cryptocurrency’s uniqueness and combinations that can be utilized to create the use cases.

Decentralized

Perceived failures of the existing financial system and introduction of Nakamoto’s solution to the double-spending problem created an opportunity for financial innovation. Peer-to-peer transactions have been occurring since individuals could agree that an item represented value and they were willing to trade for it with the assumption that its worth would be recognized in a different transaction. 

With the advent of modern finance, more individuals and organizations were involved in this exchange, but it came at the expense of privacy, increased cost, and complexity. The original vision behind blockchain and Bitcoin was to solve the double-spending issue without requiring a middleman, which is the innovation internet money provides; a (almost) frictionless transfer of value between two peers.

Unalterable Ledger

The concept of Satoshi Nakamoto’s blockchain was to create a ledger of all transactions (blocks) that continually build on themselves (hashes) into one long record (chain) shared with everyone (transparent). A copy of the ledger is then distributed to all peers involved in these exchanges. Thus, a chronological record of all transactions is recorded and available for review by anyone, anywhere. This record is intended to establish trust in a new peer-to-peer currency based on transparency; not one built on intermediaries and a government guarantee. In this new environment, instead of an institution holding the recordkeeping responsibility (and retaining control), the blockchain records these transactions between two wallets without the need of an intermediary. Since 2008, blockchain technology has become an accepted form of accounting for the exchange of value between individuals and continues to usher in new forms of decentralized finance products.

Decrease Transaction Costs

Electronic transactions of fiat value are often a multi-step process involving point of sale, processers, transmitters, and multiple financial institutions. Each time value is moved along a transaction chain, multiple financial institutions are taking a small fee. The costs for maintaining this multi-layered system are borne by the customers and retailers. One of cryptocurrency’s primary value propositions is to stop an outflow of money to middlemen and keep it in the pocket of the earner. A token transaction can be almost 1/10 the cost of a traditional financial reconciliation among multiple fiduciaries. Distributed ledger technology (the blockchain) permits peer-to-peer transactions because transactions are recorded publicly and do not require an intermediary, which thus reduces transaction costs.

Hedge Against Instability

When a government increases the supply of money, currency already in circulation decreases in value. Since many cryptocurrencies have a fixed supply, they give the appearance of being a more stable asset. During COVID, many governments chose to increase the money supply to promote spending and prevent a recession; a key function of a central bank. For investors and large institutions with significant value stored in cash, they sought out an alternative.  Cryptocurrency allows store of value unlinked from fiat currency and not subject to government decisions. Token-based securities with mathematically programmed constraints (i.e., scarcity) present an alternative to the devaluing fiat currencies issued by governments. They are an alternate vehicle to preserve wealth rather than have it diluted through monetary supply manipulation.

Financial Fraud/Scam

Pump and dump token schemes are technological variants of Ponzi schemes and intended to defraud investors through unregulated coin offerings. Criminals (or entrepreneurs as they call themselves in marketing materials) will create a new cryptocurrency token with unique features designed to meet a specific market gap or exploit a new investment opportunity.

When new tokens are released or exchanges want to promote their services on social media, web blogs, and Reddit threads, influencers hype up perceived scarcity, which creates artificial demand, and the token value rises. Then, when a certain value is reached, the criminals controlling the token (it is a programmable asset with no oversight) exchange their majority share of artificially inflated coins for dollars or other crypto assets. Following this “rug pull,” the price plummets, which leaves the remaining investors with a worthless stake.

Ransomware

Ransomware attacks are a pervasive scam affecting individuals and businesses alike, often beginning with a fraudulent email and convincing wording that gets an unsuspecting user to click on a malicious weblink that then causes harmful software to be downloaded and encrypt a user’s computer files.

These files remain encrypted until the unsuspecting, and now thoroughly pissed, individual pays for the encryption key (which works less than 10% of the time) (link article). Initial ransomware attacks were scattershot, the result of millions of emails sent out to unsuspecting individuals and asking for only a few hundred dollars (in cryptocurrency) for the key, but these attacks have become increasingly sophisticated.

Illegal Purchases

Most illegal purchases taking place on the dark web use cryptocurrency. The dark web is a very small (0.01%) portion of the internet and commonly accessed using an anonymizing browser. In these dens of ill-repute, all manner of illegal items can be purchased, and services obtained. Individuals use cryptocurrency to limit the tracking of dark web economic activity including purchasing drugs, weapons, exploitative media, and services for hire, one of the most common negative uses of cryptocurrency.

Sanction Avoidance

Economic pressure is one of the primary ways governments can influence domestic and international behavior. Restricting access to the western financial system through sanctions severely limits other nation’s ability to access markets and capital.

Financial intermediaries are responsible for reporting value transfers in accordance with statutes and laws. Know Your Customer, Anti-Money Laundering, Travel Rule, securities regulations, and tax codes are some of the anti-fraud focused statutes and laws requiring Money Service Businesses (MSB) to know the source of the value they custody and transmit.

Cryptocurrency, and its peer-to-peer transaction capabilities, combined with unhosted wallets, bypasses financial intermediaries. Sanctioned nations use cryptocurrency to bypass the sanctions and continue to conduct business, which thereby reduces the efficacy of the intended economic pressure.

Conclusion

Satoshi Nakamoto said, “The World needs an electronic system based on cryptographic proof instead of trust” and this sentiment drove the creation of Bitcoin and the blockchain. The four primary capabilities of blockchain and Bitcoin have led to the rise of many use cases. Twelve primary use cases are profiled and give some context of how the new technology is being used.  Although it is important to acknowledge that these use cases also differ in their level of adoption. Hedge against instability, access to the financial market, decreased costs, and transaction efficiency are all benefits touted by fintech innovators.

So where are these benefits and who is using them?

New financial products are being created but consumers are not using them because gaps have occurred in functionality, education, and access. Individuals new to cryptocurrency hear the media reports and think crypto is the beginning of a financial revolution but still lack the knowledge to understand how it will help them.

When evaluating the utility of the new technology and deciding if they should switch, people make a comparison with what they are currently doing. They have practical use cases in mind; they need to remit money to family, do not have access to a bank for simple financial transactions, or do not want a cheaper way to store value. Harmful uses will continue, but they will become a smaller portion of the market overall. Innovation will focus on unmet needs and customized financial products rather than requiring scalability for mass market profitability.

Any future use case must be similarly considered; what is promised, has it been delivered, and how many people are using it for that purpose. Subsequent modules will explore the impacts of each use case on economic, homeland, and national security.