What is “Cryptocurrency”?

Cryptocurrency is tamperproof digital money that can be traded openly. Cryptocurrency technology enables the ability to reliably create and exchange value over the internet without an intermediary. Bitcoin was the first viable example of cryptocurrency. Bitcoin proved the capabilities of cryptocurrency technology and initiated the digital economy.

Many other cryptocurrency technologies have emerged following bitcoin and more will be created. Different cryptocurrency technologies possess different attributes, but they all share the same ability to reliably exchange value. A “general-purpose cryptocurrency”, such as bitcoin, is meant for use in open markets with no designated trade purpose or associated value.

What is an “Asset-Based Cryptocurrency”?

An asset-based cryptocurrency (ABC) is a cryptocurrency that uses digital tokens to represent a tangible pool of assets. The value of the digital tokens is based on the assets. An ABC uses the same underlying technologies as general-purpose cryptocurrencies, but is different in how those technologies interact with systems and people.

How is an Asset-Based Cryptocurrency Created?

ABCs have characteristics and challenges that are unique when compared with general-purpose cryptocurrencies such as bitcoin. An ABC ecosystem has a distinct set of requirements that define the success or failure of that ecosystem.

To be viable, an ABC, like any cryptocurrency, must establish the “Three Pillars of Digital Money Viability”, as shown in Figure 1. An ABC can more likely build the pillars, since the nature of an ABC is more focused and targeted.

The three pillars as applied to an ABC ecosystem are: network services, for the Technology Pillar; asset supporters for the Community Pillar; and token exchange for the Liquidity Pillar.

The differentiator for an ABC, compared with a general-purpose cryptocurrency, is the allocation of a pool of assets to be exchanged against the digital tokens. This distinction is significant and raises considerations that are unique to an ABC ecosystem.

Network Services

The ABC network services are the technology elements needed to support transactions with the digital tokens that represent the asset pool. Of critical importance to this functionality are the nodes in the network. Nodes are required for peer-to-peer network support, as well as being the foundation for related services. Services, such as exchange or redemption, require node communications for completing transactions.

The Network Platform

Cryptocurrency technology is based on open source software with different platform types available for ABC deployment. The benefits and drawbacks to each type are affected by the nature of the assets.

• Dedicated platform. A dedicated platform is purpose-built for the asset pool and surrounding applications. This type of platform has the benefits of being completely customizable and can be built according to the exact requirements of the assets represented. The main drawback is high development overheads.
• Modified fork of existing technology. Modifying existing technology provides the benefits of a proven history. Existing technologies have extensions allowing for more rapid deployment of services. This type of platform can have limitations or dependencies on previous development efforts that may not be aligned with the objectives of the assets being represented.
• Sub-token on existing network. Some existing cryptocurrency platforms allow the creation of separate digital tokens to exist on a network with other digital tokens. These tokens are independent in their represented value but are dependent on the existing network for functionality. There can be network effect benefits to using an established cryptocurrency network with a proven performance record. These dependencies can possess limitations, with customizations restricted to the specifications of the existing network technology.

The Wallet

Cryptocurrency tokens are accessed using software that is typically called a “wallet”. The wallet provides an end-user interface for interaction with the cryptocurrency. Wallets use a semi-standard interface to enable consistent interaction and complete user control of their tokens. Wallet software is typically open source and can be a local client or online service. Wallet platform support is typically driven by the requirements of those interacting with the system. Support for wallets can include: desktop clients for Windows, MacOS and Linux; smartphone apps; web-based wallets; and physical wallets, such as paper or other printed versions.

The Block Explorer

Unique to cryptocurrency technology is the “block explorer”. A block explorer is a service that allows users to view transactions in the network. This is done through an interface that allows easier access to the data within the network. The block explorer is not just used by people to view transactions, but is also the common application used for confirming transactions in commerce. Block explorers are typically web-accessed services.

Asset Supporters

The community supporting an ABC is vital to its viability, but may not be as robust as that of a general-purpose cryptocurrency. Those supporting an ABC will have more interest in the benefits of the underlying asset as opposed to the general benefits of cryptocurrency.

Market Opportunities

The benefits and opportunities created for asset managers when representing an asset pool with a digital token revolve around increasing markets through enhanced liquidity.

The deployment of an ABC creates new opportunities that are only possible through cryptocurrency. Using cryptocurrency, it is possible to exchange value that is represented digitally without an intermediary. This ability to reliably exchange digital value creates a new form of liquidity previously unattainable. More liquidity creates new market conditions that can facilitate previously unexplored forms of trade. Liquidity comes from the community and building liquidity also extends the community.

Community Building

The best efforts for building and maintaining a supportive community surrounding an ABC involve channelling participants. With an ABC the supporting community is likely already established, or is more easily rallied. The nature of the community will be directly affected by the nature of the asset pool associated with the ABC.

The community supporting an ABC will immediately consist of:

• asset managers
• token speculators
• liquidity providers
• aftermarket exchangers.

Existing interest should be leveraged by the ABC community building efforts. The supporting community affects the overall trust of the ecosystem. Having trustful entities responsible for important components in the ecosystem increases the overall trustfulness of the ecosystem.

Regulatory Concerns

The supporting community of an ABC is affected by regulation. Regulatory issues relating to cryptocurrency are regional, but cryptocurrency technology by nature is global. When dealing with an ABC, however, the regulatory issues can become more clearly defined. This can be affected by the nature of the assets represented by the tokens, in addition to the methods used for redemption.

Detailed aspects of regulatory issues surrounding ABCs are beyond the scope of this chapter. It is very important to take appropriate precautionary measures during the earliest stages of ABC development, to mitigate risk. Improper handling of assets can have severe regulatory repercussions, so be sure to seek legal counsel regarding any potential regulatory pitfalls that may exist.

Token Exchange

The value of an ABC comes from its association of value with the asset pool. The conversion of the digital token into the asset, or the reverse, is where implementation and logistics raise challenges. Liquidity and divisibility of the asset are the primary considerations for the deployment of an exchange system.

Security Mention

Cryptocurrency technology offers an inherent level of security regarding transactions and other aspects related to the supporting network activities. An ABC has dependencies on service components that have separate security concerns. The transactions stored within a cryptocurrency network are cryptographically secure, but the surrounding technologies are not secured by the same technology. A multidirectional approach to network security is critical to the establishment of trust and ultimately the success of an ABC.

Redemption Logistics

Options for how to offer exchange of digital tokens for tangible assets – as represented by the cryptocurrency – are specific to the nature of the represented assets. The exchange of the digital tokens represents liquidity resulting from the assured value, but the practical liquidity of the underlying assets may not be as fluid. It is important for the asset manager to make allowances for (or restrictions on) the redemption of digital tokens as directly applied to the asset pool.

Reconciliation of Value

Digital tokens used for exchange of value representing a specific pool of assets must have a consistent valuation for redemption. Although cryptocurrency technology does provide a very high level of security, the system is still vulnerable to human conditions. It is up to the asset pool manager to determine the value of associated digital tokens and how their redemption will impact the open-market value of digital tokens that have not been redeemed.

Conclusion

The development and deployment of an asset-based cryptocurrency offers challenges and benefits while creating new opportunities. ABCs can have economic effects that can only be realized as more become available. Viable ABCs can be used as part of digital economies that are built with cryptocurrencies and open markets. The ability to tokenize and exchange any value, reliably and without intermediaries, reshapes how assets function.