The Cryptocurrency Phenomenon: The Origins, Evolution and Economics of Digital Currencies 1032404426, 9781032404424

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The Cryptocurrency Phenomenon

This book provides a comprehensive analysis of the cryptocurrency phenomenon from a financial/monetary point of view. It offers a unique slant in at least two ways, with the financial perspective as the reference point. An examination of the technicalities surrounding blockchain and the mining of cryptocurrencies is included, but the reading is oriented to those who seek to better understand how these technical issues help to explain the functioning and the potential of cryptocurrencies, without touching on coding aspects. Moreover, the book addresses cryptocurrencies as an evolution of the concept of money, and it frames the analysis to give readers all the knowledge needed to connect the cryptocurrency phenomena with traditional monetary theories. In so doing, cryptocurrencies are not considered as a completely disconnected trend, set apart from traditional financial systems, but as innovations that will push the concept of money forward, without dismantling previous foundations. The book also includes a discussion on central banks and stresses how their initial diffidence toward cryptocurrencies has turned into a more active approach that includes projects to develop the so-called Central Bank Digital Currencies (CBDCs), thereby completing the analysis of the state of the art of the cryptocurrency surge. The mix of theoretical content on the concept of money, the description of payment tools and the functioning of the payment industry, and the analysis of blockchain and the cryptocurrency markets makes the book interesting reading for researchers, scholars, and students of economics, finance, or business, enabling them to develop the ability to understand the dynamics of the cryptocurrency phenomenon and its possible evolution. Gianni Nicolini is Full Professor of Finance, Department of Management and Law, Faculty of Economics, University of Rome “Tor Vergata”, Rome, Italy. Silvia Intini is Assistant Professor, Department of Management, Finance, and Technology, LUM – Libera Università Mediterranea “Giuseppe Degennaro”, Bari, Italy.

Routledge International Studies in Money and Banking

Environmental Risk Modelling in Banking Edited by Magdalena Zioło Money, Debt and Politics The Bank of Lisbon and the Portuguese Liberal Revolution of 1820 José Luís Cardoso The Digital Revolution in Banking, Insurance and Capital Markets Edited by Lech Gąsiorkiewicz and Jan Monkiewicz Activist Retail Investors and the Future of Financial Markets Understanding YOLO Capitalism Edited by Usman W. Chohan and Sven van Kerckhoven Banking, Risk and Crises in Europe From the Global Financial Crisis to COVID-19 Renata Karkowska, Zbigniew Korzeb, Anna Matysek-Jędrych and Paweł Niedziółka Inflation Dynamic Global Positive Economic Analysis Weshah Razzak COVID-19 and European Banking Performance Resilience, Recovery and Sustainability Edited by Paul Wachtel and Ewa Miklaszewska The Cryptocurrency Phenomenon The Origins, Evolution and Economics of Digital Currencies Gianni Nicolini and Silvia Intini For more information about this series, please visit: www.routledge.com/Routledge-InternationalStudies-in-Money-and-Banking/book-series/SE0403

The Cryptocurrency Phenomenon The Origins, Evolution and Economics of Digital Currencies Gianni Nicolini and Silvia Intini

First published 2024 by Routledge 4 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 605 Third Avenue, New York, NY 10158 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2024 Gianni Nicolini and Silvia Intini The right of Gianni Nicolini and Silvia Intini to be identified as authors of this work has been asserted in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks and are used only for identification and explanation without intent to infringe. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library ISBN: 978-1-032-40442-4 (hbk) ISBN: 978-1-032-40443-1 (pbk) ISBN: 978-1-003-35310-2 (ebk) DOI: 10.4324/9781003353102 Typeset in Bembo by Apex CoVantage, LLC

Contents

List of Figures

viii

Introduction

1

1 The Concept of Money and Its Evolution Over Time 1.1 Introduction 4 1.2 Definition of Money and Its Functions  4 1.2.1 Money as a Medium of Exchange  5 1.2.2 Money as a Store of Value  5 1.2.3 Money as a Unit of Account  5 1.3 From Barter to Commodities  6 1.4 The Use of Metal Coins  7 1.4.1 Precious Metals and the Risk of Fake  8 1.4.2 Coinage and the “Seignorage”  8 1.5 Banking and Banknotes  9 1.6 Governments, Money, and Central Banking  9 1.7 The Bretton Woods Agreement  10 1.8 The “Fiat Money” Era  11 1.8.1 The Federal Reserve and the Role of the US Dollar in International Trades  11 1.8.2 The Euro and the Eurosystem  12 1.9 The (Continuous) Evolution of the Concept of Money  13 References 14

4

2 The Payment Industry and the Payment Tools 2.1 Introduction 16 2.2 The Role of Banks in the Payment Industry  16 2.3 Payment Cards and Payment Circuits  18 2.4 E-payments Options  19 References 22

16

vi  Contents 3 Blockchain, Virtual currencies, Cryptocurrencies, and Tokens 3.1 Introduction 23 3.2 The Blockchain Technology  23 3.3 Blockchain and Digital Currencies  36 3.3.1 The Cryptocurrencies  37 3.3.2 The Virtual Currencies  40 3.3.3 The Tokens  41 3.4 Conclusion 42 References 44

23

4 The Mining of Cryptocurrencies 4.1 Introduction 45 4.2 Mining, Consensus, and Consensus Algorithms  45 4.3 The Proof of Work  50 4.4 The Proof of Stake  51 4.5 Computational Power, Cost of Mining, Footprint, and Sustainability Issues  52 References 55

45

5 The Main Cryptocurrencies on the Market 5.1 Introduction 56 5.2 The Bitcoin  57 5.3 The Ethereum  61 5.4 Altcoins 63 References 69

56

6 The Handling of Cryptocurrencies 6.1 Introduction 71 6.2 Holding Cryptocurrencies: The e-Wallets  72 6.3 Exchanging Cryptocurrencies: The Trading Platforms  75 6.4 Expendability 79 References 82

71

7 The Central Bank Digital Currencies (CBDCs) 7.1 Introduction 83 7.2 Central Banks and Digital Currencies: Risk and Opportunities  84 7.3 First Attempts to Approach Cryptocurrencies and the Blockchain Technology  89 Uruguay 90 Sweden 90 China 91

83

Contents vii Switzerland 92 Hong Kong and Thailand  92 7.4 The Federal Reserve (FED) Point of View  93 Technological Experimentation  93 Economic and Policy Investigation  94 Stakeholder Involvement  94 International Collaboration  94 7.5 The ECB and the Digital Euro  96 7.6 Conclusion 100 References 101 Conclusion

104

Index106

Figures

3.1a 3.1b 3.1c 3.1d 3.1e 3.1f 3.1g 3.1h 3.1i 3.1j 3.1k 3.1l 3.1m 3.1n 3.1o 3 .2a 3.2b

The Distribution Ledger Technology (DLT) and the Blockchain – A new blockchain starts The Distribution Ledger Technology (DLT) and the Blockchain – The ledger is distributed The Distribution Ledger Technology (DLT) and the Blockchain – Request to add a new block The Distribution Ledger Technology (DLT) and the Blockchain – The validation process The Distribution Ledger Technology (DLT) and the Blockchain – A complete validation The Distribution Ledger Technology (DLT) and the Blockchain – The ledger is updated The Distribution Ledger Technology (DLT) and the Blockchain – Additional requests: proposal of a new block The Distribution Ledger Technology (DLT) and the Blockchain – Additional requests: Comparison with other ledgers The Distribution Ledger Technology (DLT) and the Blockchain – Additional requests: A new validation The Distribution Ledger Technology (DLT) and the Blockchain – Additional requests: Update of the distributed ledgers The Distribution Ledger Technology (DLT) and the Blockchain – Additional requests: iteration of the process The Distribution Ledger Technology (DLT) and the Blockchain – A tampered ledger The Distribution Ledger Technology (DLT) and the Blockchain – Validation denied The Distribution Ledger Technology (DLT) and the Blockchain – A new block is NOT added The Distribution Ledger Technology (DLT) and the Blockchain – The blockchain does not change The Hashing Function and the Use of “Digest” – A new request The Hashing Function and the Use of “Digest” – The validation

25 25 25 25 26 26 26 27 27 27 28 28 28 29 29 30 30

Figures ix 3.2c The Hashing Function and the Use of “Digest” – A not tampered block 3.2d The Hashing Function and the Use of “Digest” – Update of the distributed ledgers 3.3 Hashing Properties 1 3.4 Hashing Properties 2 3.5 Hashing Properties 3 3.6 Hashing Properties 4 4.1 Energy Consumption by Country 4.2 Bitcoin Energy Consumption 4.3 Ethereum Energy Consumption 5.1 Bitcoin Price 5.2 Ethereum Price 5.3 Litecoin Price 6.1 Type of Wallets 7.1 Model of Back-End Infrastructure for Digital Euro

31 31 32 32 32 33 53 54 54 60 63 65 75 99

Introduction

Money, in its basic form of banknotes and coins, represents the fundamental pillar of finance. Finance itself can be defined as the discipline that studies the management of money, and any financial transaction always involves (directly or indirectly) a money transfer. Thus, the proposal to dismantle the functioning of the monetary system – based on a central authority responsible for the issuing of money and the monetary policy  – by the adoption of a decentralized issuing system represents a revolutionary (and provocative) idea. Since 2008, when the first cryptocurrency – the Bitcoin – was launched, the cryptocurrency market has bloomed, up to current time, with more than 20,000 cryptocurrencies available. In the beginning, cryptocurrencies were addressed as experimental projects, with the main goal to prove how much powerful the blockchain technology can be. The issuing of new coins – the so-called “mining” – was quite affordable and cheap. A single laptop computer and a free software were enough to join a cryptocurrency network and to be rewarded with few new units of the cryptocurrency. However, the rapid growth of the networks and the interest in cryptocurrencies changed the perception of cryptocurrencies. People started to consider cryptocurrencies as valuable assets and so the trading grew. That was the time when central banks started to pay attention to the cryptocurrency markets and tried to keep them out of the traditional financial market. Banks and other investment firms were strongly advised to avoid the use of cryptocurrencies, while the inner nature of the Bitcoin and other cryptocurrencies was argued. The status of “currency” was essentially denied, referring to them as “crypto-assets”. The main concerns were about the lack of transparency about the identities of the promoters of cryptocurrency projects, the lack of a central authority responsible for the reliability of the currency (the lack of a “central bank”), and the lack of regulation, including the risk of abuse or misuse of those financial instruments for illegal purposes, such as drug dealing, tax evasion, corruption, and other similar practices. To make cryptocurrencies being considered as a threat to the stability of the financial system by central banks and financial authorities was essentially the underlying assumption of cryptocurrencies that a currency does not have to be a monopoly of a single public entity (a central bank). On the contrary, cryptocurrencies’ promoters argue that a decentralized system represents a democratization of money and paves the way for a fairer financial system. DOI: 10.4324/9781003353102-1

2  Introduction The growing number of cryptocurrencies and the growing trading volumes ­ required central banks to change their strategy, after they realized that ­cryptocurrencies were not a temporary fad. That change was even necessary by the ­evidence of a growing interest by the private sector about the idea to issue private (crypto-)­currencies, reshaping the financial system from a single currency system to a m ­ ulti-currency system. Big-tech companies like Facebook (now Meta), Apple Inc., Google, or Amazon have all the potential to play an active role in the payment industry, promoting their own cryptocurrencies and taking benefits from their huge network of customers. In this new scenario, the reaction of central banks has been the starting of exploratory projects to assess how the benefits of the new technologies, as the blockchain, could be applied to the fiat money issued by central banks, and promote the co-called Central Bank Digital Currencies (CBDC). The rapid growth of the cryptocurrency phenomenon and its unpredictable evolution are quite fascinating from both an ITC (Information and Communication Technology) and financial perspectives. This book aims to address cryptocurrencies mainly from an economic and financial perspective. The aim is to provide, in a single study, all the contents needed to understand, assess, and correctly approach the cryptocurrency phenomenon, from the point of view of a financial decision-maker. Technicalities about algorithms, protocols, and cryptography will be addressed with the aim to understand their role in the functioning of a financial tool (the cryptocurrency), avoiding the most complex technical explanations, and without the will to provide an ITC guidebook. The structure of the book proposes in the first chapters an analysis of the concept of money. Basic definitions and a detailed analysis of what money is and which are its function in a financial system provide the reader with fundamental reference points to assess any kind of money. These financial criteria allow to address cryptocurrencies from a point of view that is not biased by the concept of money currently in use, based on fiat currencies issued by single entities (the central banks). To stress how the concept of money evolved by the time, without big changes in the role of money in a financial system, a description of the evolution of the monetary systems from ancient times to nowadays is provided. The financial contents of the first part of the book include an analysis of the payment industry, with a description of how different payment tools (e.g., checks, bank transfers, credit cards, e-payment options) relate to each other and how this architecture is based on the assumption that – in case of need – this money can be withdrawn, making cash available. The analysis of the current functioning of the monetary and payment systems gives the chance to understand how cryptocurrencies can interact and/or co-exist with other monetary tools. In the next part, the functioning of a blockchain, the role of Distributed Ledger Technology (DLT), and cryptography allow to understand the functioning of a cryptocurrency from a technical point of view, stressing how the issue of a cryptocurrency could be impossible without the blockchain technology, but the potential application of the blockchain technology goes far beyond the issuing of cryptocurrencies. At that point, the differences between virtual currencies, cryptocurrencies, and tokens will be clear, and the analysis of the functioning of cryptocurrencies from a financial point of view will be possible. The mining

Introduction 3 of cryptocurrencies will be analyzed in detail, and all the main cryptocurrencies on the market (including Bitcoin, Ether, and the so-called “altcoins”) will be addressed in detail, showing the differences and the similarities. At this point, the handling of cryptocurrencies will follow. How to store cryptocurrencies in e-Wallets, how to use cryptocurrencies for payments or trading, and the role of trading platforms (exchange) will complete the analysis of the cryptocurrencies as they are at the current time. The last chapter will address the point of view of central banks, with a description of several ongoing projects, that aim to maintain the pivotal role of central banks in the monetary system by the issue of the so-called Centra Bank Digital Currencies (CBDCs).

1 The Concept of Money and Its Evolution Over Time

1.1 Introduction Cryptocurrencies are one of the most fascinating topics in recent financial history. Since the introduction of Bitcoin in 2008, the idea to develop a new concept of money, based on a decentralized and peer-to-peer based system, required to question the current structure of financial systems, arguing about the need and the role of central banks in the issue of money. The blooming of several cryptocurrencies and their use as a speculative tool by traders around the world required to question even about their inner nature, arguing if they can be considered (crypto)currencies or just (crypto)assets. To address these topics, it is necessary to recall what is behind the concept of money and what are the roles of money in a financial system. The aim of this chapter is to summarize the evolution of the concept of money and the history of the monetary systems to stress when and how a certain asset can be referred to as money, and which are the criteria we should use to assess a currency. 1.2 Definition of Money and Its Functions Cryptocurrencies represent an additional step in the evolution of money. Such evolution dates back in time across centuries and it roots with the concept of finance itself. A clear understanding of cryptocurrencies and how they can change the functioning of the financial system require to start from the concept of money and to stress the main functions that money has in finance. Friedman and Meltzer (2022) define money as a commodity accepted by general consent as a medium of economic exchange. The same authors add that it is the medium in which prices and values are expressed and as currency, it circulates anonymously from person to person and country to country, thus facilitating trade, and it is the principal measure of wealth. On the role of money in the society, the ECB (2022a) reminds that money is not only a means of payment, but it is used as a store of value too. Hence, we can identify three main functions of money: (1) the ability to work as a medium of exchange; (2) the chance to use it as a unit of account, to price and compare different goods and services; and (3) and the use of money as a store of value. DOI: 10.4324/9781003353102-2

The Concept of Money and Its Evolution Over Time 5 1.2.1 Money as a Medium of Exchange

The first and pivotal function of money is to be a medium of exchange (Lagos 2010). People use money to purchase goods and services, and the transaction involves the acquisition of the good (or the benefit of a service) by the payment of its price, which happens by the transfer of an amount of money. The acceptance of money as a medium of exchange by the seller of an item essentially happens on a voluntary base. An individual accepts an amount of money in exchange for a certain good or service, under the assumption that that money will be accepted for payments by other individuals. In that case, it is the general consensus that money is valuable to guarantee its acceptance. It is the confidence that the money received – for instance – selling a good, can be used to buy another good, that will guarantee the circulation and the acceptance of money. It follows that the value of money is related to its acceptance rate, and the bigger the number of individuals that accept a money for payment, the bigger is the value of this money as a medium of exchange. On the contrary, an item that struggles to be accepted for payment in economic transactions will make people lose interest in its use as money. In a modern society, the acceptance of money for payments can be supported by the fact to be a “legal tender” (Helleiner 2002). It means, for instance, that economic agents cannot deny their counterparts a cash payment in the local currency if the Government recognizes such currency as a means of payment. However, the assumption to force people to use a certain currency by law is pretty weak and creates the premise for the circulation of alternative currencies or the rise of “black markets”, where goods and services officially not available or not on sale can be traded when the payment is offered by alternative means of payments (e.g., foreign currencies, commodities). In conclusion, the acceptance rate of money in economic transactions represents the main value of money as a medium of exchange. Higher the confidence that money can be easily spent in further transactions, higher is the willingness to accept it in a current trade. 1.2.2 Money as a Store of Value

Money does not represent merely a medium of exchange, and people rely on money even if they are not dealing with a purchase. The chance to receive money and keep it (not spending it), to use it in future transactions, gives money an additional utility function, commonly referred to as its ability to store value (Kubát 2015). To receive money, do not spend it or do not switch it for other assets, but to store it for a ­future purchase allows to use money as a basic saving tool. In that manner money is a ­vehicle to transfer purchase power from a current time to a future time. It follows that money has not value only for the chance to facilitate spot transactions, but the value of money is even due to the chance to store value and transfer it across time. In that manner, money works as an asset allocation tool. 1.2.3 Money as a Unit of Account

An additional function of money is the chance to use money to compare the values of different items. To express that the value of an item is double than the value of

6  The Concept of Money and Its Evolution Over Time another item, we can use money and say that the price (or the monetary value) of the first item double the price (value) of the second. At the same time, knowing that the price of the second item is equal to the price of a third item, we can conclude that the value of the first doubles the value of the third item too. Like meters or yards represent a unit of account for distance, and kilos or pounds are units of weight, in the same manner, money works as a unit of account in economics and finance. Such utility – to understand the relative values of multiple items – creates value for the money users, regardless of the interest to use money for a current or future transaction, and regardless of the current ownership of money (Young and Lee 2017). Hence, money is useful even for its role in assessing the values of things. As will be noted in the rest of the chapter, these essential functions of money represent the main parameters used by (potential) money users to decide if and how to use a certain money and to identify a certain asset as a money tool or not. Such analysis about the potential use of money, and the following decision to adopt it or not as a financial tool, remained essentially unchanged across time, and the decision to deal with cryptocurrencies or not, as the potential role of cryptocurrencies in a modern financial system, still refer to the chance to use them as a medium of exchange, as a store of value, and to make it work as a unit of account. 1.3 From Barter to Commodities Finance is the discipline that studies money-related issues (Melicher and Norton 2019). The creation, management, and transfer of money are examples of processes that belong to finance. That makes money a fundamental pillar of financial studies, and it makes the origin of money overlaps with the origin of finance. The concept of money and the need to have some tools to settle economic transactions makes the difference between an economy supported by financial tools and a barter-based economy (Beattie 2015). Without a social agreement about assets that can work as a means of exchange, a barter is the only available option to close a deal and make a transaction ­(Ritter 1995). However, a so primitive economy will suffer from several inconvenient ­issues, that represents the main incentives to develop the concept of money as we know it. Without money, the counterparts of a potential transaction need to be interested in each other goods. If the interest of the buyer is the premise to trade an asset, in a barter the interest of a part to own the item owned by the counterpart is not enough to start a negotiation, if the owner of that item is not interested in any item the potential buyer proposes to exchange. Moreover, if two counterparts find a couple of assets to switch, the lack of money involves a difficult negotiation about the relative value of the assets, which becomes even more challenging in the case of indivisible goods. An additional issue, due to lack of money, is the lack of “a financial yardstick”. Without a unit of account, it is hard to price different assets and make comparisons between the value of different assets. So, the development of the concept of money is due to the need to facilitate economic transactions and was driven by the preferences of traders (Ritter 1995). Once certain assets started to be interesting for some groups of individuals, the likelihood

The Concept of Money and Its Evolution Over Time 7 to close a deal proposing these assets increased, thanks to the willingness to accept the asset by a large group of individuals. At the same time, even those that are not interested in these items, but are aware that that asset will be easy to exchange, will start to accept that asset as a payment in a transaction, and doing so they help to improve the acceptance rate of these assets. The growing acceptance rate will be the premise to develop a social agreement about what should be preferred as a medium of exchange. The logic behind the need to facilitate trades, by identifying a set of goods and service more likely to exchange, thanks to the common interest in their ownership, has seen the use of commodities as standard goods for payments. In ancient times, livestock represented a common means of payment, thanks to the large interest to own them. The chance to milk cows, to use the wool of sheep, or to ride horses, camels, or other animals can be seen as the interest behind livestock, and their role as a medium of exchange. However, if the high acceptance rate of livestock (thanks to the benefit coming from their ownership) is a good thing for a money tool, livestock involves two cons related to the holding cost and the lack of standardization. The need to feed animals and other costs of maintenance reduces the willingness to own them. At the same time, the fact that two animals differ in several terms (e.g., age, health status, productivity) requires traders to be able to assess those differences before closing a deal and making a transaction. An additional issue is the low flexibility of livestock as a means of payment. As indivisible goods, livestock cannot be used for payments when the agreement about the value to exchange includes fractions of a unit.1 The evolution of the concept of money has seen the replacement of livestock with other widely accepted commodities, such as lower holding costs, higher standardization, and higher divisibility. In history, commodities like salt have been widely accepted for payments and were used as a means of payment. The standard use of salt to preserve food had guaranteed the acceptance rate. The low holding cost and the high flexibility as a means of payment have made it a common payment tool.2 However, the low intrinsic value3 of salt and other technical issues4 have seen the concept of money and the social agreement about assets to prefer in commercial trades evolve to other assets. 1.4 The Use of Metal Coins With the use of metals – including precious metals like silver and gold – the acceptance of an item as a means of payment is not related anymore to the chance to use such items or, generally speaking, to the benefits coming from its ownership. The acceptance of gold as a means of payment is based on the common belief that gold is precious, even if there is not a direct benefit from its ownership.5 People accept to exchange goods and services with gold under the assumption that gold is precious, and it will be easy to switch with other goods and services because there is a strong and common belief about its value (Desan 2014). It can be noted that, compared to other commodities, metals require a lower cost of maintenance, and, in the case of precious metals, the high intrinsic value of gold makes it a convenient option in case of a large trade.6

8  The Concept of Money and Its Evolution Over Time 1.4.1 Precious Metals and the Risk of Fake

The use of precious metals as means of payment exposes to the risk of fake, which refers to the acceptance of other assets or mixed assets that look like gold even if they are not.7 The risk of fake has always been an issue for gold-based systems (Charney 2012). The acceptance rate in an economic system of gold as a means of payment can be negatively affected by the risk to receive fake gold. The higher the skepticism about the quality of gold circulating in a system, the lower is the attitude to use it as a payment tool. From a technical point of view, the need to develop skills in recognizing real gold, and to spend time and effort to test gold anytime it is exchanged in a transaction, increases the implicit cost of the use of gold as a means of payment. To solve these issues, the evolution of money tools introduced “coinage”. The certification of the quality of gold and the standardization of the circulating units of gold in a financial system are guaranteed by a central authority represented by the coinage.

1.4.2 Coinage and the “Seignorage”

Today coinage is defined as “the act or process of coining8”. In history that word referred even to an entity responsible for the production of coins. This entity worked essentially as a certification authority (Crawford 1975). The same amount of gold, if issued by a coinage by the issue of standardized coins – all with the same weight and shape – becomes more valuable due to the intrinsic certification of the gold quality and the time saved to check the weight of the gold. The use of this “certified gold” reduced the risk of fake and/or the need to test the quality of gold by counterparts of a trade. In this scenario, the acceptance of gold (coins) is still based on the intrinsic value of gold, but the reputation of the issuer is pivotal. Typically, the coinage was related to political authorities that severely punished coin fakers.9 To prevent the manipulations of coins (e.g., coin clipping to reduce the amount of gold from a coin and use it elsewhere) and discourage coin fakers, the hedge of coins has been “reeded”.10 The figures and writes on both sides of the coins have a similar scope, beyond reporting the issuer and making the coin recognizable by the users. However, the political authorities responsible for the coinage have soon realized that the issue of coins was not only a financial infrastructure, but it could be a source of revenue (Cipolla 1982; Motomura 1994). If the same amount of gold, once coined, increases its value, it follows that there is the chance to issue coins with less gold than the official weight without decreasing the acceptance by the users. A certified gold coin was considered as valuable as a bigger amount of uncertified gold. Doing so the coinage can make profit from the issue of coins, saving gold from each coin or being able to coinage more coins from the same amount of gold. The additional coins generated from the same amount of gold – thanks to underweight coins that respect their official weight – remain in the hand of the issuer. The word “seignorage” (from the old French “seigneuriage” that means “the right of the lord the – ‘seigneur’ – to mint money”) is used to stress the difference between the face value of a coin and its cost of production, including the physical materials of the coin (Reich 2017). That phenomenon is still present in modern monetary systems, and

The Concept of Money and Its Evolution Over Time 9 it represents the chance for the issuer to gain from the issue of money. Central banks take benefit from the seignorage (even if their monetary policies are not driven by it) and the willingness to mine a new unit of a cryptocurrency is driven by the chance to make profit from the cost of production of a new unit and the reward from this process. 1.5 Banking and Banknotes Once the concept of money developed to a standard unit (coin) of a certain metal, issued by a central authority, the growing circulation of money has stressed the risk of thefts, robberies, and other negative events. If the risk to be a victim of these crimes exists even by using other commodities as a means of payment (e.g., livestock, salt), the high intrinsic value of precious metals emphasizes that risk. To lose a single coin can be related to the loss of a great purchase power. For that reason, the circulation of coins (especially precious coins), and the risk related to this circulation, have seen the rise of a new financial service and new financial players. In a time of flourishing international trade, the risk for merchants to travel with big amounts of money has seen the need to cover the risk of loss, theft, and robberies. The solution was to deposit money in a safe place, receiving a paper note that certifies this deposit (De Roover 1954). The note received can be cashed once arrived at destination, by claiming the credit represented by the note to another branch of the same institution. By doing so all the risks of traveling (loss, theft, etc.) are avoided, thanks to the fact that the paper note cannot be cashed by other than the depositor. Such financial institutions that offered this deposit facility were referred to as “banks”11 and the notes issued as a certificate of deposit were the “bank-notes” (Dunbar et al. 1922). The next step in the evolution of the concept of money was the chance to transfer the banknotes between counterparts. In that manner, the circulation of money is based on the circulation of banknotes, while coins are stored in bank deposits. The chance to issue banknotes representing different numbers of coins, and the standardization of these banknotes increased even more the circulation of banknotes. People accept banknotes as a certificate of a certain amount of gold. Hence, the system is still a gold-based system, even if gold does not circulate anymore, being replaced by banknotes. 1.6 Governments, Money, and Central Banking Money is the most basic financial infrastructure of a financial system. Savings, borrowing, and investing can be seen as transactions that involve the managing of money. The pivotal role of money in finance and the need for a good financial system to support economic development have seen the coinage and the issue of money to be centralized in a single monetary institution, under the control of Governments (Bordo 2022). Central banks have replaced commercial banks in the issue of banknotes. In that scenario, the monetary system is still a gold-standard system, with banknotes issued directly from a public entity (the central bank) but collateralized by gold, deposited in the reserve of the central bank.12 The circulation of gold

10  The Concept of Money and Its Evolution Over Time coins is replaced by the circulation of banknotes, representing a certain amount of gold. The evidence that people do not claim gold, preferring to use banknotes, and the chance to deposit banknotes in commercial banks to prevent the risk related with the ­ownership (e.g., destruction, loss, theft) give to central banks the chance to issue banknotes without an equivalent collateral of gold (Desan 2014). This is, of course, a cheating behavior that should be avoided, but the people’s a­ wareness about this chance makes the reputation of the central bank, and the people’s trust in this institution, fundamental pillars for the sustainability of the monetary ­system. Issuing banknotes not collateralized by gold represents a sort of free borrowing facility for the issuer managing the system. In systems where ­Governments have a direct ­control on central banks, the issue of banknotes beyond the value of the gold reserves ­exposes the monetary system to the risk of a “bank run”. In case the trust of people in the central bank decreases and the doubt that not all the i­ssued banknotes can be ­exchanged for gold rises, people would decide to not rely on p­ aper money ­(banknotes) anymore and to claim for gold, trying to be first in line and avoid ­remaining with uncollateralized (and worthless) banknotes. This so-called “gold-standard” system featured the functioning of central banks until the end of World War II. 1.7 The Bretton Woods Agreement The end of World War II was a time of new world equilibria from different points of view (social, political, economic, etc.), and even monetary systems were reorganized from a worldwide perspective. The so-called Bretton Woods Agreement represented the most evident post-war financial change in the monetary systems. Around 730 delegates from 44 countries have met in Bretton Woods (New Hampshire, USA) in June 1944, with the will to create a new international foreign exchange system, aiming for a stable financial environment and promoting economic growth (Bordo and Eichengreen 2007). The agreement assigns a pivotal role to the US dollar. This was the only currency to be converted in gold, by submitting requests to the Federal Reserve (issuer of the US dollar). Other countries of the agreement will collateralize their issue of new local currencies’ bill by the US dollar. Doing so, the system involves an indirect gold-based collateralization for non-American currencies. Holders of these currencies (e.g., German marks, French francs, Italian liras) could change their currencies in US dollars first, and then claim for gold to the Federal Reserve. When the system became fully functional in 1958, the exchange rate of the US dollar versus gold was $35 for an ounce.13 As any other gold-based system, even the gold-standard system of the Bretton Woods Agreement requires – to remain on balance – that the issuer will fully collateralize new issues by gold, and the trust of the currencies’ users is pivotal to guarantee the circulation of currencies. However, the use of seignorage by the US Government and the Federal Reserve system, that have financed their policies by non-collateralized dollars, arrived at the end in August 1971, when the US President announced that the USA would no longer exchange gold for US dollars (Bordo 2020). This decision was taken to stop the growing number of requests from foreign countries that started to be afraid that the practice to finance the systematically

The Concept of Money and Its Evolution Over Time 11 negative American balance of payments by the issue of US dollars could be unsustainable in the long term. The lack of trust about the full collateralization of banknotes by the issuer brings the end of the gold-based system. 1.8 The “Fiat Money” Era The end of the Bretton Woods agreement and the gold-standard systems required additional changes in the concept of money and introduced the concept of “fiat money”14. Banknotes issued by central banks do not represent anymore a document certifying the ownership of a certain amount of gold or other collaterals. The fact that central banks own reserves in gold or foreign currencies is not anymore a warranty of the value of money. The exchange rate of a currency with another one is driven by the demand and supply in the market, as any other good. The acceptance rate of a (local) currency as a means of payment in a certain country is supported by the law, which denies the chance for a seller to deny payments in the local currency. However, as it happens in any monetary system (regardless of the historical time), the acceptance of money by the people and its use as a means of payment cannot be simply imposed by the law, but it is driven by the perception of traders about the chance to spend this money in another trade, and the perceived likelihood to find counterparts prone to accept that money for payment (the acceptance rate). In this scenario, the reputation of the central bank and the trust in its monetary policies become even more crucial than in the past. The intervention of central banks to prevent or contrast the loss of value of money (inflation) will affect the reputation of the central bank and the perception about its ability to make the local currency work as a reliable store of value, and not only as a means of payment. So, the central bank, having the chance to influence the demand and the supply of money, is responsible for its value, and the central bank’s decisions are monitored by economic agents. 1.8.1 The Federal Reserve and the Role of the US Dollar in International Trades

The Federal Reserve system was established in 1913 in the USA by the Federal Reserve Act. The system includes 12 regional federal reserve banks15, a Board of Governors (BoG), and a Federal Open Market Committee (FOMC). The board is made by a President (nominated by the President of the USA) and six board members. The FOMC is made by the presidents of the 12 regional banks and the seven members of the BoG (Federal Reserve 2022a). However, only five bank presidents vote at any given time, according to a rotation process through one-year terms, except for the president of the New York Fed who is a stable voting member. The BoG is an independent agency of the federal government, overseen by the US Congress. The monetary policy decisions are made by the FOMC16 in accordance with the “double-mandate” of the Fed. According to its statute, the aims of the Fed and its monetary policies are to foster economic conditions that achieve both stable prices and maximum sustainable employment (Federal Reserve 2022b). It means that the monetary policies intervention are not only oriented to guarantee the “quality of the money”, taking care of its use as a means of payment, its role as a

12  The Concept of Money and Its Evolution Over Time store of value, and its application as a unit of account, but such goals can be replaced or affected by economic goals as the employment rate in the USA. The US dollar is the official currency in the USA. However, its role goes far beyond the borders of the American economy, due to the large use of the US dollar in international trade. The US dollar is the currency used to price assets and commodities such as crude oil and gold. In the meantime, most of the international payments and several securities issues (e.g., bonds) are denominated in US dollar, and the use of the US dollar as an asset included in the reserves of central banks is quite common too. Hence, the US dollar represents an international currency.17 The role of the US dollar as an international currency allows the US to benefit from the seignorage. This benefit includes the chance to print dollar bills and spend it to buy goods and services from outside the USA, without affecting the purchase power of dollar (no consequence on inflation or exchange rates with other currencies), due to the fact that sellers of goods and services to American entities prefer to deposit US dollars in their bank accounts and to do not exchange them in local currencies, because they are aware of the high acceptance rate of the US dollar in other international trades. Once again, it is the acceptance rate of the US dollar that push international traders to accept it and use it as a means of payment. Moreover, the stable value of the US dollar makes it work as a store of value too. The fact that most of the prices in international trade are denominated in the US dollar completes the analysis of this currency as a global currency. 1.8.2 The Euro and the Eurosystem

Since January 2002, the citizens of several European countries started to use Euro instead of local currencies (e.g., German marks, French francs, Italian liras). The official launch of the Euro dates back to 1999, even if for the first three years it represented an “invisible currency”, only used for accounting purposes and electronic payments (ECB 2022b). The so-called Eurozone started with 11 countries18 adopting the Euro as a circulating currency. Additional ten countries have joined the Euro in the next years.19 The 21 countries in the Eurozone, could be joined by other five countries (Sweden, Poland, Czechia, Hungary, and Romania) once they will meet the “convergence criteria”. Monetary agreements with other four micro-states (Andorra, Monaco, San Marino, Vatican City) enlarge the number of countries where the Euro is the official currency, and there are countries (Kosovo and Montenegro) that decided to use the Euro as a unilateral decision. The issuer of the Euro is the European Central Bank (ECB), responsible for the monetary policy of the Euro area (ECB 2022c). The ECB is made by the General council, the Governing council, and the Executive Board. The General council has advisory functions that do not include monetary policy decisions. The Governing council is made by the governors of all the national central banks of the Euro area, plus the six members of the Executive Boards, and it is the main decisionmaking body of the Eurosystem. The Executive Board contributes to the monetary policy decisions (being part of the Governing council) and it is responsible for its implementations.

The Concept of Money and Its Evolution Over Time 13 With respect to the Federal Reserve System, the ECB is a single mandate agency, whose main target is price stability. The chance to act in order to support economic development and the employment rates of national economies is allowed by the statute of the ECB, but only if the first goal of price control is achieved. Like the US dollar, the Euro is a “fiat money” too, with no obligation to exchange Euro bills with gold or foreign currencies. The acceptance of Euro as a means of payment is stated by the law, but – as in any monetary system – it is the stable value of the currency (low inflation and stable exchange rates with other currencies) and the reputation of the ECB to represent the main explanation behind the acceptance rate and the use of the Euro as a means of payment, a store of value, and a unit of account. As with any network-based system (e.g., telephone networks, internet), an increasing number of participants represents – ceteris paribus – an additional value for the previous participants, and a benefit for the new ones. 1.9 The (Continuous) Evolution of the Concept of Money The evolution of the concept of money and the reasons why people replaced some assets with others as means of payment, stores of value, and units of account helps to understand how the concept of money is not static, and the development of more and more sophisticated financial architectures allow to rethink  – from time to time – the concept of money. However, at the same time, the most evident changes, with the replacement of livestock with other commodities, then the switch of metal coins, until the use of banknotes and the concept of fiat money, did not change the fundamental pillars of money. Regardless of the nature of the assets used to circulate money, the reasons why people decide to use a certain currency still rely on the chance to spend it to buy goods and services (acceptance rate), and the confidence that holding money for a period of time, spending it later, will not affect the purchase power of money (holding cost of money), taking care of inflation and, generally speaking, price stability. Price stability (stable exchange rate) over time allows even to compare asset values from an investment point of view, and not only to compare current values, making a currency work as a unit of account. These criteria should be used to assess the chance that alternative assets – including cryptoassets – could replace the use of what is currently used as money. To sponsor an asset as a currency, or simply to include the word currency in the asset’s name, is not enough to make it work as a currency. The chance to consider cryptocurrencies as currencies or not will be addressed in detail in further chapters. Notes 1 A payment of 2.5 units is not feasible with livestock, because it is not possible to divide it in two and preserve its value and its functioning. 2 The use of salt to pay labor force is related to the word “salary” that is still used today to express the payment for a job. 3 In case of large payment, the amount of salt needed to transfer could be too big or too complicated to manage.

14  The Concept of Money and Its Evolution Over Time 4 If salt has lower holding cost than livestock, there are still the risk of destruction and the need of large storage facilities. 5 People can use salt to preserve food, or can milk a cow or a goat, while the ownership of gold has no similar consequence. 6 A single bar of gold can buy much more than a bar of salt. Hence, the same purchase can be done using much less gold than salt, with all the consequences in terms of physical transfer and storage. 7 “Not everything that shines is gold”. 8 Webster’s New World College Dictionary (2010). 4th Edition. Houghton Mifflin Harcourt. 9 In the Roman Empire the coin fakers were sentenced to death (Charney 2012). 10 The “reeding” is the process by which coins’ hedges are carved using a “kurnling” techniques, generating a regular pattern that disappears in case of scratching, showing a manipulation of the coin. 11 The word “bank” seems to be originally used in the 11th century in Italy as “banco”. That word identifies a long table or desk typically used by merchant to meet their customers and to show their goods. The merchants were on one side of the table, the customers at the other. With a similar process the depositors have met their counterparts being on different sides of the desk. Depositors, after having left their money on the desk, received a note from their counterparts that, doing so, offer a money custody service, with a paper note representing a certificate of deposit. Source: www.treccani.it/magazine/ lingua_italiana/articoli/parole/banca.html#:~:text=Torniamo%20a%20banca%20 (vocabolo%20attestato,la%20parola%20%22panca%22). 12 In the case of a central bank, gold does not have to be stored as coins, while gold bullions were preferred. 13 One ounce is 28.3495 grams. Hence, the official exchange rate for the US dollar was 1.2345 grams of gold. 14 This expression stresses that the issue of new banknotes seems to create a sudden value, which is not justified by another asset as it happens in the case of a collateralization. 15 Those reserve banks are located in New York, Boston, Philadelphia, Richmond, Cleveland, Chicago, St. Louis, Atlanta, Dallas, Kansas City, Minneapolis, and San Francisco. 16 The decision to print US dollar belongs to the FOMC of the Fed. However, the dollar bills are printed by the Treasury Department’s Bureau of Engraving and Printing. 17 There are even countries that adopted the US dollar as their official currency. That list includes Panama, Ecuador, El Salvador, Puerto Rico, and the British Virgin Islands. 18 Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain. 19 Greece (2001), Slovenia (2007), Cyprus (2008), Malta (2008), Slovakia (2009), Estonia (2011), Latvia (2014) and Lithuania (2015), Croatia (2023), and Bulgaria (2023).

References Beattie, A. (2015). The History of Money: From Barter to Banknotes. www.investopedia.com/ articles/07/roots_of_money Bordo, M. D. (2020). The imbalances of the Bretton Woods system 1965 to 1973: U.S. inflation, the elephant in the room. Open Economies Review, 31, 195–211. https://doi.org/10.1007/ s11079-019-09574-2 Bordo, M. D. (2022). A Brief History of Central Banks. Federal Reserve Bank of Cleveland. www.clevelandfed.org/publications/economic-commentary/2007/ec-20071201-a-briefhistory-of-central-banks Bordo, M. D., Eichengreen, B. (eds.) (2007). A Retrospective on the Bretton Woods System: Lessons for International Monetary Reform. Chicago: University of Chicago Press.

The Concept of Money and Its Evolution Over Time 15 Charney, N. (2012). Lessons from the history of art crime. Journal of Art Crime, 8, 85. Cipolla, C. M. (1982). The Monetary Policy of Fourteenth-Century Florence. Berkeley: University of California Press, p. 63. Crawford, M. (1975). Finance, coinage and money from the severans to constantine.  In: Temporini, H. (ed.) Band 2 Politische Geschichte (Kaisergeschichte). Berlin and Boston: De Gruyter, pp. 560–593. https://doi.org/10.1515/9783110830880-018 De Roover, R. (1954). New interpretations of the history of banking. Cahiers d’Histoire Mondiale: Journal of World History. Cuadernos de Historia Mundial, 2(1), 38. Desan, C. (2014). Making Money: Coin, Currency, and the Coming of Capitalism. Oxford: Oxford University Press. ISBN 978-0-19-870957-2 Dunbar, C. F., Willis, H. P., Sprague, O. M. W. (1922). The Theory and History of Banking. New York: Putnam’s. ECB (2022a). The Eurosystem Cash Strategy. www.ecb.europa.eu/euro/cash_strategy/html/ index.en.html ECB (2022b). History and Purpose. https://european-union.europa.eu/institutions-law-budget/ euro/history-and-purpose_en#:~:text=After%20a%20decade%20of%20preparations,change over%20in%20history%20took%20place ECB (2022c). About the ECB. www.ecb.europa.eu/ecb/html/index.en.html Federal Reserve (2022a). About the Fed. www.federalreserve.gov/aboutthefed.htm Federal Reserve (2022b). The Federal Reserve’s Dual Mandate. www.chicagofed.org/research/ dual-mandate/dual-mandate Friedman, M., Meltzer, A. H. (2022). Money. In: Encyclopedia Britannica, 23 August. www. britannica.com/topic/money (Last access 18 November 2022) Helleiner, E. (2002). The Making of National Money: Territorial Currencies in Historical Perspective. Ithaca, NY: Cornell University Press. https://doi.org/10.7591/9781501720727; https:// doi.org/10.1016/S2212-5671(15)01308-8 Kubát, M. (2015). Virtual currency bitcoin in the scope of money definition and store of value. Procedia Economics and Finance, 30, 409–416. ISSN 2212–5671. Lagos, R. (2010). Inside and outside money. In: Durlauf, S. N., Blume, L. E. (eds.) Monetary Economics: The New Palgrave Economics Collection. London: Palgrave Macmillan. https://doi. org/10.1057/9780230280854_17 Melicher, R. W., Norton, E. A. (2019). Introduction to Finance: Markets, Investments, and Financial Management (17th edition). Hoboken: Wiley. ISBN: 978-1-119-56117-0 Motomura, A. (1994). The best and worst of currencies: Seigniorage and currency policy in Spain, 1597–1650. The Journal of Economic History, 54(1), 104–127. Reich, J. (2017). Seigniorage. Cham: Springer. ISBN: 978-3-319-63124-0 Ritter, J. A. (1995). The transition from barter to fiat money.  The American Economic ­Review, 85(1), 134–149. www.jstor.org/stable/2118000 Young, S. K., Lee, M. (2017). Money, unit of account, and nominal rigidity. Economics Letters, 160, 59–63. https://doi.org/10.1016/j.econlet.2017.08.008

2 The Payment Industry and the Payment Tools

2.1 Introduction To understand the inner nature of cryptocurrencies and forecast their possible future evolution, it is necessary to connect the concept of money  – as described in the previous chapter – to the concept of cryptocurrencies, by an analysis of the payment industry. Cash is the fundamental pillar of any payment system, but several other payment tools and payment services have been developed to solve the issues related to the use of cash and to provide more efficient options to market traders. The understanding of how different payment tools relate to each other, and how some payment infrastructures represent the prerequisite to develop additional payment facilities, helps to figure out the role of current market players (e.g., central banks, commercial banks, payment circuits’ companies) in the payment industry, and how their products and services can be affected by the growth of cryptocurrencies. 2.2 The Role of Banks in the Payment Industry The concept of money is strictly related to cash (banknotes and coins), but the ­evolution of financial systems provided several alternative payment options to cash. Alternative solutions to cash tried to improve the quality of money transfers and ­payment services. Protection against the risk of loss, theft, and fraud has to be ­accounted in the payment industry. The timing of money transfer is another key variable to assess the quality of a payment tool (Carstens 2019). The cost related to the use of payment tools is, of course, another factor that affects the use of products and services of the payment industry (McKinsey & Company 2018). However, the aim of all payment tools (e.g., bank transfers, checks, credit cards) is to transfer money between two counterparts and, except cash payments, the transfer happens without a physical transfer of banknotes. What is needed is an infrastructure that keeps notes of the transfer of money between the two counterparts (e.g., buyer and seller in a purchase) by a bookkeeping process where the transfer of money is not physical but virtual, and the ownership of money is proved by an accountancy record. A pivotal player in the infrastructure of modern payment systems is the DOI: 10.4324/9781003353102-3

The Payment Industry and the Payment Tools 17 banking industry. Commercial banks – whose core business is to accept deposits and issue of credits – are natural market players in the payment industry (Omarini 2018). Checking accounts and other types of deposits allow banks’ customers to use their money even without withdrawing cash. The issue of checks, where the owner of the checking account orders the bank to pay an amount of money to a beneficiary, represents a traditional option to transfer money without using cash. Different things make a check a good alternative to cash. For instance, the chance to avoid the risk of loss or theft of money is a pro of the use of checks. The loss of the booklet of checks does not involve any loss of money, because the checks will not be cashed by the bank without the signature of the account owner. In the meantime, the money deposited in the bank can grow, thanks to the interest that the bank can pay on it. There are even some cons in the use of checks, like the chance that the money transferred by the checks exceeds the balance of the deposit, exposing the beneficiary of the checks to a counterpart risk. Another con of checks payments is the time needed for the beneficiary to have money available. An alternative option to money transfer is bank transfer. With a bank transfer the owner of a bank account orders the bank to transfer money directly in the bank account of the recipient. This wire transfer is another alternative to the use of cash, and it gives the chance to the ordering party to transfer an even big amount of money, tracking the payment. Thanks to remote access guaranteed by e-banking, the money transfer can be ordered – and the money be received by the recipient – with no need for counterparts of a physical meeting. The short timing1 of the transaction and the chance for the beneficiary to track the transfer are two pros of this option. However, this option is limited to owners of bank accounts and – in the case of e-banking – to those who have access to the Internet. So, banks, thanks to their role in holding deposits, can be seen as the first and most close alternative to the use of cash. People rely on banks and use deposits to store their values under the assumption that money is safer in a bank account than any other storage facility, that the use of banknotes is still possible by withdrawing cash, that the use of cash can be replaced by alternative payment solutions directly offered by the bank, and (in some cases) deposit are rewarded with an interest (while cash does not pay any interest). Of course, in case the trust in the banking industry will be over, and people will start to be afraid that banks are not able to cover all the possible requests of withdrawal, there is the risk of a “bank run” with people closing their accounts and claiming for their money (Zingales 2011). The negative consequences of a bank failure, and the possible consequent domino effect, are the main reasons supporting the need for regulation for the banking industry and the presence of financial supervision authorities to prevent such a scenario (Rajkamal and Puri 2012). The lack of regulation and the complete anonymity of cryptocurrencies will be discussed in the next chapters of this book. However, it can be noted that the will to protect savings and to guarantee the functioning of the financial system explains the need for financial regulation and financial supervision. The lack of regulation in the cryptocurrency markets should not be related to freedom and liberty but as a source of potential fragility of the financial architecture that makes possible the mining and the exchange of cryptocurrencies.

18  The Payment Industry and the Payment Tools 2.3 Payment Cards and Payment Circuits The need to transfer money to do payments (or investments) has seen the development of different alternatives to cash. If the deposit of cash in a bank deposit and the use of bank services of money transfer is one option to move money without moving cash, payment cards – like credit cards, debit cards, and pre-paid cards – are available options too. Today, these payment tools are even referred to as “plastic money”, due to the physical support of those cards, made of plastic. However, the use of letter of credits since the middle age should remind us that the practices to allow spending money with the implicit warranty of a financial institution that issued a document that guarantee a successful payment to the seller is not recent (McLean and Padgett 2017). What is more recent (Salman and Munir 2015) is the development of the idea, and the following industry, that develops protocols, technical infrastructures, and financial networks that guarantee to participants of the network to spend money in millions of point of sales around the world. A  credit card allows its user to buy goods and services (or to withdraw cash) using a credit line with a certain cap. With a certain frequency (typically on a monthly basis) the balance of the money spent has to be paid in full or by installment, and – doing so – the credit line is again available in full, according to the functioning of revolving credit products. Until the payment of the balance happens in full amount, the credit card is a merely payment tool. In case of reimbursement by installments, the use of the credit line will make a credit card being even a borrowing option for the card user. The chance to be granted of a credit card by the issuer without having a bank account is (in theory) possible, but it is so hard to be granted of a credit card being unbanked that we can refer to credit cards as financial products that require to be a bank account holder. Hence, credit cards can be referred to as a financial product that is a further step away from banknotes and coins. A bank deposit (e.g., a checking account) includes access to checks and bank transfers. To be granted of a credit card requires to own a bank account, but the ownership of a bank account does not involve the ownership of a credit card. Hence, a payment by credit card will be accepted under the awareness that the use of the card will generate a credit for the receiver of the payment. It will turn into a credit in the bank account of the receiver, which is considered equivalent to the ownership of cash. With a debit card, the owner of the card can access a payment circuit (e.g., Visa, Mastercard), having the chance to spend money without the need to use cash. With respect to a credit card, the debit card is not linked to any credit line. The use of the card activates a real-time check to the bank that issued the debit card, checking that the request of payment is covered by the balance of the bank account linked to the debit card.2 So, with respect to a credit card where the card user pays in a future point in time (e.g., the end of the month), with a debit card money has to be already available and it will be immediately withdrawn from the account of the debit card holder. The functioning of a debit card highlights the role of banks even in the payment card industry. At the same time, it can be noted that the use of “plastic money” makes the use of money easier and more convenient than cash3, but the financial

The Payment Industry and the Payment Tools 19 infrastructures required to manage payment circuits, to issue cards, to monitor and prevent frauds, and so on, increase the sophistication of the financial system. About debit cards, as credit cards, they represent a third level of the payment infrastructure. Banknotes and coins are the first (ground) level, and their acceptance rate is due to the nature of the “legal tender” of cash. Bank accounts and their money transfers options (e.g., checks and bank transfers) represent a second level of the payment system, and their acceptance is based on the chance to turn in cash the balance of banks’ accounts. Credit and debit cards improve the degree of sophistication of the system, requiring additional players (companies responsible for the administration of the payment circuits), and generating credits (or debts) that will affect the balance of bank accounts for cardholders.4 In the case of a pre-paid card, the chance to access a payment circuit (e.g., American Express, Diners, Visa) is still the main pro of the payment tool. The chance to recharge a pre-paid card and manage it without the need to own a bank account5 is the main feature of a pre-paid card. The card can be purchased from the issuer and requires to be charged by cash or other transfers (e.g., a bank transfer), before spending this money in the circuit. The lack of need to be a bank’s customer makes these payment tools an interesting alternative option to cash for the unbanked (Anong and Routh 2022). The fact that it is not possible to spend more than the pre-charged money can help individuals to take their spending behaviors under control, and the risk of frauds or other abuse of the card will limit the risk to the value of money in the card (Esoimeme 2018). About payment cards, it can be stressed how the worldwide scale of payment circuits is bigger than banking networks, which are usually developed to work at their best on national bases or referring to international scales, rather than a global scale. It follows that in some cases – as the retail markets and specially on e-commerce – the use of payment cards can be a more convenient option and, sometimes, the only option available. This is an example of how the sophistication of the payment system can arrive to the point that the use of cash is not a payment option anymore, even if the system still relies on currencies that are only physically issued in paper (banknotes) and coins. 2.4 E-payments Options With the development of e-commerce, where counterparts of a trade do not physically meet anymore, the need to settle payments from remote has grown as well. The use of credit cards online is an option, but the share of information and the risk to be victim of a scam required the development of new payment options as electronic money or “e-money”. As defined by the ECB (2022)6 Electronic money (e-money) is broadly defined as an electronic store of monetary value on a technical device that may be widely used for making payments to entities other than the e-money issuer. The device acts as a prepaid bearer instrument which does not necessarily involve bank accounts in transactions.

20  The Payment Industry and the Payment Tools Moreover, e-money represents an electronically stored monetary value represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions, and which is accepted by a natural or legal person other than the electronic money issuer (ECB 2022). E-money can be hardware based or software based. In the first case, the purchase power resides in a personal physical device (e.g., a chip card), which guarantees security by hardware-based features. The software-based options use softwares that function on common personal devices as personal computer or tablets (ECB 2022). The transfer of money typically happens by establishing an Internet connection with a remote server that controls that bookkeeps the transactions and updates the balance of e-money users’ accounts. The issue of e-money is a regulated activity that requires to be authorized by regulatory authorities. The issuers of e-money are authorized as “Monetary Financial Institutions” (MFI). Those institutions do not issue different currencies7, but allow to exchange monetary values between counterparts, that can withdraw from their online accounts money and transfer it to more traditional bank accounts. The ways money can be spent on the web are different. E-money can be based on a virtual account. The user can charge an account with money first, and use it to spend later. Different architectures allow to link the e-payment option to another option (e.g., credit card, checking account) avoiding the need for a two-step process (Foster et  al. 2021). However, this option requires to recharge the virtual account before using the money stored in it. Without a virtual account, and with a direct link to another payment tool, people can use the e-payment option in an e-commerce transaction, knowing that when a payment request is submitted, the system will directly forward the request to the payment option linked to the e-money option. If, for instance, the payment is authorized by the credit card ­issuer – which card has been linked to the e-money tool – the transaction will be validated by the e-money system too and the purchase is over. At the current time, the most popular e-money option providers are PayPal8, ApplePay, GooglePay, and AmazonPay. So far, these payment services providers rely on the chance to make payment online safer, easier, and faster, than directly using a credit card or a bank account. Doing so they add an additional step to the sophistication path of the payment system. The money issued from a central bank is deposited in a bank account. This money can be used without the need to withdraw cash, thanks to the payment circuits and the use of payment cards. The risk of mismanagement of these cards in online transactions is avoided by using e-money options that, in the meantime, can make the transaction even easier and faster.9 As was stressed before, the e-money options rely on other currencies. However, the fact that big tech companies are the main players in the e-money industry, cannot exclude that in the future they will reshape their services, trying to have a more central role in the value chain of the payment industry (Hofmann 2020). Being aware that money is overall a means of payment, and its power is based on its acceptance rate by market sellers, the huge number of customers for e-commerce platforms, or users of cell phones for a device-seller company, make big-tech companies in the condition

The Payment Industry and the Payment Tools 21 to go beyond the offer of their own payment option, or they e-wallet solutions, planning the issue of digital tokens that work like digital currencies. The chance to spend these tokens in a marketplace that is already populated by millions of sellers, and that is already used on a daily based by even more buyers, makes the limitation of the acceptance of this “digital currency” to the single marketplace not an issue. At the same time, the fact that a digital currency can be initially exchanged only between users of a certain brand of cellphones, it is not an issue if the number of current users is already big enough to be a very large network. Moreover, the reputation of their brands reinforces the chance to be considered a reliable money issuer. Such a scenario requires managing the typical problems of the issuing of money, such as the risk of fake, the risk related with the ownership of cash (theft, robberies, etc.), and the ability of the issuer to guarantee the value of money over time (e.g., inflation). We will see, in the next chapters, how the use of blockchain technology has the potential to solve the issues related to the issue and the circulation of “digital ­tokens”, that can work as “digital banknotes” of a “digital currency”. Of course, such a scenario can be seen as the next step in the evolution of the concept of money, but it involves a potential revolution for the functioning of the financial system as we know it. The issue of money by private entities, the chance to have multiple currencies competing to be the reference point for the market (e.g., to be the standard unit of account), and the chance that a (foreign?) currency will replace the local (national) currency – issued by the national central bank – are only few of the shocking changes of this potential scenario. Notes 1 The chance to order an instant bank transfer erased the time gap between the order of the transfer and the confirmation of payment by the receiver, with just few seconds to complete the transaction and to transfer the money. 2 Source VISA (2022) and Mastercard (2022). 3 Credit and debit cards allow to keep track of the expenses, thanks to the monthly reports received by the cardholders. 4 In some countries the payment of the balance of credit cards cannot be done by a direct and automatic withdrawal to a bank account, but the cardholder can be called to authorize this withdrawal from time to time, or he/she can decide to pay by other options. However, the acceptance of a credit card payment by a seller relies on the assumption that this credit will generate a further money transfer that will increase the balance of the seller’s bank account. 5 A pre-paid card can be issued by banks, but the issue of a pre-paid card does not require the ownership of a bank account, and in some countries they are issued by entities others than banks (e.g., postal service). 6 www.ecb.europa.eu/stats/money_credit_banking/electronic_money/html/­i ndex. en.html#:~:text=Electronic%20money%20(e%2Dmoney),involve%20bank%20 accounts%20in%20transactions. 7 For instance, recharging an online e-money wallet/account with 100€ will give to the account holder the chance to make payments online paying prices denominated in euros. A deposit in an e-money account will not “exchange” the Euros with a different currency (e.g., “e-Euros”). 8 www.statista.com/statistics/277841/paypals-total-payment-volume/

22  The Payment Industry and the Payment Tools 9 In case the data of the payment card is stored in the user’s device (e.g., smartphone, smartwatch, laptop), clicking on the purchase button will not require to insert card numbers or to follow other security check procedures, making the payment faster and easier.

References Anong, S. T., Routh, A. (2022). Prepaid debit cards and banking intention. International Journal of Bank Marketing, 40(2), 321–340. https://doi.org/10.1108/IJBM-09-2021-0401 Carstens, A. (2019). The Future of Money and Payments. SUERF Policy Note, Issue No. 66. Dublin: Central Bank of Ireland. ECB  – European Central Bank (2022). Electronic Money (definition). https://www.ecb. europa.eu/stats/money_credit_banking/electronic_money/html/index.en.html#:~: text=Electronic%20money%20(e%2Dmoney),involve%20bank%20accounts%20in%20 transactions. Esoimeme, E. E. (2018). A  comparative analysis of the prepaid card laws/regulations in ­Nigeria, the UK, the USA and India. Journal of Money Laundering Control, 21(4), 481–493. https://doi.org/10.1108/JMLC-03-2017-0010 Foster, K., Greene, C., Stavins, J. (2021). The 2020 Survey of Consumer Payment Choice: Summary Results. Atlanta: Federal Reserve Bank of Atlanta. Hofmann, C. (2020). The changing concept of money: A threat to the monetary system or an opportunity for the financial sector? European Business Organization Law Review, 21, 37–68. https://doi.org/10.1007/s40804-020-00182-z Mastercard (2022). Debit Cards. www.mastercard.it/it-it/privati/trova-la-tua-carta/cartedi-debito.html McKinsey  & Company (2018). Global Payments 2018  – A  Dynamic Industry Continuous to Break New Ground. www.mckinsey.com/~/media/mckinsey/industries/financial%20 ­services/our%20insights/global%20payments%20expansive%20growth%20targeted%20 opportunities/global-payments-map-2018.pdf McLean, P., Padgett, J. F. (2017). Commerce and credit in renaissance Florence. In: Caferro, W. (ed.) The Routledge History of the Renaissance. London: Routledge. https://doi.org/ 10.4324/9781315226217 Omarini, A. E. (2018). Fintech and the future of the payment landscape: The mobile wallet ecosystem. A challenge for retail banks? International Journal of Financial Research, 9(4). https://doi.org/10.5430/ijfr.v9n4p97 Rajkamal, I., Puri, M. (2012). Understanding bank runs: The importance of depositor-bank relationships and networks.  American Economic Review,  102(4), 1414–1445. https://doi. org/10.1257/aer.102.4.1414 Salman, A., Munir, N. (2015). Relationship between the incentives offered on credit card and its usage. Journal of Finance, Accounting and Management, 6(1), 30–40. VISA (2022). Debit Card – Visa Debit. www.visaeurope.ch/it_CH/debit.html Zingales, L. (2011). The role of trust in the 2008 financial crisis. Review of Austrian Economics, 24, 235–249. https://doi.org/10.1007/s11138-010-0134-0

3 Blockchain, Virtual currencies, Cryptocurrencies, and Tokens

3.1 Introduction To understand the current and the potential future role of cryptocurrencies in the international monetary system, it is necessary to understand the logic, functioning, and main technical aspect of cryptocurrencies. The aim of this chapter is to present and describe the technologies that have made cryptocurrencies possible and that guarantee their reliability, to understand if (and how) cryptocurrencies represent a potential evolution of the concept of money and their chance to compete with traditional money and payment systems. The analysis of the blockchain and its combination with cryptography will help to understand how the creation and circulation of cryptocurrencies are possible. The analysis is not oriented to explain the technicalities of the blockchain, but to stress how this technology allows to replicate the functioning of money in a digital framework. So, the topics presented and discussed are limited to those needed to approach cryptocurrencies from an economic and financial point of view. An analysis of the main cryptocurrencies in the market and the potential applications in new contexts or by new users (e.g., central banks) will be done in the next chapters. 3.2 The Blockchain Technology An analysis of cryptocurrencies cannot be properly done without an analysis of blockchain technology. A  blockchain is a tamper evident and tamper resistant digital ledger implemented in a distributed fashion (i.e., without a central repository) and usually without a central authority (i.e., a bank, company, or government) (Yaga et al. 2018). The basic concept of “ledger” is not far from the one in accountancy. A ledger account contains a record of business transactions, usually reported in a chronological order from the oldest to the newest. The aim of a ledger is to take note of each single event that has effect on the business and to keep note of each counterpart involved in the business (e.g., clients, providers, creditors, debtors). As a “digital ledger”, blockchain technology is able to do the same, not writing notes on paper, but storing information in a digital format. A new record in the (digital) ledger is reported in a “block”. As in a physical ledger, a new record follows the previous one, so in a digital ledger, each block follows the previous one. The result is a sequence of blocks where each DOI: 10.4324/9781003353102-4

24  Blockchain, Virtual currencies, Cryptocurrencies, and Tokens block is linked to a single previous block, forming a sort of “chain” as expressed by the name of the technology: “block-chain”. Reading the contents of a blockchain it is possible to read each step of the evolution of the phenomenon described by the digital ledger, arriving to its current status, represented by the last block of the chain. With respect to a physical ledger used in accountancy, a blockchain uses a “distributed” (digital) ledger. It means that the information of the ledger is not written in a single object (the ledger) and is not under the control of a single entity, but it is spread in a network of individuals (the “nodes” of the blockchain network) that represents the community of the blockchain. Anytime a new block (a “new registration”) is added to the chain, the information of this new block is compared with the information of other (previous) blocks, to check that the history of records (the ledger) used to add a new registration does not differ from the history of records reported in the block of other participants. If that history of records does not perfectly match with the ones in other blocks, the new block is not validated and the update of the blockchain is not allowed. In that manner, the reliability of the ledger is not based on the reputation of a single ledger holder and on the trust in that entity by the other counterparts. The fact that the ledger has not been tampered is guaranteed by the direct checks that members of the community do on their own full copy of the ledger, checking that the history of the new block matches with the one reported in their blocks. In case a block is tampered, it will not be validated by the other block owners, because the information in the new (tampered) block does not match with the ones in previous blocks, and the attempt to cheat the system is avoided. If the history of records of the new block matches with the one of other (previous) blocks, the new block is validated, and the new registration in the (distributed digital) ledger will be added to all the previous blocks, updating all the “copies” of the ledger held by the blockchain participants. These multiple checks, which happen anytime a new information is added to the previous one, avoid the potential manipulation that is possible in the case of a single physical ledger managed by a single accountant (see Figure 3.1a-o). Once the digitally distributed ledger is updated – with the validation of a new block – the new record cannot be deleted or modified anymore. What can be done is to add a new change in the ledger – by adding a new block – whose contents have the effect to cancel the effect of the previous block, but the history of events reported in the ledger will report both the blocks with both the transactions. Hence, a traditional physical ledger can be easily manipulated (e.g., a new record can be tampered or completely deleted, with no evidence that it has ever existed), while a digitally distributed ledger could be manipulated only if all the previous blocks of a transaction (hosting all the “copies” of the ledger) would be manipulated as well. To be more precise, the cheating of the system could succeed if the majority of the blocks have been cheated. In fact, the validation of a transaction does not require that all the previous blocks validate the new block, but  – in case the validation process made by the comparison with different blocks will be inconsistent1 – the new block will be officially validated and included as a new part of the blockchain ­(updating all the distributed ledgers) when the majority of the previous blocks recognize the new block as valid. However, the likelihood that such an event will happen is extremely low, and it is not even convenient for the cheater(s), because the other

Blockchain, Virtual currencies, Cryptocurrencies, and Tokens 25

Figure 3.1  The Distribution Ledger Technology (DLT) and the Blockchain

26

Blockchain, Virtual currencies, Cryptocurrencies, and Tokens

Figure 3.1 (Continued)

Blockchain, Virtual currencies, Cryptocurrencies, and Tokens

Figure 3.1 (Continued)

27

28  Blockchain, Virtual currencies, Cryptocurrencies, and Tokens

Figure 3.1 (Continued)

Blockchain, Virtual currencies, Cryptocurrencies, and Tokens 29

Figure 3.1 (Continued)

(cheated) participants will probably leave the blockchain once they realize that it is not reliable anymore. All the procedures to create a new block, to validate it by the comparison with previous blocks, and (in case of validation) to upgrade all the previous blocks, with the inclusion of the new transaction required by the new block, follow a standard protocol that is part itself of the blockchain. To summarize the reasons why a blockchain is a reliable system, we can say that a blockchain is a system where the distributed control of the reliability of the system will see the system be under attack only if one counterpart (or a group of counterparts that cooperate and works like a single entity) controls the majority of the blocks. But the efforts needed to reach this status and the awareness that cheating the system will lead to the failure of the system2, avoid the risk of cheating, and make the technology reliable. The basic functioning of a blockchain technology, as described earlier, is completed by the use of cryptography. Cryptography is a different and independent technology with respect to the blockchain, but it plays a pivotal role in the application of blockchain technology. Cryptography is the study of secure communications

30  Blockchain, Virtual currencies, Cryptocurrencies, and Tokens techniques that allow only the sender and intended recipient of a message to view its content.3 In doing so, cryptography is associated with the process of converting ordinary plain text into unintelligible text and vice-versa. Thanks to cryptography, the protocol of the blockchain, the links between blocks, and the contents of the validated blocks cannot be read (so not even changed) by unauthorized entities. When the blockchain protocol requires to encrypt data, it uses a cryptography method called “hashing”. The use of cryptographic hash functions to data allows to start from an input of nearly any size (e.g., a file, text, image) and to calculate a relatively unique output, called the “message digest” or simply the “digest”. If during the validation process of a new block, its digest differs from the one of previous blocks it means that the information of the ledger in the new block differs from the information of the previous blocks – so it has been tampered – and the new block is not validated. On the contrary, if the digest of the new block is equal to the digest generated by the hashing of previous blocks, it means that the information of the previous ledger is correctly included in the new block, and no data manipulation happened (see Figure 3.2a-d).

Figure 3.2  The Hashing Function and the Use of “Digest”

Blockchain, Virtual currencies, Cryptocurrencies, and Tokens 31

Figure 3.2 (Continued)

The hashing of data guarantees several useful technical properties. First of all, it is impossible4 to start from the digest and to regress the correct input value that generated it. It makes this process a one-way process: from input you can calculate the digest (the output), but from the digest you cannot calculate the input (Figure 3.3). So, it is impossible to unveil the content of the ledger from the code (the “digest”) generated for its validation.5 Hence, the sharing of the digest does not jeopardize the security of the encrypted ledger. Second, starting from an input (the contents of the ledger), it is technically impossible6 to find a second input (a ledger with different contents) which produces the same output (Figure 3.4). It follows that if you know the input (the ledger) and hashing of the input (the digest) you cannot find a second input that produces the same digest (e.g., a tampered ledger). That property avoids the chance that a second input (e.g., a “manipulated” ledger) can be replaced to the original one, and then validated by other participants, assuming that two inputs lead to the same digest: two inputs always generate two different

32  Blockchain, Virtual currencies, Cryptocurrencies, and Tokens

Figure 3.3  Hashing Properties 1

Figure 3.4  Hashing Properties 2

Figure 3.5  Hashing Properties 3

digests.7 Hence, the digest of a ledger is unique, and it is not possible to replace a ledger with another (fake) ledger because it is not possible to find two inputs (two ledgers) that produce the same output (same digest) (see Figure 3.5). Third, even if not starting from a specific input, it is not possible to find two inputs whose hashes generate the same digests.8 It follows that you cannot intentionally add new blocks to the blockchain with the goal to arrive at an input (the ledger) that you know can be replaced with another one, assuming that you know that the hashes of the two will give the same digests. Two inputs (e.g., two ledgers) will always generate different outputs (two digests) (see Figure 3.6).

Blockchain, Virtual currencies, Cryptocurrencies, and Tokens 33

Figure 3.6  Hashing Properties 4

An example of what makes a hashing function so powerful in securing encrypted data, and makes it impossible to tamper the data, can help to better understand the meaning of the word “impossible”. Technically, if you have a function that combines its input, you could try to combine the same input until you arrive at the same output, “breaking the code” of the encryption. The more the treating of data is sophisticated, more attempts will be needed, and longer it is the time to solve the puzzle. The Secure Hash Algorithm (SHA) is a specific algorithm hash function used in many blockchain implementations. Its output size is 256 bits (SHA-256), equal to 32 bytes.9 A bit is a unit that can be equal only to two values (0 or 1). Two bits generate four combinations of values: #

Bit values’ combination

1 2 3 4

0-0 0-1 1-0 1-1

Three bits generate eight combinations: #

Bit values’ combination

1 2 3 4 5 6 7 8

0–0–0 0–0–1 0–1–0 0–1–1 1–0–0 1–0–1 1–1–0 1–1–1

Four bits generate 16 combinations: #

Bit values’ combination

1 2 3

0-0-0-0 0-0-0-1 0-0-1-0

34  Blockchain, Virtual currencies, Cryptocurrencies, and Tokens #

Bit values’ combination

4 5 6 7 8 9 10 11 12 13 14 15 16

0-0-1-1 0-1-0-0 0-1-0-1 0-1-1-0 0-1-1-1 1-0-0-0 1-0-0-1 1-0-1-0 1-0-1-1 1-1-0-0 1-1-0-1 1-1-1-0 1-1-1-1

In general10, if a bit can have only two values (zero or one) the possible values of “n” bits are equal to 2n. If the SHA-256 uses 32 bytes – so 256 bits – the possible combinations are equal to 2256, that is around11 equal to 1077. That means that we have much more than billions of billions of possible digests generated by the algorithm. Trying to figure out the meaning of these numbers, we can say that if a computer was able to make 1,000,000 attempts per second, it will take many centuries before trying all the possible combinations. It means that to verify if a certain hashing function is the one that generates a certain digest having a certain input, that process will take so much time that is (in practice) impossible to do, given the current computational power. Hence, the actual cryptography technology is able to avoid that the encrypted data can be read by unauthorized individuals. Cryptography is used in a blockchain for many purposes. It is used to secure the so-called “block header”, which is the part of the block that includes the link to the previous block, making the “chain” between blocks possible and uniquely identified (Yaga et al. 2018). The contents of the block are encrypted too. Moreover, the identity of the participants can be encrypted. In that case, the identification of a certain participant is possible, because the encryption of the user’s personal data will generate a single and unique “digest”, but his/her/its real identity is not anymore. To summarize the functioning of a blockchain and to understand why it is a powerful tool, we can stress the following points: 1) The blockchain takes record of any interaction between counterparts (any “transaction” between the “nodes” of the blockchain) by adding new blocks, without overwriting information from previous blocks, that remain tracked. 2) Doing so, the blockchain allows to track backward all the events that generated the current status of the blockchain or (in the other way) to start from the initial status of the blockchain and to follow its entire evolution step by step. It guarantees maximum transparency to the process described by the blockchain. 3) The chance that the history of events recorded in the ledger of the blockchain can be tampered is secured by both the validation process that is done anytime a new block is added to the blockchain, and by the encryption of data, as the

Blockchain, Virtual currencies, Cryptocurrencies, and Tokens 35 result of the use of cryptography to protect unauthorized access and to prevent attacks to the reliability of the blockchain. It means that there is no need to “trust” the manager of the holder, because there is not a single manager: the ledger is simultaneously held by all the blockchain participants (the “nodes” of the blockchain network) that hold their own copy of the ledger in their blocks. It is the trust in the protocol of the blockchain, and its validation process (that adds a new block only when at least the majority of the participants validate it, “reaching the consensus” of the blockchain participants), that is now pivotal to guarantee the reliability of the system. The functioning of a blockchain, as described earlier, is the one of any blockchain, and it represents the core of the technology: any new block represents an additional layer of a multilayer history, and the ledger records any added layer without modifying the previous ones. However, not all blockchains are equal, and one classification criterion separates “permissionless blockchain” from “permissioned blockchains”. A blockchain is a permissionless blockchain if all the participants of the blockchain network are allowed to publish blocks, modifying the distributed ledger. Permissionless blockchain platforms are often open-source software, freely available to anyone who wishes to download them (Yaga et al. 2018). It follows that the ledger is a “public” ledger. A permissionless blockchain could be used, for instance, to collect orders in a restaurant. Each client could place an order, adding a block to the blockchain, and the new block will be validated if the new customer adds its order at (1) the bottom of the list (not trying to be served before than previous customers) and (2) without any change to previous orders (e.g., not changing the sequence of the orders inserted by other clients, and not changing the contents of these orders, for instance, adding, removing, or changing what has been ordered). If the new block did not change the order list, the hashing function of the blockchain will make a digest that is equal to the one of the other blocks and validate the new block (updating the list in all the other blocks, including the new order). In that case, other clients in the restaurant cannot exclude a new customer. In the case the new customer tries to tamper with the list of orders (the ledger of the blockchain), the digest of the new block will not fit with the digest of previous blocks, and the order (new block) will not be added to the list. In other cases, it could happen that the blockchain is permissionless, so everybody can be part of the blockchain network, but the chance to participate – adding a new block – is subject to a multiparty agreement or “consensus system” to prevent malicious users to destabilize the system. Referring to the previous example, it could happen that the restaurant is a university cafeteria, that rewards with a free lunch all the students that prove to have contributed to the university community (e.g., mentoring other students, working in the library). In that case, any student can place an order (trying to add a new block) but other participants (the other “nodes” of the blockchain network) will check if he/she did enough to deserve a free meal, according to a pre-defined set of rules (the “protocol”). In this case, the blockchain is still open (anyone can join the network) but the chance to add a new block (to place an order for a free meal) is subject to a consensus system.

36  Blockchain, Virtual currencies, Cryptocurrencies, and Tokens In a permissioned blockchain a user publishing blocks must be authorized by some authority (be centralized or decentralized). The need of an authorization can refer to the reading of data, the writing of data, or both of them. For instance, people could need an authorization to access data stored in a blockchain with information of a land register (e.g., building maps, locations, values), or they could have an open access to this data. In a case of a public land register, it is likely that only authorized individuals will have the permit to change the data of the register adding a new block to the blockchain. The blockchain is a private blockchain if only authorized individuals can read the blockchain. It could be the case of a blockchain that keeps track of all the improvements of a business project in a company and that blockchain is accessible only to the team members of the project. At the same time, it could be that all the team members can modify the blockchain, adding new blocks, or only few of them can do it. It could even happen that some team members can only add new blocks (for instance, adding information about their contribution to the project) without the chance to read information stored in previous blocks. Another example of a blockchain that allows users to add a block, without having access to the contents of previous blocks, could be the case of individuals uploading personal data about their health status in a blockchain of a medical structure (e.g., a hospital, a national health system, an insurance company) without the chance to access the data of other individuals. All the examples used to describe the differences between blockchains were limited to data management, using blockchain technology to manage a database (e.g., add a new record, read previous records). However, the application of the blockchain goes far beyond this purpose. For instance, in the case of a blockchain used to collect orders in a restaurant, the protocol encrypted in the blockchain could not only trace the orders, but it could even issue the bill and charge the credit card of the customer once the meal is served, it could transfer the amount of the tip to the account of the waiter, to keep track of the preference of that specific customer, and much more. The blockchain of a business project could make some actions when, for instance, the project is on time and the targets are achieved (e.g., to submit ­requests for additional funding to the top management of the company), and some other actions in case of delay (e.g., to send a warning to team leader). When the evolution of the events, according to the new information added to the blockchain with the adding of new blocks, triggers different consequences, it means that the protocol of the blockchain includes an algorithm that is not limited to record and store the information – as it happens in a database – but includes a set of rules that can be automatically applied when some conditions are satisfied or some status are achieved. These kinds of applications of blockchain technology allows the definition of the so-called “smart contracts” (Kõlvart et al. 2016). 3.3 Blockchain and Digital Currencies Blockchain is a technology appliable in several areas. Public register management (e.g., land registers, car ownership registers), private register management (e.g., shareholder registers in a company, list of authorized market makers in a stock

Blockchain, Virtual currencies, Cryptocurrencies, and Tokens 37 exchange), and project management (e.g., to keep track of the state of play of a project) are just a few examples of potential applications of the blockchain technology. Before addressing the case of cryptocurrencies, we need to stress that cryptocurrencies do not perfectly overlap with the concept of digital currencies. A  digital currency is a type of currency available only in digital form (Oxford Dictionaries 2022). It follows that cryptocurrencies are a type of digital currency, but we can have other currencies available in digital forms. The main reference is to “virtual currencies”, which differ from a cryptocurrency in the presence of a central entity that usually controls the issue of the currency and monitors how members of a virtual community use it. 3.3.1 The Cryptocurrencies

Within the possible applications of blockchain technology, cryptocurrencies are a clear example of the possibilities offered by this technology. However, if cryptocurrencies could not exist without blockchain technology, blockchain technology ­application is not limited to cryptocurrencies. From a financial point of view, a cryptocurrency is a currency with only digital representation of its value (not even a physical support like banknotes or coins), which “monetary policy” (including the issuing decisions of new units of money) is not driven by a central authority (a central bank) but it is defined by an algorithm and the behavior of the members of a community of users. From a technical point of view, a cryptocurrency is the application of blockchain technology to create a self-managing system able to replicate a monetary system in a virtual environment. The algorithm of the cryptocurrency is itself in the blockchain, and it defines the rules to follow in order to let a new unit of the (crypto-)currency comes into being and to attribute its property to a blockchain participant/member. According to the algorithm, the information representing a specific unit of the currency (what it could be visualized as the “digital banknote” or a “digital coin”) is attached to a digital address. Anytime the users satisfy the conditions of the algorithm to issue a new unit of the cryptocurrency, a new digital address starts to exist (a “new digital banknote”), and its ownership is given to the user that started the so-called “mining” process. Each unit of the cryptocurrency is equal to the other. That guarantees the “standardization” of the cryptocurrency, which is a pivotal feature of money. Anytime a new unit of the cryptocurrency is created (“mined”) it is included in a new block of the blockchain. This block is validated by the comparison with the information of other previous blocks, according to the standard validation process of a distributed ledger technology. So, if the ledger reported in the new block, where the new unit has been added, is not tampered (as proved by the “digest” included in the new block, that is the same as the “digest” of the previous block), the new block is validated, and a new unit of the cryptocurrency starts to exist in all the distributed copies of the ledger. Hence, the decision to increase the amount of money in the (monetary) system is not taken by a central authority, but it comes from the running of the algorithm.

38  Blockchain, Virtual currencies, Cryptocurrencies, and Tokens However, the fact that the algorithm remains the same from block to block does not mean that its functioning is not able to adjust the criteria that drive the issue of new units of the cryptocurrency (new blocks). For instance, by monitoring the speed of the mining process, the algorithm can slow down the issuing of new units of the currency when the number of new coins in a certain time frame exceeds a certain ceiling number, or it can facilitate the issue of new coins when the mining in the same time frame issued less than a certain number of coins. So, what could be referred to as a “monetary policy” is not static, but its intervention criteria are pre-set and incorporated in the rules and the criteria of the algorithm. Comparing a cryptocurrency with a real-world currency, the former does not contemplate the presence of a central bank as the latter, but the concept of monetary policy that belong and drive central banking is still present, and it is the core of the blockchain underlying protocol (the algorithm) that drives the cryptocurrency. However, users add blocks to the blockchain not only to issue new units of the cryptocurrency but even to record transactions. A new block can be used to transfer the property of the digital address representing a single unit of the cryptocurrency – even referred to as “coins” – from a user (the current owner) to another (the new owner). Again, the validation of this transaction requires that the algorithm of the blockchain compares the digest in the new block (generated by the hashing functions of the cryptography protocol coming from the information of the distributed ledger) with the digests of other blocks, reaching a consensus about the integrity of the (distributed) ledger. The validation of the new block will add new information to the distributed ledger, that in this case is not about the mining of a new coin, but involves the transfer of property of a pre-existing coin. Doing so, a cryptocurrency is not able only to attribute the ownership of each existing coin, but it can track the ownership over time, storing in the public ledger the transfer of each coin from user to user, since the issue of that coin. However, this chance  – given by blockchain technology and not possible with a physical banknote – does not affect the anonymity of the transaction, which is guaranteed by cryptocurrencies too. In fact, a cryptocurrency user can identify him/her/itself with a pseudonym and, doing so, there is not any sharing of personal information, with the effect to hide the real identity. The blockchain guarantees transparency about the identity of the users and the transaction history, but by allowing pseudonymous, the users of the cryptocurrency can only know what a certain user does and owns, but not even who really is the owner in a real world (e.g., a person, a company, an agency, a government). In fact, all the data about the users, as well as all the information of the blocks, are ­encrypted, so unintelligible to other users. It means that an owner can transfer coins to another user knowing the pseudonym (needed to uniquely identify the new owner), being aware that this transfer will remain evident in the blockchain, but without any knowledge about the real identity behind the pseudonym.12 The understanding of how blockchain technology can be used to manage a cryptocurrency from a technical point of view allows to address the financial issues of cryptocurrencies. The first chapters of this book addressed in detail the concept of money and stressed how it is related to three main functions. Money is (1) a means of payment, (2) a store of value, and (3) a unit of account. Hence, approaching

Blockchain, Virtual currencies, Cryptocurrencies, and Tokens 39 cryptocurrencies from a financial point of view is necessary to analyze if (and how) cryptocurrencies have such properties. In fact, it could be argued that the use of the word “currency” proposing a new item is not enough to make it work as a currency. Starting from the function of the means of payment, cryptocurrencies are born to be exchanged between the user of a community. However, to be a means of payment, there is the need to use cryptocurrency to settle transactions such as the purchase of goods and services. The potential to be used for such purposes and the efficiency and reliability of the technical infrastructure needed for the transfer of digital coins are not enough to refer to a cryptocurrency as a means of payment. On the contrary, an asset can be seen as a means of payment if a reasonable number of members in a community accept it as a payment in a transaction. It is the acceptance rate for payment of a cryptocurrency within a community to be the financial yardstick that makes the cryptocurrency a means of payment or not. The second function of money is to be a store of value. It means that buying or receiving cryptocurrencies as a payment, and postponing it to be used in the ­future, should not involve a loss of purchase power. The quality of money is assessed by the chance to buy the same amount of goods and services at different times. This concept is strictly related to inflation, defined as the loss of purchase power of money over time. The exchange rate of a cryptocurrency with a real currency, that measures – for instance – the amount of US Dollars or Euros needed to buy a unit of a certain cryptocurrency (e.g., the Bitcoin) can be referred to as the “price of the cryptocurrency”. The volatility of this price can be a good proxy of the ability of the cryptocurrency to work like a (good) store of value. Higher the volatility of that price (the exchange rate), lower is the ability to work like a store of value and, by consequence, lower is the chance to refer to a cryptocurrency as money. If the value of a cryptocurrency tends to change a lot in a short period of time it means that the value stored in that cryptocurrency will not remain stable, as it should be in the case of a (good and reliable) currency. This is true regardless of the fact that the value of the cryptocurrency decreases (inflation) or increases (deflation) over time. The concern about the cryptocurrencies’ price volatility and their chance to work as a store of value are behind the development of so-called “stable coins”. A cryptocurrency can work not as a public ledger, where the issue of new units is defined by a decentralized process (the run of the underlying algorithm of the cryptocurrency), but to be issued by a central entity. In the case of “stable coins” (d’Avernas et  al. 2022) the issuer takes the obligation to collateralize the issue of each single new unit (coin) of the cryptocurrency by an equivalent amount of a certain “real” currency (e.g., US dollars, euros, British pounds, Yen). Doing so, the cryptocurrency remains linked to real currencies and works like a digital vehicle that allows to transfer cash in a digital world. For instance, money can be deposited in a bank that issues coins of a cryptocurrency managed by the bank, and the customer of the bank can transfer these (stable-) coins to another account or to a counterpart. This digital money can be exchanged back in a real currency and then withdrawn by the owner. The users that accept such cryptocurrency rely on the price stability of the underlying currency and, of course, must trust the issuer of the cryptocurrency, taking the risk of issuing non-collateralized coins.

40  Blockchain, Virtual currencies, Cryptocurrencies, and Tokens With stablecoins cryptocurrencies benefit from the price stability of the underlying real currency. However, with a link to a real currency, there is the question if such coins are cryptocurrencies, or if they are the digitalization of a real currency, or just a payment service that facilitates the transfer of money, without the need for the traditional financial infrastructure of the banking system13, and with the chance to anonymize the transaction. The third function of money is to be a unit of account. Money is useful to compare values of different assets and define the relative differences between values. This function makes a currency useful even for those that do not own it but can use it to price other goods. The use of an asset (including cryptocurrencies) as a unit of account depends on the use of the asset by market agents and the general consensus that this asset is widely used and referred to as a financial standard. In practice, it is the attitude of people to price things (e.g., goods, services, assets, liabilities) using a cryptocurrency that testifies its nature of unit of account or not. In case a cryptocurrency will not fit in the definition of money and will not guarantee its functions, it is likely that it will not be referred to as a currency but generally labeled as an asset. As will be stressed in the further chapters of this book, the approach to cryptocurrencies by central banks, financial supervision authorities, and regulators was extremely cautious, since the beginning of the cryptocurrency phenomenon. They have always denied the inner nature of currency – despite blockchains like Bitcoin being used only to propose digital currencies – referring to cryptocurrencies as “digital assets” or “cryptoassets” (Bullmann et al. 2019). 3.3.2 The Virtual Currencies

A virtual currency is a digital representation of value that is neither issued by a central bank or a public authority, nor necessarily attached to a fiat currency, but is accepted by natural or legal persons as a means of payment and can be transferred, stored or traded electronically. (EBA 2014) What makes a virtual currency different from a cryptocurrency is the presence of an issuer, while cryptocurrencies rely on a protocol (the algorithm) that manages the issuing (or “mining”) of new coins. A virtual currency is usually designed to serve a closed community and can be unconnected from a real currency (Gawron and Strzelecki 2021). This is the case of virtual currencies used in massive multiplayer online role-playing games (e.g., World of Warcraft, Fornite, Minecraft). Players can use the virtual currency of a game to purchase things like outfits, wraps, or “battle passes” that can help the player to achieve the goal of the game or to make the game more enjoyable. These currencies exist and can be used only in these “digital worlds” where, however, the number of users is far to be small.14 This money cannot be bought or sold using real money, and it remains an asset only in the game context.

Blockchain, Virtual currencies, Cryptocurrencies, and Tokens 41 Another type of virtual currency refers to those that can be issued within customer incentive programs or loyalty programs (Buchinger et al. 2013). They can be addressed as the evolution of the (printed) coupons or stamps used in the past to reward loyal customers. The coupons, for instance, can be used to receive a discount on further purchases, and the owner of a certain number of stamps can “spend” it receiving assets or services (e.g., home appliances, cinema tickets). With the evolution of loyalty programs and the chance to gain credits using products and services of different companies (e.g., earning miles in frequent flyer programs not only buying flight tickets) the chance to “cash” the credits in different ways has increased the acceptance rate of these credits, that can be incorporated and accounted as a virtual currency. With respect to the case of online communities of role-players, in this case, those virtual currencies can be used to buy real goods and services. They can be even transferred from customer to customer, and people could buy – paying with real money – additional credits. The evolution of e-commerce and online services can pave the way to a larger use of these virtual currencies. The idea to accept, store, and spend virtual currencies that can be used only in a certain virtual marketplace – receiving real goods and services – can be probably easily accepted if the marketplace is big, if it offers a variety of items, and the reputation of the issuer is high enough to guarantee the reliability of the system.15 The acceptance rate of the (virtual) currency, required to work as a means of payment, could be guaranteed by definition by e-commerce platforms, and the reputation of big companies can make users trust the issuers and not be afraid of potential risks of scams. Of course, it cannot be excluded that these virtual currencies could be converted into fiat currencies, as it happens with stablecoins. 3.3.3 The Tokens

The analysis of “tokens” (or “cryptotokens”) completes the analysis of the possible application of blockchain technology in the case of digital currencies. A token is a digital asset. Like a cryptocurrency, it is built using blockchain technology and it is created by adding blocks to a blockchain. With respect to a cryptocurrency, the issue of a token does not require to begin a new blockchain, but it can be built on top of a pre-existing blockchain as a smart contract (Liu and Wang 2019). A token can be used for different purposes. It can be the digital representation of a physical asset, representing a share of ownership or certificate of property. It can represent a right to use an asset for a certain period of time. It can be the digital representation of a fiat money, and many other things more. As a digital asset, a token can be transferred from an original owner to a new one, by adding a new block to the blockchain that hosts the token. Doing so a token – digitalizing a real asset – is able to ease the transfer of the property of the underlying asset. Tokens can be fungible tokens and non-fungible tokens. In the first case, different tokens are issued in order to make them interchangeable (or “fungible”), and all the tokens give the same right and work in the same manner. Non-fungible

42  Blockchain, Virtual currencies, Cryptocurrencies, and Tokens tokens – usually referred to as NFT – are tokens that identify a single and unique asset (Ante 2022). With respect to cryptocurrencies, tokens differ because they cannot be “mined” as it happens with cryptocurrencies. A  token can represent a cryptocurrency (or the right to use it), so we can have tokens that work like cryptocurrencies. But if a token can do what a coin of a cryptocurrency does, a cryptocurrency cannot do all the things a token is able to do. Just to stress the differences between a cryptocurrency and a token, a cryptocurrency can be used as a means of payment, transferring the property of the coins. A token can receive money from different sources (including cryptocurrencies) and transfer them to one or multiple counterparts, even adding some conditions, necessary to complete the transfer for some or all the beneficiaries. Hence, a token can do what a cryptocurrency does, but it is not itself a cryptocurrency. 3.4 Conclusion The aim of the chapter was to analyze the functioning of cryptocurrencies from a technical point of view, to understand their potential (and their risks) from an economic and financial perspective. The understanding of the basic logic of distributed ledger technology (DLT), the blockchain, and cryptography allows to relate cryptocurrencies to the traditional monetary system. The evolution of the concept of money – as described in the previous ­chapters – is based on improvements to the money tools used as means of payment, store of value, and unit of accounts. The current structure of the (international) monetary systems relies on fiat money issued by central banks, with deposits, bank transfers, payment cards, and e-money tools facilitating the use of money. However, all the non-cash payment options see their acceptance rate be based on the chance to receive cash or cash equivalent assets. With cryptocurrencies, we have a financial architecture of the financial system that completely differs from the current one, and they represent a revolution  – more than an innovation  – of the monetary system. Cryptocurrencies do not aim to make the use of fiat money easier or safer than what it is, but they propose to replace the concept of a central authority ­issuing a fiat money (central banks) with a distributed and self-controlling ­mechanism, where the issue of money is not controlled by single entities. The scenario proposed by cryptocurrency projects does not include central banks but dismantles even the structure of the payment systems, making banks and other payment institutions as we know it not so necessary anymore (if not even useless). Such a fresh start for the international monetary system, with a new “ground level” made by cryptocurrencies, will probably require new repository facilities, that will play the role currently played by banks and other financial intermediaries.16 As with any fresh start, it would be interesting to analyze the consequences for the currencies that take advantage of their status of international currencies (e.g., US dollar, euro) that risk being re-aligned to other currencies, or being replaced by others.

Blockchain, Virtual currencies, Cryptocurrencies, and Tokens 43 An open question, that the further chapters will help to address, is if the market (and the market players) are ready for the revolution proposed by cryptocurrencies and if they are prone to adopt this technology-based concept of money. If not, cryptocurrencies – as we know them today – will remain a utopia or just a marginal phenomenon in the financial system. What will make the difference is the approach that central banks will have to the innovation proposed by cryptocurrencies and their underlying technology. The times when central banks ignored cryptocurrency projects are over. But the attempts to “defuse” the disruptive effects proposed by cryptocurrencies by regulation and the will to incorporate them into the current structure of the financial system risk not being enough. The next chapters will go into detail about the functioning of the main existing cryptocurrencies, trying to shed light on the pros and cons of different cryptocurrency projects and to help to figure out the possible future evolution of the cryptocurrency phenomenon, including the point of view of central banks and the possibilities to use the blockchain technology to issue the so-called Central Bank Digital Currencies (CBDCs). Notes 1 This is the case where some previous blocks recognize the history of records of the new block as authentic, so they validate the new block; while other previous blocks identify some differences in that history of records and – doing so – they do not validate the new block. 2 The minority of participants that realize the system is not reliable anymore will leave the system, leaving only the cheater in it. 3 Source: www.kaspersky.com/resource-center/definitions/what-is-cryptography. 4 Or it should be said “it is computationally infeasible”. 5 This property is referred to as the “preimage resistance” of the hashing function. 6 From a technical point of view it should be said that it is “computationally infeasible” to do. The number of calculation needed to achieve the result are so big that the time needed to do it is too big even with the highest computational power (currently) available. 7 That property of the hashing functions is referred to as being “second preimage resistant”. 8 This property is the one that makes the hashing function “collision resistant”. 9 1 byte = 8 bits, 32 bytes = 256 bits 10 From the tables reported it can be easily found that with n = 2 we have 22 = 2 × 2 = 4 combinations, when n = 4 we have 23 = 2 × 2 × 2 = 8 combinations. With n = 4 we have 24 = 2 ×  2 × 2 × 2 = 16 combination, and so on. 11 The exact number is 115,792,089,237,316,195,423,570,985,008,687,907,853,269,984, 665,640,564,039,457,584,007,913,129,639,936 12 Details about the mining process and the criteria used to issue new coins will be ­described in the next chapter of this book. 13 The money transfer from a bank account to another bank account requires to set standards (e.g., IBAN, SWIFT), physical infrastructures and central structures that guarantee the accountancy of the transfers. 14 The estimated number of online gamers in 2022 is 1.17 billion, and the global online gaming revenues in 2022 were 23.56 billion of US dollars (source Statista 2022). 15 Examples of such scenarios could be Amazon, Alibaba, eBay, and others.

44  Blockchain, Virtual currencies, Cryptocurrencies, and Tokens 16 Even if cryptocurrencies can be stored locally, using standard hard disks, there are storage providers online that offer online storage facilities. Examples of these services are Binance Custody and Coinbase Wallet.

References Ante, L. (2022). The non-fungible token (NFT) market and its relationship with bitcoin and ethereum. FinTech, 1(3), 216–224. https://doi.org/10.3390/fintech1030017 Buchinger, U., Ranaivoson, H., Ballon, P. (2013). From loyalty points to virtual currencies: Expanding loyalty schemes for mobile platforms.  2013 International Conference on Mobile Business, 9. https://aisel.aisnet.org/icmb2013/9 Bullmann, D., Klemm, J., Pinna, A. (2019). In Search for Stability in Crypto-Assets: Are Stablecoins the Solution? ECB Occasional Paper No. 230. www.ecb.europa.eu/pub/pdf/scpops/ ecb.op230~d57946be3b.en.pdf d’Avernas, A., Maurin, V., Vandeweyer, Q. (2022). Can Stablecoins Be Stable? Becker Friedman Institute for Economics Working Paper 2022–131. Chicago: University of Chicago Press. EBA – European Banking Association (2014). EBA Opinion on “Virtual Currencies”. EBA/Op/ 2014/08. www.eba.europa.eu/sites/default/documents/files/documents/10180/657547/ 81409b94-4222-45d7-ba3b-7deb5863ab57/EBA-Op-2014-08%20Opinion%20on%20 Virtual%20Currencies.pdf?retry=1 Gawron, M., Strzelecki, A. (2021). Consumers’ adoption and use of e-currencies in virtual markets in the context of an online game. Journal of Theoretical and Applied Electronic Commerce Research, 16(5), 1266–1279. https://doi.org/10.3390/jtaer16050071 Kaspersky.com (2022). Cryptography Definition. www.kaspersky.com/resource-center/definitions/ what-is-cryptographyy Kõlvart, M., Poola, M., Rull, A. (2016). Smart contracts. In: Kerikmäe, T., Rull, A. (eds.) The Future of Law and eTechnologies. Cham: Springer. https://doi.org/10.1007/978-3-31926896-5_7 Liu, C., Wang, H. (2019). Crypto tokens and token offerings: An introduction. In: Goutte, S., Guesmi, K., Saadi, S. (eds.) Cryptofinance and Mechanisms of Exchange: Contributions to Management Science. Cham: Springer. https://doi.org/10.1007/978-3-030-30738-7_8 Oxford Dictionaries (2022). Digital Currency Definition. www.oxfordlearnersdictionaries.com/ definition/english/digital-currency Statista (2022). Online Gaming – Statistics and Facts. www.statista.com/topics/1551/onlinegaming/#topicHeader__wrapper Yaga, D., Mell, P., Roby, N., Scarfone, K. (2018). Blockchain Technology Overview. Gaithersburg: National Institute of Standard Technology  – U.S. Department of Commerce. https://doi.org/10.6028/NIST.IR.8202

4 The Mining of Cryptocurrencies

4.1 Introduction This chapter describes the process behind the issue of cryptocurrencies, which is known as “mining”. The mining activity is the method by which new coins of cryptocurrencies are generated and transactions among cryptocurrency’s users are verified. Bitcoin and other cryptocurrencies can be obtained in three primary ways. First, they can be bought on an exchange. Second, cryptocurrencies can be received as payment for goods or services. Finally, they can be virtually “mined”. The last option is the topic of this chapter. The first part of the chapter will analyze the process of mining and its functioning, then the two primary consensus mechanisms are discussed. The last part of the chapter discusses the sustainability and the costs relating to the mining activity, ­addressing environmental issues. The purpose of the chapter is to describe in detail the logic and the process of the mining activity, and all the related issues. Knowledge and understanding of the mining process are necessary to understand the differences among cryptocurrencies and their characteristics. 4.2 Mining, Consensus, and Consensus Algorithms In traditional digital transactions, people trust a third party, which is a central authority. A transaction happens thanks to the faith that people have in this third party, which guarantees the finalization and the execution of the transaction. The system is completely centralized, and all the transactions and information are managed by the central authority. When a transaction happens on a decentralized system and in a peer-to-peer way, people do not trust the counterpart but the technology behind the functioning of the system. Blockchain technology makes possible the decentralization of the records and peer-to-peer transactions. Blockchain technology has made possible the development of cryptocurrencies and the possibility to make transactions outside the traditional financial system. As was analyzed in Chapter 3, each transaction is recorded on a public ledger which is shared among all the nodes belonging to the network, and it is impossible to modify a transaction or alter the information recorded. It is important to understand the mechanism behind the functioning of a blockchain and what happens each time a new block is added to DOI: 10.4324/9781003353102-5

46  The Mining of Cryptocurrencies the chain. It is this mechanism that guarantees the well-functioning of a blockchain. This mechanism is called mining. The mining activity is needed by cryptocurrencies to create new coins and to validate existing transactions. Since cryptocurrencies are decentralized and no one authenticates transactions, there could be the risk of double spending and fraudulent behaviors. Double spending refers to the chance that a cryptocurrency could be spent more than once at the same time. The mining activity reduces this risk and rises users’ confidence in the coin. Doing so, the mining activity is pivotal to guarantee the security of cryptocurrencies. It validates and secures the blockchain, which is the element that makes it possible for a cryptocurrency to function as a peer-to-peer decentralized network without the necessity of a trusted third party. The mining activity is strictly related to the moment in which a new block is added, in this moment not only a set of transactions are validated and at the same time new coins are created. First, a blockchain has the form of a chain of “transaction blocks” and employs a set of specific mathematical algorithms to create and verify the continuously growing data structure. The mining activity is related to the validation of every transaction, building and storing all the blocks and reaching consensus on which block to include in the blockchain. The mining activity is performed by miners, which are independent computers located all over the world to spend resources and compete to record new blocks of transactions. Indeed, miners receive a reward for their activity, which is a new unit of cryptocurrency. So, miners have the incentive to validate transactions by the possibility to earn the reward, and only the first miner who solves the algorithms receives the reward. Miners compete to validate the block and to be the first to solve the puzzle. This mechanism guarantees the well-functioning of a blockchain and the continuous growth of data. Most of the blockchains, those that are permissionless, use mining activity. Looking at the mining activity it is possible to classify the miners’ tasks into two groups. Some activities – such as validating transactions and blocks – improve the cryptocurrency network and are essential for its existence. This is the first reason why miners are required by the protocol of a cryptocurrency. Other activities – such as the race to find blocks and profit – are not needed for the network but are planned to incentivize miners to perform the fundamental steps. Both groups of activities are essential for the functioning of the network; indeed miners require an incentive to perform crucial tasks. First of all, miners have to decide how many transactions of a specific cryptocurrency to include in a block up to the limit of the total dimension of the block. Once the block with a header is created, it is ready to be added to the chain. At that point, miners start to compete in order to identify the nonce, which is needed to produce a valid hash. Each block has its own hash, which is an alphanumeric code. This code is generated by the information inserted in the block. The hash is a unique code, which will change if any information in the block is changed. The hash of a block can be seen as the fingerprint of a person, unique to the block. A nonce is a “number only used once”, which is a number that makes it possible to create a valid hash. This number is added to the hash of the block in a blockchain. The nonce is

The Mining of Cryptocurrencies 47 used to verify the data and transactions included in a block. A valid hash is a code starting with a series of zeros, and the number of zeros is those needed to demonstrate the work of the miner at a specific point in time. It is the number of zeros that determine the difficulty of the puzzle. The security of a blockchain is linked to the capacity of creating and validating long, encrypted numbers, called “hash”. The cryptographic function employed to create a hash is deterministic; this means that it generates always the same result any time the same inputs are used. Any changes to the inputs result in a different hash. To guarantee the security of a blockchain, the data from the previous block are encrypted into a series of numbers that are in the block header for the next block. The header is metadata, which includes the blockchain version number, the previous block’s hash, timestamp, the difficulty target, and the nonce. The only part which is independent from the information inserted in the block is the nonce. So, the nonce is the number for which miners spend efforts. Since, in a cryptocurrency, a nonce is used to validate the information included in the block, the purpose of miners is to find the nonce in order to receive the block reward. To find this number, miners use a mining program that generates a random number, then this number is attached to the hash of the current header, which rehashes the value, and this is compared to the target hash. The miner generates a solution and receives the reward for the block only if the hash value resulting from the previous step meets the requirements. If the value generated does not meet the target, the process starts again. The procedure goes ahead until one miner matches the target. It is improbable that the nonce will be found at the first attempt. Miners, usually, must try out a large number of nonce alternatives before finding the right one. The difficulty of mining a new block is proportional to the time and effort required to generate the solution. The block difficulty is the same across the whole network, which means that all miners of the network have the same possibility of solving and finding the right hash. Most cryptocurrency networks set up a target number of blocks that can be processed during a specific period and, from time to time, the difficulty is adjusted to guarantee that the target is met. The opposite happens if the number of blocks processed does not meet the target: in that case, the difficulty will be reduced. Miners can act alone or in a pool. At the beginning of the cryptocurrency era, most of the miners processed the transaction alone, due to the low level of difficulty of the mining process. Low level of difficulty is linked to low efforts and costs required to verify a block. Nowadays, most of the blocks are verified and validated by mining pools. Many cryptocurrencies have seen an increase in mining pool, where miners partner together and share mining rewards, as opposed to “solo mining”, where a single miner supports all the risks and costs. The rise of mining pools coincides with a growth of the global hash rate1 (Cong et al. 2019). Mining pools use a combination of resources to increase the probability of finding a block and successfully solve the algorithms to find the right nonce. In other words, a pool combines the hash rate of multiple miners to solve a single cryptographic problem and then assigns the rewards to the miners in proportion to their hash rate contribution. A mining pool can be seen as an insurance for miners. In other words, it is a group of miners sharing all the risks linked to the mining activity. The primary risk for miners is connected to the likelihood to find a block in a period of time that is

48  The Mining of Cryptocurrencies sustainable in relation to all the costs sustained for the activity, such as equipment and energy costs. If the expectation is to earn enough to return of the investment the variance is so high that there is the possibility the miner will make nothing at all. That means that, for a small miner, mining is a sort of gambling. In a mining pool, no matter whose pool member finds the block, because in any case is the pool manager to receive the reward. Then, the pool manager will distribute the reward among all the participants to the mining pool, according to the work performed by each miner. The pool manager will apply some cuts for being the manager of the pool. In a pool, all the attempts to mine a block are made with a designated coinbase recipient, which is the pool manager. Indeed, a pool is born with a pool manager that makes available the hardware infrastructure, programming the necessary codes for the implementation of the compensation of the pool, and then promoting it among the miner community. The cryptocurrency’s users pay a transaction fee to miners in order to include their intended transactions into the new block. In the past, the transaction fees were kept by the pool manager and only the fixed r­ewards were distributed. However, given the rise in transaction fees, more pools have started sharing transaction fees. There are three different categories of fee ­contracts: ­proportional, pay per share (PPS), and cloud mining. The fee contracts are the way in which the reward and fees are distributed by the pool manager to all the participants of the pool. In the proportional fee contract, the pool pays the participant only when the pool finds a solution, so a valid block is found, and the payment is proportional to the work that each miner actually did (their hash rate). In this model miners still take some risk, but if the mining pool is large enough, the variance of how often a block is found is quite low. At the same time, this model generates lower risk for the pool manager, since payments will be done only when a block is found, and the reward is gained. In the pay-per-share (PPS) contracts every pool participant receives a fixed amount after finding a partial solution. In this model, the pool manager pays a flat fee per every share which is above a specific level of difficulty for block on which the pool is working on. Miners send their shares to the pool manager immediately and are paid without waiting to find the block. This solution is the best for miners, because a specific amount of money is guaranteed anytime they find a share. On the other hand, the pool manager assumes all the risk paying rewards even if the block is not found and the reward is not jet gained. Cloud mining works in a completely different manner from the two previous models. In this model, a miner pays to obtain some hash rates from the pool, and then the miner works and performs as an independent miner. In practice, miners buy from the mining pool some hash rates to perform their mining activity autonomously. In this case, if the miner finds the block and gains the reward, the latter will be not shared with the other participant in the pool. The pro to being an individual miner is to gain full ownership of the reward, at the same time, the likelihood to reach the goal is very low due to the big power and resources required. In recent years, for many cryptocurrencies, the difficulty to mine increased, because their popularity and the costs linked to expensive hardware (needed to be a competitive miner) as well as the electricity bills increased too,

The Mining of Cryptocurrencies 49 reducing the potential rewards. This means that often mining is not profitable for individuals. On the contrary, mining pools require from each pool’s member less, in terms of both hardware and electricity costs, increasing at the same time the chance to make a profit. In a pool, the chance of finding a block and receiving a reward – the so-called “success rate” – dramatically increases. The main con to being part of the pool is that individuals give up some of their independence in the mining process. Most of the time, how to approach the mining process is dictated by the terms set by the pool. Moreover, being part of a pool requires sharing any rewards. This means that the share of profit is less for an individual in a pool than the profit for solo mining. At this point, it is important to underline and understand what the reward for the mining activity is. When a new block is validated, and the algorithm problem is solved, the miner receives the reward. The reward is a new coin of the cryptocurrency. For instance, mining the Bitcoin, which is the dominant cryptocurrency on the market, needs almost 10 minutes. This means that a new block takes 10 minutes to be validated. Bitcoin’s miners will receive 6.25 bitcoin as a reward for their mining activities. It follows that any time a new block is created, and a valid hash is found by a miner or a mining pool, they receive 6.25 bitcoin. At the time of writing2, the price of a bitcoin is around 16,000€, this means that a miner will receive around 100,000€. The coins received by miners are new coins that are put in circulation. Mining is not only the process by which the functioning and the reliability of the cryptocurrency’s blockchain is guaranteed, but it is also the system used to issue new coins. So, the mechanism has a double function in which one is a consequence of the happening of the other one. Indeed, only if a transaction block is added in a correct way miners will receive the rewards. So, only if the tasks needed for the wellfunctioning of the blockchain are performed then miners receive a new quantity of coins, namely new coins are issued and put in circulation. The analysis of mining requires to analyze the so-called consensus mechanism. A consensus mechanism is any mechanism used to reach agreement, security, and trust in a decentralized network (IMF 2022). In a centralized system, a central ­authority or a central administration has the power to maintain and update the ­database. The responsibility to make any updates is carried out by a central a­ uthority. The central authority is the only one in charge to maintain the records and the database. A decentralized system works on a global scale without any central authority. In this case, a common protocol is needed to make sure that all nodes are coordinated on which transactions are legitimate to be added to the chain. This protocol is known as consensus mechanism. A consensus mechanism is a group of rules which establish the legitimacy of the contributions performed by all the participants of the blockchain (Aggarwal and Kumar 2021). The function of these rules is to guarantee the authenticity and validity of the transactions. The consensus mechanisms are a crucial element for every Distributed Ledger Technology, including the blockchain, since they have the role to guarantee the integrity and security of the information contained in ledger being compliant with the rules of the protocol.

50  The Mining of Cryptocurrencies The protocol is a set of primary rules of a blockchain, while the consensus a­ lgorithm is the mechanism by which these rules are enforced by the network. The protocol defines the way in which the nodes interact, the data are transmitted, and which are the requisites to validate the new transactions or to modify an operation already approved. The consensus algorithm, instead, has the role to verify the correct interaction among nodes and to confirm the operations executed by the network. In the context of blockchain and cryptocurrencies, there are various types of consensus mechanisms algorithms, and each of them works on different principles. The main goal in the cryptocurrencies context is to prevent bad behaviors, and the most common example is “double-spending”. The consensus mechanism solves this issue by making it expensive and difficult to propose a new block of validated transactions, discouraging bad behaviors. At the same time, the mechanisms encourage the nodes to suggest “good” blocks that will be accepted in order to receive valuable rewards. The two most common consensus mechanisms in the cryptocurrency world are the Proof of Work (PoW) and the Proof of Stake (PoS). Even if the PoW and PoS have similar purposes, they present some differences and peculiarities. 4.3 The Proof of Work The term Proof of Work (PoW) is the consensus algorithm which is at the base of many blockchain networks. This algorithm is used to validate transactions and create a new block, which is added to the chain. This mechanism requires the participants of a network to spend efforts to solve mathematical problems. The level of difficulty of the mathematical problem is changing and increasing over time, according to the rules set by the blockchain protocol. This mechanism aims to disincentivize bad behavior and the possibility to add malicious blocks to the chain. This type of consensus mechanism is used in cryptocurrency mining in order to validate transactions and mine new tokens. This consensus mechanism uses what is generally called “mining activity”. A  bigger computational power increases the chance to solve a mathematical problem, due to the bigger number of possible attempts-per-second. The mathematical problem can be solved only by attempting, and the first miner that finds the solution receives the reward. The PoW allows miners to validate and to add a new block to the blockchain only if the other nodes of the network agree on the solution provided by the miner. This consensus is achieved by repeating the solved operation by the majority of the network’s nodes. There are several pros in the PoW. This system allows cryptocurrencies to be processed peer-to-peer in a safe manner, without the presence of a trusted third party. As was described in detail in previous chapters, altering a blockchain that uses this type of consensus is extremely difficult (and very unlikely). If a block is altered, it should be necessary to re-mining all subsequent blocks. This is possible only if a single entity (a miner or a pool) controls the network’s computing power. Due to the fact that this is very unlikely, due to the fact that the machinery and power needed to complete the hash functions are more and more expensive, the risk of altering blocks in a blockchain is extremely low. In addition, the function of the PoW is independent from the stake belonging to the miners, and the only thing that

The Mining of Cryptocurrencies 51 is important in this system is the computational power used to solve the mathematical problem. This means that controlling a greater amount of coins does not give a greater control on the network. The main cons of the PoW are high costs and the uselessness of the calculation. Relating to the costs, the mining process requires potential infrastructure able to solve in a few times complex algorithms. These infrastructures are not only extremely expensive, but they even use huge quantities of electricity. Moreover, miners spend a lot of time and energy generating new blocks, making calculations that are not useful in any other sector. The algorithm’s problems guarantee the safety of the network, but they cannot be used in any other context. The last problem is related to the 51% attack. This is the case in which a single user or a group finds the way to control most of the mining power of the network. In this way, the attackers are able to control the result of the events that happened in the network. They could have the possibility to monopolize the creation of new blocks or to cancel transactions. This could be possible because they can achieve a consensus in the network, even if a tampered block is added to the blockchain, thanks to the control of the majority of the blocks. However, a 51% attack tends to be not profitable. The computation power required to control the entire blockchain is extremely high, and, once the attack is known by other users, the network will be considered damaged, and the participants would decide to leave it. This situation would lead to a decrease in the value of the cryptocurrency, which will impact the value of the funds of the attackers. For all those reasons, the 51% attack is a marginal (if not irrelevant) issue of cryptocurrencies. The most popular application of PoW is Bitcoin, which was the first cryptocurrency to use and implement this type of algorithm and still to be the dominant cryptocurrency of the cryptomarkets (Schoar and Makarov 2022). Other cryptocurrencies use similar systems and, at the current time, around 75% of the projects are based on PoW (ECB 2022). 4.4 The Proof of Stake The Proof of Stake (PoS) is the second most widespread consensus mechanism in the cryptocurrency context.3 This is an alternative consensus mechanism, developed to solve the PoW issues related to electricity overconsumption and computational power needs. In the PoS the procedure through which computers compete with each other to solve the mathematical problem (the mining activity) is replaced by a system in which the so-called validators guarantee the validity of the operation done by a miner, using a fraction of their cryptocurrencies, called “stake”. So, this mechanism needs validators simply hold and stake tokens. PoS changes the way in which blocks are verified using the mechanism of coin owners. The owner of coins uses their coins as collateral for the possibility of validating a block. In this way, the owner of coins with staked coins becomes the validator. Different from the proof-of-work mechanism based on a competition mechanism uses a system that randomizes who gets to “mine”. The validators are chosen randomly,

52  The Mining of Cryptocurrencies but to become a validator a specific number of coins must be “staked” by the coin owner. Moreover, more than one validator validates the blocks, and only after that an exact number of validators verify the accuracy of the block, the later is finalized and closed. The PoS would seem to facilitate the nodes that have more economic resources, making richer those that are the richest of the network. It is true that the probability to be selected as a validator depends on the number of coins staked, so greater is the amount staked, more is the probability to be a validator. But this is not the only parameter used by the algorithm which is composed of a random component. In addition, some rules of the protocols used to guarantee a turnover of validators incentivize the purchase of cryptocurrencies and the participation in the system by all the nodes of the network guaranteeing the decentralization of the system. The idea behind this system is to avoid wastefulness of energy and competition among nodes based on computational power. At the same time, the risk of 51% attack is a problem when PoS is used. In this case, a group or individual should have to own 51% of the staked cryptocurrency. Not only is it very expensive to have this amount of cryptocurrency but the miners that try to store a block using a 51% attack could lose all their staked coins. This mechanism wants to create an incentive to act in good faith for the benefit of the network. In this system miners do not receive as reward new coins, but the transaction fee paid by the cryptocurrency’s users. Moreover, PoS systems provide a greater scalability with respect to the PoW systems. Frequently, given the computational power available in the mining pool, the mathematical problems are so complex that require time to be solved. This means that from the moment in which a specific transaction is done and the moment in which the transaction is validated can take some time, making it impossible to use the cryptocurrencies based on PoW for real-time payment or instant purchases. In the PoS systems, this problem does not exist. The selection process of the algorithm takes a few seconds and the same is the time required by the validators to validate the transaction. The operation is guaranteed by the validator by their portion of cryptocurrency deposited in the network. This peculiarity makes blockchains based on PoS systems suitable to support electronic payments in real time. This technology (the PoS) is more respectful of the environment than the PoW, since powerful computers are not needed for mining activity, reducing drastically the electricity consumption. At the current time, the Proof of Stake is not used by the major cryptocurrencies, but its potential benefits and its advantages will probably show all the limits of the PoW system. 4.5 Computational Power, Cost of Mining, Footprint, and Sustainability Issues The previous paragraphs have shown how mining activities work and how new coins of a cryptocurrency are issued. From the analysis of the mining activity strictly related to the PoW mechanism, the need for high capacity of computational power is clear. Higher the required computational power, the more powerful computers have to be, and bigger is the amount of energy to run the machines. The large use

The Mining of Cryptocurrencies

53

of the PoW in the cryptocurrency world raises an environmental issue, related to the waste of resources (electricity) and the footprint of electricity production (Gallersdörfer et al. 2020). For instance, Bitcoin has a significant carbon footprint, with an annual consumption of energy estimated similarly to some mid-sized countries, such as Spain, the Netherlands, or Austria (ECB 2022). A reliable assessment of the quantity of energy used for the mining of Bitcoin and other PoWs cryptocurrency is not possible. However, it is possible to make an estimation by the network’s hash rate. From Digiconomist was developed the Bitcoin Energy Consumption Index.4 This index shows the last estimates of the total energy consumption of the Bitcoin network. The annual electricity consumption is comparable to the power consumption of Sweden (134.85 TWh), the annual carbon footprint is like the impact of Colombia (75.21 Mt CO2). Instead, for a single Bitcoin transaction is needed an amount of electricity comparable to the power consumption of an average U.S. household over 51 days, the carbon footprint is equivalent to 1,843,342 transactions using VISA.5 In addition, cryptocurrency mining generates significant electronic waste, since mining hardware becomes obsolete very quickly. Digiconomist estimates that the annual electronic waste is similar to the small IT equipment waste of the Netherlands (32.48 kt). The increasing incentives to improve the mining activity in order to increase the power of machines, in order to get a piece of Bitcoin, has caused the total energy consumption of Bitcoin network has grown. Figure 4.1 shows how the energy use of Bitcoin mining is comparable with several large countries. Figure 4.2 highlights the behavior through the last six years of Bitcoin energy consumption. It is evident the increase in consumption from July 2021, from which the two lines, estimated TWh per year and minimum TWh per year, drastically diverge.

Figure 4.1 Energy Consumption by Country Source: Author’s elaboration on data Digiconomist (https://digiconomist.net/bitcoin-energy-consumption)

54  The Mining of Cryptocurrencies

Figure 4.2  Bitcoin Energy Consumption Source: Author’s elaboration on data Digiconomist (https://digiconomist.net/bitcoin-energy-consumption)

Figure 4.3  Ethereum Energy Consumption Source: Author’s elaboration on data Digiconomist (https://digiconomist.net/bitcoin-energy-consumption)

Digiconomist, also, has created an index equal to the Bitcoin Energy Consumption Index for Ethereum’s network. The total energy consumption of Bitcoin and Ethereum networks is around 194.2 TWh per year. The environmental issues of cryptocurrencies can be even a financial issue. In recent times, even financial investors have begun to pay attention to climate change and the consequent environmental issues, driving their investment toward environmentally friendly investment vehicles. The overuse (if not the “waste”) of energy could reduce the demand for cryptocurrencies, with consequences on their market trends. The challenges of the energy transition from fossil fuels to clean and renewable energies will probably require changes even in the functioning of cryptocurrencies or will see cryptocurrencies based on energy-consuming protocols to be replaced

The Mining of Cryptocurrencies 55 by other more efficient solutions. If the Proof-of-Work is now the dominant mining mechanism, it has been estimated (ECB 2022) that a switch to Proof-of-Stake mechanism could save up to 99% of the energy used to run a proof-of-work system. This clearly emerges from Figure 4.3. Figure 4.3 shows the behavior through the last six years of Ethereum energy consumption. It is relevant to highlight how the trend has drastically changed after that Ethereum changed its consensus mechanism from PoW to PoS in September 2022. Consumptions have drastically fallen. Notes 1 The hashing power or hash power is the power that a computer or hardware uses to run and solve different hashing algorithms. The hash rate is the number of hash operations done in a given amount of time, namely, it is a measure of the computational power per second used when mining. 2 January 2023. 3 Gemini.com 4 digiconomist.net 5 digiconomist.net

References Aggarwal, S., Kumar, N. (2021). Chapter eleven- cryptographic consensus mechanisms. ­Advances in Computers, 121, 211–226. Cong, L. W., He, Z., Li, J. (2019). Decentralized Mining in Centralized Pools. www.nber.org/ papers/w25592 (Last access October 2022) ECB – European Central Bank (2022). Mining the Environment – Is Climate Risk Priced Into Crypto-Assets? www.ecb.europa.eu/ (Last access October 2022) Gallersdörfer, U., Klaaßen, L., Stoll, C. (2020). Energy consumption of cryptocurrencies beyond bitcoin. Joule, 4(9), 1843–1846. IMF-International Monetary Fund (2022). Fintech Note  – Blockchain Consensus Mechanisms: A  Primer for Supervisors. https://www.imf.org/en/Publications/fintech-notes/ Issues/2022/01/25/Blockchain-Consensus-Mechanisms-511769 Schoar, A., Makarov, I. (2022). Blockchain Analysis of the Bitcoin Market. https://papers.ssrn. com/sol3/papers.cfm?abstract_id=3942181 (Last access December 2022) Website Coindesk. www.coindesk.com/ (Last access December 2022) Website Digiconomist. https://digiconomist.net/bitcoin-energy-consumption/ (Last access December 2022) Website Gemini. www.gemini.com/ (Last access December 2022)

5 The Main Cryptocurrencies on the Market

5.1 Introduction In the last few years, the cryptocurrency market has bloomed, showing an exponential growth in the number of cryptocurrencies on the market. At the moment of writing, the number of cryptocurrencies created is more than 22,100.1 This number is growing day by day but not all cryptocurrencies have the same functions and characteristics. Even if the number of cryptocurrencies continuously grows, Bitcoin is still the dominant cryptocurrency on the market. Indeed, the cryptocurrency market includes Bitcoin, Ethereum, and the so-called “altcoins”. The term altcoin is used to refer to all the cryptocurrencies that are on the market but different from Bitcoin and Ethereum. Alternatively to the term cryptocurrencies is used the term crypto-asset (ECB 2019). This underlines the fact that not all cryptocurrencies have the same nature or are created with the same function. Some of them are tokens issued as an instrument in an ICO2, with the purpose to represent a share of a project or a company, or to have some utilities from the project financed by the acquisition of the token. Other cryptocurrencies are issued with the only purpose to be a trading speculative asset. Other cryptocurrencies are tokens that can be used only in specific contexts to pay for the acquisition of services and goods, such as MANA, which is the token used in Decentraland.3 Some cryptocurrencies are developed with the purpose to create an alternative payment system or a new payment tool, that want to be an alternative to the traditional system, such as Bitcoin. There are also some cryptocurrencies that are developed to have a stable value, with the aim to be used as a new currency alternative to a fiat currency, such as Tether.4 The presence of multiple cryptocurrencies, issued for different purposes, requires analyzing more in detail the main cryptocurrencies on the market and stressing their main features. The previous chapter described the technical aspects relating to the general functioning of a cryptocurrency, analyzing mining activity and the two prevalent typologies of consensus mechanism. This knowledge is pivotal to understanding the variety of cryptocurrencies and the technical differences among them. This chapter aims to present and discuss the functioning of the most relevant cryptocurrencies on the market. The analysis will start by describing the origin of each cryptocurrency and will analyze technical characteristics, discussing the market DOI: 10.4324/9781003353102-6

The Main Cryptocurrencies on the Market 57 capitalization and the evolution of the price over time. The next two paragraphs will focus on the two dominant cryptocurrencies on the market: Bitcoin and Ethereum. They represent, respectively, 40% and 20% of the market dominance.5 The last paragraph analyzes the variety of altcoins looking at their market capitalization and based on their basic characteristics and functions. The source of data on market position, price, and market capitalization is Coinmarketcap.6 Coinmarketcap is a referenced price-tracking website for cryptoassets. Its mission is to deliver high-quality and accurate information to retail users in order to make cryptocurrencies discoverable and efficient globally. The purpose is to provide accurate data, which gives to final users all the information needed to draw their own opinions. It was founded in 2013 and has become the most trusted source by users, institutions, and media. 5.2 The Bitcoin The number of cryptocurrencies on the market is growing over time but the dominant cryptocurrency on the market is still Bitcoin (40%). Bitcoin is the first decentralized open-source cryptocurrency presented for the first time in 2008 by Satoshi Nakamoto7 in the whitepaper titled “A Peer-to-Peer Electronic Cash System”. The first bitcoin’s block was mined on January 3, 2009.8 In the white paper, the author defines Bitcoin, as a purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution a new way to allow electronic payment (p. 1). The initial idea behind Bitcoin was to create a new system far from the traditional financial system, which allows peer-to-peer payment. In this system, transactions happen directly between users and are verified by network nodes, so a trusted third party is not required. The idea was to create a tool to make it possible to exchange electronic cash in every moment, independently from the geographic position and the legal tender used in the different countries. Anybody with a connection and the requisite software on their computer, smartphone, or tablet can make a payment using Bitcoin. The system is based on an exchange of encrypted messages and is verified by the network participants. The system is based on “asymmetrical encryption”. This means that any participant in the network has two keys, a private key and a public key. They are used to send and receive cryptocurrency. The public key is known to the network and is used to identify the counterpart and to encrypt the message, which can be seen as an IBAN code.9 The private key is a secret one that is used to decrypt the messages, to access the fund, and to sign the transactions. The private key is known only by the receiver of the message, such as a password used to access and to give orders to bank from the website or the app of the bank. Each transaction must be verified and added to a block, then the new block created must be added to the existing blockchain. Bitcoin is based on the proof of work consensus mechanism.10 The mining activity is incentivized by the reward mechanism, namely, an amount of bitcoin is received by the miner who is the first that solves the mathematical problem. The time required by the network in order to verify and to validate a block is around 10 minutes. The system of reward is designed

58  The Main Cryptocurrencies on the Market to decrease the amount of Bitcoin created over time. Every 210,000 blocks, which is about 4 years, the amount of Bitcoin created by miners (every time a block is added) is halved. In the beginning, the number of bitcoins created after a block was approved was 50 bitcoins. Today the reward is 6.25 bitcoin. The last having was in May 2020, and it was the third halving in Bitcoin history. The next halving is expected in March or April 2024. The previous halvings were in 2012, 2016, and 2020. After each halving, the Bitcoin price increased. Different from the national currencies which are governed by central banks, the creation of new bitcoins is governed by the protocol. The number of Bitcoin that can be created is fixed with a limit of 21 million of bitcoin by protocol. At the moment, around 19 million of bitcoins are in circulation.11 The halving system allows to maintain and regulate the creation of new coins, following halving rule the last coin should be created in 2140. The Bitcoin payment cannot be in real time because a transaction takes more or less one hour to be processed and added to the chain. This is one of the limits for Bitcoin and its implementation as a currency in everyday payments, with the high computational power and energy consumption required to mine a new block. Bitcoin is not the first attempt to develop a decentralized system12, but it is the first that has reached public attention successfully. Moreover, Bitcoin is based on and takes advantages from previous cryptocurrencies’ attempts and previous studies. In 1991 two computational procedures to time-stamp digitally documents were published. The purpose was to make it impossible for users to back-date or to forward-date documents even with the collusion of a time-stamping service. The problem was related to the possibility to certificate when a digital document was created or last changed, so as to time-stamp the data (Haber and Stornetta 1991). The two solutions proposed involve the use of hash functions and digital signatures. A few years before Rivest et al. (1978) presented an encryption system for digital signature. This method had the property that a message can be signed, namely encrypted using a public key revealed by the planned recipient. The recipient is the only one able to decrypt the message, since they are the only ones to know the corresponding private key (decryption key). The method presented allows that the encryption key, which is publicly known, does not reveal the related decryption key, the private one. This system is at the base of the asymmetric cryptography used in the Bitcoin system to send and receive money. There were several attempts to create an accepted cryptocurrency before Bitcoin. The first attempt was eCash, launched and developed by the company DigiCash in 1990 (European Commission). The company and project were created by David Chaum, who was the author of the paper with the title “Blind Signatures for Untraceable Payments” published in 1983. In this paper, the author proposes a new type of cryptography and blind signatures. The purpose is the creation of untraceable payment systems, which offer the same level of control of the current systems and, at the same time, guarantee higher levels of personal privacy. eCash represents the first attempts to create a new payment tool and a new payment system in line with the idea in the paper. The idea was to create a token currency that could be exchanged among individuals privately and safely, which is similar to the modern concept of cryptocurrency. DigiCash went bankrupt in 1998 (European

The Main Cryptocurrencies on the Market 59 Commission). The attempt and the formula presented by this company played a relevant role in the following efforts. The other three are the attempts that influenced the most the creation of Bitcoin, namely B-money, Bit Gold, and Hashcash.13 Bit Gold, a pioneer project presented in 1998, was created with some concepts that led to the creation of Bitcoin. This tool uses some blockchain techniques which are the same of Bitcoin, such as peer-to-peer network, a ledger, mining, and cryptography. The revolutionary aspect is the purpose to be far from a centralized status. Indeed, the aim of Bit Gold was to avoid the presence of centralized currency distributors and authorities, giving to users the possibility to eliminate the intermediary. This attempt, like others, was unsuccessful. In the same year, Wei Dai proposed B-money, which would be an anonymous, distributed electronic cash system.14 He designed two different protocols which assume the presence of an untraceable network, where users are identified by digital pseudonyms, such as public keys, and every message is crypted by its sender and encrypted by the recipient. The first protocol was defined by the author as impractical, but useful in order to understand the second practical protocol. In this system, digital pseudonyms could be used in order to exchange currency through a decentralized network. Even if Wei Dai published a B-money’s white paper, this tool was not able to obtain sufficient attention from the public in order to have a successful launch. The last relevant and most successful pre-bitcoin cryptocurrency is Hashcash (Back 2002). Hashcash was first presented in 1997 as a mechanism to minimize email spam and prevent DDoS.15 Hashcash uses proof-of-work algorithms to generate new coins, such as the majority of modern cryptocurrencies. As contemporary cryptocurrencies, it faced the problem of the increasing need for power, becoming less and less effective. The interest in this tool decreased, but many of the elements of this system were implemented in the development of Bitcoin. Bitcoin is the first cryptocurrency implemented and used by the public, developing a new market and starting the circulation of this new instrument. Gradually, many other cryptocurrencies were developed with different characteristics and purposes. Bitcoin is also the first cryptocurrency used as an official currency in a country. In September 2021 Bitcoin was declared a legal tender in El Salvador, which means that all economic agents were obligated to accept Bitcoin for all payments (Alvarez et al. 2022). Bitcoin has its own unit of account that is Bitcoin, and one Bitcoin is divisible in small units, which are called satoshi, and each satoshi is worth 0.00000001. The price of Bitcoin is determined by demand and supply, resulting in high price volatility as Figure 5.1 shows. The price of Bitcoin is around $16,000 and the market capitalization16 is more than $300 billion.17 Figure 5.1 shows the evolution of the Bitcoin price over the years, from 2014 to January 2023. The high volatility of this cryptocurrency is clear, as even the peak of more than $60,000 was reached in November 2021, followed by values below $20,000 in November 2022. Many things can affect the price of a cryptocurrency, Bitcoin included. Sometimes there are market events that trigger a big change in the Bitcoin price. For instance, in June 2022 the Bitcoin price plumbed due to the decisions of two trading platforms – Binance and Celsius – to stop Bitcoin withdrawals.18 On the other hand, Bitcoin reacts also to economic, political, and global conditions (Intini et al. 2022).

60  The Main Cryptocurrencies on the Market

Figure 5.1  Bitcoin Price Source: coinmarketcap.com

The word Bitcoin is frequently associated with the term “bubble “or “speculative bubbles”. The speculation on Bitcoin is clear by looking at the evolution of the price shown in Figure 5.1. Several studies in the literature analyzed the presence of bubble in the Bitcoin price time series. The crash of December 2013 was preceded by a bubble (Cheah and Fry 2015; Geuder et  al. 2019), identifying six separate ­periods containing bubble behavior. The results of the study by Chaim and Laurini (2019) show the existence of a bubble from early 2013 to mid-2014, but not in 2017. Finally, Li et al. (2021) analyzed the Bitcoin price trend from September 2011 to October 2020 and have found several speculative bubbles in this time frame, with the last in June 2019. Bitcoin was presented by its creator as a new payment system, so a system that allows to exchange money peer to peer without the presence of a third party. The parties involved in the trade trust the system and the technology. This makes it possible to exchange value in a way far from the traditional financial system without limits. The idea is to have a tool that makes it possible to exchange value independently from the geographic position of the parties, the regulation of the systems, and the legal tenders. Moreover, it is a tool usable without the need to have a bank account or any relation with the traditional financial system. In this scenario, Bitcoin could be seen as a potential competitor of the official legal tender and a possible currency usable without boundaries all around the world. However, the potentialities of this cryptocurrency are limited by some of its own characteristics. The time required for a transaction to be approved makes it impossible for real-time payments. The high volatility and instability of its price makes it difficult to use Bitcoin as a potential currency. Looking at the three functions of money from the monetary theory, Bitcoin does not fit with at least two of the three. A currency should be a medium of exchange, a store of value, and a unit of account. The only function that Bitcoin barely shows is to be a medium of exchange. In 2014 the European Banking Authority (EBA), looking at the impact of digital innovation on the processing of electronic payments, states that virtual currencies are digital representations of value

The Main Cryptocurrencies on the Market 61 which . . . are voluntarily accepted, by natural or legal persons, as a means of exchange19. Moreover, many market players of the payment industry are developing projects to allow everyday payments using cryptocurrencies. Two of the major players in the traditional payment card circuits, MasterCard and Visa, have active roles and are sponsoring the process. The purpose is to integrate cryptocurrencies’ world with the everyday economy. An example is the new Nexo Card developed by Mastercard.20 Nexo Card will offer liquidity to Bitcoin and other cryptocurrencies’ owner, allowing them to make purchases without selling their digital asset. It is a credit card that guarantees liquidity to their clients based on their cryptocurrencies. This product was created in partnership with Mastercard and DiPocket, a fintech company, and it will be available in some European markets.21 The credit line of this card is supported by cryptocurrencies and allows their owner to use their digital resources as collateral instead to sell them. The card will be available physically and virtually, thanks to the collaboration with Apple Pay and Google Pay. This card does not require transaction fees; instead, it remunerates each transaction with a cashback of 2%, paid in Bitcoin or using the Nexo token. The idea behind this card is to simplify everyday payment in cryptocurrency, transforming Bitcoin and other cryptocurrencies from financial instruments into a spendable currency. Visa has already launched a credit prepaid card linked to Crypto.com.22 Using this card it is possible to exchange cryptocurrencies into fiat currencies and make payments, receiving cashback in digital tokens. Crypto.com is the bigger supplier of payment services in cryptocurrencies; its purpose is to allow millions of customers around the world to use digital currency. These are examples that make evident how cryptocurrencies are becoming new payment tools accepted widely. The other two properties of money are more difficult to be satisfied by Bitcoin. The high volatility of the price makes Bitcoin an awful store of value. In fact, to be a store of value, a currency should maintain its value over a long period of time. The Bitcoin price trend shows, for instance, that in less than one year Bitcoin has lost more than 60% of its value, from around $60,000 to $20,000. For the same reason, it is hard to use Bitcoin as a unit of account. 5.3 The Ethereum The white paper on Ethereum was published in 2014 by Vitalik Buterin.23 The launch of Ethereum platform was in 2015. Ethereum platform was launched with the idea to provide something more innovative than Bitcoin. Ethereum is not only a new way to provide a payment network without banks and traditional financial services but is something programmable. This means that it is possible to build and use decentralized applications on its network. This makes Ethereum a more complex blockchain than Bitcoin. Indeed Bitcoin is only a payment network; instead, Ethereum is a marketplace of games, financial services, and other apps. Ethereum is based on an opensource, decentralized blockchain technology to store data. This platform allows to run decentralized applications with integrated economic functions. The technology guarantees the usability, transparency, and neutrality of information. This platform was designed to support the so-called

62  The Main Cryptocurrencies on the Market smart contracts, which are the essential elements behind decentralized applications. ­Indeed, many decentralized applications and solutions are based on smart contracts and blockchain technology. Ethereum is the dominant blockchain used to run smart contracts24, to create NFT25, and to develop DApps.26 The consensus mechanism used was the PoW until the so-called “merge” happened in September 2022, which sign the transition to the PoS mechanism. The purpose of the merge is to accelerate the transaction and to reach higher levels of safety and sustainability. The reward for the mining activity is in ethers, which is the cryptocurrency related to the Ethereum platform. Ether is the second dominant cryptocurrency on the market with a market capitalization of more than $153 billion.27 Ether differently from Bitcoin does not have a limit in the supply, it can be created unlimitedly. At the moment, more than 120 million of ethers are in circulation. Ether was not designed, as Bitcoin, in order to be a new payment system and a new currency but is a transaction token that makes easy operations on the Ethereum platform. Ether is a token with the function to facilitate all the operations on the Ethereum blockchain. The users of the network must pay for the use of applications and ether token acts as a medium to make possible these payments. The amount paid by the users depends on the quantity of resources that the creator needs for their application. It is important to underline that, even if there are some similarities among Bitcoin and Ethereum systems, there are also important differences that made the two systems completely different. First, ether does not have a limitation in the number of tokens that can be created. So, the number of tokens can grow according to the demand. The consequence of this characteristic is that the dimension of the Ethereum blockchain is larger than the Bitcoin one. Second, using the Ethereum platform is possible to create smart contracts which are at the bases of many ­decentralized applications. Moreover, the time required to build a new block in the Ethereum blockchain takes a few seconds; instead, a new block in Bitcoin requires about 10 minutes. More important, it is the general purposes of the two networks. Bitcoin was designed to be a secure peer-to-peer decentralized payment system; in other words, it was created to be an alternative to traditional currencies and to be a new payment system far from the traditional one. Instead, the Ethereum platform was designed to support the creation of contracts and applications, and ether is the token used to facilitate the operations on the platform. Ether was not created with the intention to create a new currency or to substitute other mediums of exchange. Frequently the term Ethereum is used to identify the cryptocurrency even if the right term is ether. The price of ether results from demand and supply. Figure 5.2 shows the movement of the ether price through the years, starting from its launch in 2015 until August 2022. The actual price of an ether is around $1,200.00 and the market capitalization is around $153 billion.28 It is the second cryptocurrency on the market with a dominance of around 20%. The higher price reached was about $4,937 on September 2021. The behavior of the price shows a speculative use of Ethereum even if the real nature of ether is to be a token designed to facilitate transaction on the platform to develop applications in the network.

The Main Cryptocurrencies on the Market 63

Figure 5.2  Ethereum Price Source: coinmarketcap.com

5.4 Altcoins The term altcoin identifies all the cryptocurrencies on the market that are different from Bitcoin, and for some people, Ethereum. The number of altcoins on the market is more than 22,000, and they come in various types.29 It depends on the purpose for which they were created. Altcoins try to improve the limitation of existing cryptocurrencies and blockchains or to compete with them. Some of the altcoins are forked30 from Bitcoin or Ethereum. Among the variety and the numerousness of altcoins, it is possible to identify some typologies such as payment token, stablecoins, security tokens, and utility tokens. Altcoins improve other cryptocurrency’s weaknesses and there is the possibility to choose among them, giving hundred options to users. At the same time, altcoins are less liquid than Bitcoin or Ethereum and have lower popularity and smaller market capitalization. Finally, not all have become known and used. In this paragraph will be analyzed the most important altcoins and their characteristics. Tether is the third cryptocurrency on the market based on market capitalization, which is around $67.57 billion. Tether is a particular type of cryptocurrency which is called stablecoin. They are a segment of the cryptocurrency’s ecosystem. Stablecoins were developed with the purpose to solve the problem of the high price fluctuations that in general characterized cryptocurrencies such as bitcoin and ether. Stablecoins are digital unit of value which maintains a stable value relative to one or more official currencies or other assets. These tools, which are referred to as currency or assets, hold reserves of the currency or asset that the stablecoins holders can be redeemed. They use blockchain technology like any other cryptocurrency. Tether is the most adopted stablecoin on the market.31 It was launched in 2014 by Tether Limited. The aim of this project is to offer the stability and simplicity of a fiat currencies coupled the innovative nature of blockchain technology.32 All tokens are stabilized being a relation of 1-to-1 with a fiat currency and are guaranteed by Tether’s reserves. Tether

64  The Main Cryptocurrencies on the Market supports various fiat currency, in particular, US dollar, Euro, Mexican Peso, British Pound Sterling, and Chinese yuan. Tether has a fixed exchange rate with the US dollar, 1 Tether token for 1 US dollar. Each time a new unit of token is created an equal amount of dollar, or the corresponding amount of other fiat currencies, is deposited in the reserves. Anytime users give back Tether tokens, that are destroyed, they receive back the correspondent amount of fiat currency from the reserves. Tether is the stablecoin with the highest market capitalization, but more than 100 stablecoins are on the market. USD Coin and Binance USD are the other two relevant stablecoins with a market capitalization, respectively, of around $5 billion and $4 billion.33 Both are issued in collaboration with two important exchanges.34 Both tokens are 1-to-1 USD-backed stable coins. USD Coin was issued by The Centre Consortium, which have two members Circle, which is a peer-to-peer payment services company, and Coinbase, a cryptocurrency exchange. The purpose of the last enhancement in 2020 is to make easier the use of this token for everyday payments, commerce, and peer-topeer transactions. Binance USD was launched in September 2019, by Binance with Paxos, a regulated blockchain. This token is regulated and approved by the New York State Department of Financial Services. The aim is to merge blockchain technology with the stability of the dollar. It can be seen as a digital fiat currency. These are examples of stablecoins which can be seen also as payment tokens. The purpose behind the creation of these types of tokens is to propose to users a tool based on blockchain technology and with the stability of fiat currencies. In this way, a new type of payment tool is proposed. In the group of altcoins there are those cryptocurrencies that are born in the years immediately after Bitcoin, such as Litecoin (LTC), Ripple (XRP), and Cardano (ADA). They can be considered the first alternative coins to Bitcoin and Ethereum even for their characteristics. Litecoin was launched in October  2011, and only two years later the first ­Bitcoin’s block was mined. It was created by the computer scientist Charlie Lee, a Google ­employee, who designed Litecoin with the idea to create a “lite ­version of ­Bitcoin”.35 Litecoin is a cryptocurrency created on the Bitcoin protocol, with some differences such as the hashing algorithm used, or block transaction time. The time required for a block is just 2.5 minutes with low transaction fees. These elements make L ­ ­itecoin appropriate for micro-transaction and point-of-sale ­payments. It is the second most popular pure cryptocurrency. The success could be attributed to its simplicity and utility benefits. The main benefits are its speed and ­cost-­effectiveness. The Litecoin transaction is generally confirmed in a few minutes, and the ­transaction fees are ­insignificant. This makes Litecoin an ­attractive ­alternative cryptocurrency to ­Bitcoin, in particular in developing countries in which transaction fees are a relevant factor in the choice of which ­cryptocurrency to use. The price of Litecoin is the result of demand and supply. Currently, it is around $7436 and the market capitalization is $4 billion. Figure 5.3 shows the evolution of Litecoin’s price over the years. Figure 5.3 shows a high volatility and speculative behavior. Looking at the behavior of Litecoin price it is possible to see a path similar to the Bitcoin one. It is evident that the behavior of Litecoin is affected by what happened to Bitcoin.

The Main Cryptocurrencies on the Market 65

Figure 5.3  Litecoin Price Source: coinmarketcap.com

Ripple is a technology that works as cryptocurrency and as a digital payment network. It was launched in 2012 by its founders David Schwartz, Arthur Britto, and Jed McCaleb.37 Ripple is a blockchain system with the purpose to be a payment settlement system for international money transfer. The token used in this system is Ripple with the symbol XRP. So, Ripple is the name of the company and network, and XRP identifies the cryptocurrency token. XRP is used as an intermediate mechanism to exchange two currencies or networks. Ripple works as an open-source and peer-to-peer decentralized platform. It operates without interruptions to transfer any type of money, both fiat currencies and cryptocurrencies. It is a worldwide payments network and among its clients, there are the major banks and financial services. The XRP token is used to make easy and quick conversions among different currencies. It operates as a bridge currency to other currencies, and it does not make difference among fiat and cryptocurrency, making easier any exchange among them. Ripple transactions are characterized by low energy consumption, and few seconds to be confirmed. The XRP price is $0.34 with a market capitalization of $17 billion.38 Cardano was launched in 2017 by Charles Hoskinson, who is the co-founder of Ethereum.39 He started developing Cardano’s platform in 2015. Cardano is a decentralized blockchain running on Proof-of-Stake (PoS) consensus protocol. Cardano, being a decentralized application development platform, is an alternative to Ethereum. Both platforms have the aim of creating a connected and decentralized system and are employed to develop similar applications like smart contracts. Cardano presents itself as an updated version of Ethereum and a “third-generation” platform compared to Ethereum’s. This platform also has an aim to supply banking services to those who are unbanked.40 ADA is the Cardano token. ADA token is created to guarantee that owners can enjoy the operation of the network. The name of the token is taken from ADA Lovelace, a 19th-century mathematician, identified as the first computer programmer.41 Cardano has several differences with Bitcoin.

66  The Main Cryptocurrencies on the Market First Bitcoin was created to be a peer-to-peer payment system, and Cardano to be an ecosystem that permits developers to create decentralized applications and tokens. Second, Cardano employs the proof-of-stake in its consensus mechanism and does not use ADA as a reward to incentivize the competition among miners as Bitcoin does. ADA has a maximum supply of 45 billion ADA; currently, there are about 31 billion in circulation. ADA is sold in round of public sales, until now five rounds happened. The ADA’s price is around $0.27 with a market capitalization of $9 billion.42 Among the altcoins, there are those resulting from the hard fork of Bitcoin. In this group, there are Bitcoin Cash, BitcoinSV. Bitcoin Cash (BCH) is the result of the alteration of the Bitcoin code by Bitcoin Cash developers, who realized their own version of the software. The hard fork, which happened in 2017, splits Bitcoin into two different blockchains: Bitcoin and Bitcoin Cash, and consequently two different assets BTC and BCH. Many are the differences from the original blockchain. Blocks in the Bitcoin Cash blockchain can be bigger, meaning that more transactions can be processed at the same time, and the additional space allows to avoid higher fees. This allows Bitcoin Cash to work faster with lower transaction fees, which makes it a better solution for small everyday payments. Indeed, the settlement is immediate with a fee of around $0.01.43 This makes Bitcoin Cash appropriate for money transfers, everyday transactions, microtransactions, and international trade. Moreover, it supports ecosystem apps and smart contracts. For the technical aspects, it is similar to the Bitcoin algorithm. Both systems have a supply limit of 21 million coins, and use proof-of-work consensus mechanisms and nodes to validate transactions. The exchange rate is the result of demand and supply, currently around $100 with a market capitalization of around $2 billion.44 In 2018, a second hard fork took place which split the Bitcoin Cash blockchain into two parts, creating Bitcoin SV (BSV). The aim of Bitcoin SV is to realize the original version of Bitcoin protocol as illustrated in Bitcoin’s white paper. The purpose is to offer a peer-to-peer cash system and deliver a shared data network, which could support advanced blockchain applications. To reach this purpose, it has eliminated the block size limit and re-activated commands and technical abilities, which have been restricted by the programmer of Bitcoin blockchain. This permits to process thousands of transactions per second maintaining, at the same time, very low transaction fees. The block capacity of Bitcoin SV network is expected to grow more in order to support more data cases and transaction volume. In addition, the new protocol without restrictions allows to offer superior capabilities like smart contracts, tokens, and data cases. Bitcoin SV growth and the adoption of the BSV blockchain and digital currency are supported by Bitcoin Association. Bitcoin Association is a non-profit association based in Switzerland created after the hard fork from Bitcoin Cash. The price is around $43 and a market capitalization of $1 billion.45 Another typology of altcoins are those coins recently developed with the purpose to create alternative platforms to Ethereum one or to deliver services or applications which are far from the traditional and pure concept of cryptocurrency, such as

The Main Cryptocurrencies on the Market 67 Bitcoin or Litecoin. They can be seen more as utility tokens. The higher raked coins are Solana, Avalanche, and TRON. Solana (SOL) was launched in March 2020 by Solana Foundation, which has its headquarters in Switzerland. Solana was created with the idea to facilitate the creation of decentralized apps (DApps). It uses a combination of the proof-of-history (PoH)46 consensus and the proof-of-stake (PoS) consensus of the blockchain. The aim of this blockchain technology is to provide and support the implementation of decentralized finance (DeFi)47 solutions. One of the main characteristics of Solana is the very short times needed to process a block. The use of a combination of consensus mechanism permits a lower time required to validate both transactions and smart contracts. Solana is able to manage thousands of transactions per second with fees of $0.00025. The protocol was developed with the purpose to satisfy both enterprise customers and small users. The attention of Solana Foundation is focused on making decentralized finance accessible on a large scale. The price of Solana is around $13 and the market capitalization is around $4 billion.48 Avalanche (AVAX) is a platform designed for decentralized applications. It is one of the competitors of Ethereum, and it aims to become the most used network for smart contracts. Avalanche’s network consists of three blockchains, and each chain has its own purpose. This system makes it possible to having an output of 6,500 transaction per second, which is the strength of this platform. It was developed by Ava Labs, founded by Cornell University, and it closed its initial coin offering (ICO) in 2020. The price of AVAX is around $11 with a market capitalization of $3 billion.49 TRON was launched by the Tron Foundation in 2017. TRON is a decentralized blockchain developed in a first step on Ethereum but in 2018 they moved to their own network. This software supports smart contracts, different types of blockchain systems, and decentralized applications. The cryptocurrency employs a model similar to Bitcoin, so transactions happen in a public ledger. It is another system that acts as alternative to Ethereum. The advantage of TRON is the possibility for the creators to create and share contents openly without transaction fees. The price of TRON is less than one dollar, about $0.05, and the market capitalization is $5.50 Finally, there are tokens that can be used only on specific platforms to acquire other services or products. In this context an example is MANA. MANA is the token used in Decentraland, which is a platform of virtual reality created on Ethereum blockchain. Decentraland permits users to create, experience, and monetize content and applications. In this virtual world, it is possible to set avatars, names, wearables, and more on the marketplace of Decentraland. This platform uses two different tokens: MANA and LAND. Users can create a wide variety of experiences on their parcels of LAND. LAND is a non-fungible token which represents the property of a part of a territory in this virtual world. MANA is the token that must be burned to buy a parcel of LAND, in other words, MANA is the token needed to become the owner of a peace of NFT. Mana is the token that can be exchanged on cryptocurrency markets with fiat currencies and other cryptocurrencies. It is the only means of payment accepted in Decentraland. MANA tokens can also be used to pay for other services, produces, and experiences available on

68  The Main Cryptocurrencies on the Market the marketplace of Decentraland. Decentraland was created by Ariel Meilich and Esteban Orlano. Nowadays, the development of Decentraland is proceeding by the ­Decentraland Foundation. The two co-founders still work on the project as advisors. The MANA’s price is about $0.33 with a market capitalization of $600 million.51 Notes 1 Coinmarketcap.com, January 2023. 2 In the cryptocurrency industry is a way for a company to raise funds to create new app, coin, or services. Investors interested in the project receive a new cryptocurrency token, issued by the company. The token could have same utility related to the project or represent a stake in the project or company. 3 It is a software running on Ethereum. Its users can sell and buy digital real estate, at the same time they can explore, interact, and play games in the virtual world. 4 tether.to 5 coinmarketcap.com 6 https://coinmarketcap.com/ 7 Sathoshi Nakamoto is pseudonym used by the programmer or group of programmers, who created Bitcoin. The identity of Nakamoto remains a mystery. 8 coindesk.com 9 (International Bank Account Number) IBAN is an alphanumeric code which uniquely identifies a specific bank account held at a bank anywhere in the world. The length of the IBAN is different from one county to another. It facilitates payments. (ECB) 10 See Chapter 4. 11 Coinmarketcap.com, January 2023. 12 The first attempt to create a digital money based on a decentralized system was developed by David Schaum, (European commission). 13 Investopedia.com 14 weidai.com 15 DDoS (Distributed Denial-of-Service) attack is a cyberattack on information systems, devices, or other online resources that makes for users impossible to access to services and resources. DDoS attacks can slow down or completely interrupt online services, such as email, websites, and other online resources. 16 Market capitalization is the total market value of a cryptocurrency’s circulating supply. 17 Data from coinmarketcap.com, January 2023. 18 cnbc.com – Binance paused bitcoin withdrawals from several hours on Monday due to a “stuck transaction”, June 2022. 19 EBA Opinion on “virtual currencies”, 2014. 20 https://nexo.io/ 21 https://nexo.io/ 22 https://crypto.com/ 23 Ethereum.org 24 A smart contract is a contract based on terms agreed by the parties written into lines of codes. It is a self-executing contract, which works automatically based on a previous agreement. The code of the agreement is written on a decentralized blockchain. The code manages the execution and the related transactions. All the information related to a smart contract, such as the code, the transactions are traceable and irreversible. Smart contracts make possible transactions and agreements among various, anonymous parties without the presence of a central authority, or legal systems. They work on the formula “if/then”, so if a condition is verified then something will happen. 25 NFT (Non-Fungible-Token) are cryptographic assets on a blockchain. They have a unique identification code; in this way each NFT is unique and different from each other.

The Main Cryptocurrencies on the Market 69 They cannot be exchanged or traded at equivalence, differently from a cryptocurrency, which all unit are equal to each other. 26 DApps are digital applications and programs that run on a peer-to-peer and blockchain network of computers. They are not regulated or controlled by a single authority. They are developed for many purposes, such as finance, social media, and gaming. 27 Coinmarketcap.com, January 2023. 28 Data from coinmarketcap.com, January 2023. 29 Investopedia.com 30 When the existing code of a cryptocurrency platform is changed, there is a radical change to the protocol of a blockchain network, which results in two branches. The first branch proceeds with the previous protocol and the second branch works based on the new version. This is the case of hard fork, in which both branches remain valid. In the soft forks only one branch of the blockchain remains valid and users adopt the most updated one. 31 Data from coinmarketcap.com, January 2023. 32 Tether.to 33 Data from coinmarketcap.com, January 2023 34 Cryptocurrency exchange is an online trading platform that is used to buy, sell, and exchange cryptocurrencies. In these platforms it is also possible to exchange cryptocurrencies and fiat currencies. 35 gemini.com 36 January 2023. 37 ripple.com 38 Data from coinmarketcap.com, January 2023. 39 iohk.io 40 It is a term used to identify adults who do not use banks or banking services. They do not use or do not have access to any traditional financial services, such as saving account, payment cards. 41 cardano.org 42 Data from coinmarketcap.com, January 2023. 43 bitcoincash.org 44 Data from coinmarketcap.com, January 2023. 45 Data from coinmarketcap.com, January 2023. 46 It is a consensus mechanism based on proof of stakes, but the way in which time is calculated is different. In this case historical events are used to monitor the passage of time. The events are changed in hash, which can only be created by the previous events. 47 It uses new technology, based on distributed ledgers and blockchains like those used by cryptocurrencies, to remove the presence of third parties in financial transactions. The system eliminates the control on money, financial products, and financial services, that banks and institutions have. 48 Data from coinmarketcap.com, January 2023. 49 Data from coinmarketcap.com, January 2023. 50 Data from coinmarketcap.com, January 2023. 51 Data from coinmarketcap.com, January 2023.

References Alvarez, F. E., Argente, D., Van Patten, D. (2022). Are Cryptocurrencies Currencies? Bitcoin as Legal Tender in El Salvador. No. w29968. Cambridge, MA: National Bureau of Economic Research. Back, A. (2002). Hashcash  – A  Denial of Service Counter-Measure. www.hashcash.org/ (Last access October 2022) Chaim, P., Laurini, M. P. (2019). Is bitcoin a bubble? Physica A: Statistical Mechanics and Its Applications, 517, 222–232.

70  The Main Cryptocurrencies on the Market Cheah, E. T., Fry, J. (2015). Speculative bubbles in bitcoin markets? An empirical investigation into the fundamental value of bitcoin. Economics Letters, 130, 32–36. EBA (2014) EBA Opinion on “Virtual Currencies”. www.eba.europa.eu/ (Last access October 2022) ECB (2019) Crypto-Assets-Trends and Implications. www.ecb.europa.eu/ (Last access October 2022) Geuder, J., Kinateder, H., Wagner, N. F. (2019). Cryptocurrencies as financial bubbles: The case of bitcoin. Finance Research Letters, 31, 179–184. Intini, S., Nicolini, G. (2022). Un’analisi della natura prevalente del Bitcoin tra strumento monetario e asset speculativo. Minerva Bancaria Editrice, 5–6. Li, Y., Wang, Z., Wang, H., Wu, M., Xie, L. (2021). Identifying price bubble periods in the bitcoin market-based on GSADF model. Quality & Quantity, 55, 1829–1844. Haber, S., Stornetta, W. S. (1991). How to time-stamp a digital document. Journal of Cryptology, 3, 99–111. Rivest, R. L., Shamir, A., Adleman, L. (1978). A method for obtaining digital signatures and public-key cryptosystems. Communications of the ACM, 21(2), 120–126. Website BitcoinCash. https://bitcoincash.org/ (Last access October 2022) Website Cardano. https://cardano.org/ (Last access October 2022) Website CNBC. www.cnbc.com/ (Last access October 2022) Website Coinmarketcap. https://coinmarketcap.com/ (Last access January 2023) Website Crypto.com. https://crypto.com/ (Last access October 2022) Website Ecash. https://chaum.com/ecash/ (Last access September 2022) Website Ethereum. https://ethereum.org/(Last access January 2023) Website European Central Bank. www.ecb.europa.eu/ (Last access October 2022) Website European Commission. https://ec.europa.eu/ (Last access October 2022) Website Gemini. www.gemini.com/ (Last access October 2022) Website Investopedia. www.investopedia.com/ (Last access September 2022) Website IOHK. https://iohk.io/en/ (Last access October 2022) Website Kraken. www.kraken.com/ (Last access September 2022) Website Mastercard. www.mastercard.it/ (Last access September 2022) Website NBER. www.nber.org/ (Last access September 2022) Website Nexo. https://nexo.io/nexo-card/ (Last access September 2022) Website Paxos. https://paxos.com/ (Last access September 2022) Website Ripple. https://ripple.com/ (Last access October 2022) Website Riskbank. http://archive.riksbank.se/ (Last access September 2022) Website Satoshi Nakamoto Institute. https://nakamotoinstitute.org/ (Last access September 2022) Website Tether. https://tether.to/ (Last access January 2023) Website Visa Italia. www.visaitalia.com/ (Last access September 2022) Website Weidai. www.weidai.com/bmoney.txt (Last access October 2022)

6 The Handling of Cryptocurrencies

6.1 Introduction The previous chapter has analyzed the various characteristics and functionality of the cryptocurrencies existing on the market. Different typologies were identified and their prevalent use on the market was described. This chapter discusses how to deal with cryptocurrencies. The focus is on the different elements that need to account in order to buy, own, and sell digital assets. In addition, the different uses of cryptocurrencies are discussed. The first paragraph refers to the so-called e-wallets, which are essential in order to own cryptocurrencies. The possession of an e-wallet is the only possible way to store and use cryptocurrencies. In a cryptocurrency wallet the two keys, the private and public keys, are stored. The two keys are the only elements needed in order to send and receive cryptocurrencies. Moreover, they are the only elements to manage and to store. The functioning and the role of each key is described in order to give a clear view of the relevance of these elements in a cryptocurrency’s transaction. Then the various types of e-wallets are described. The idea is to specify the differences and the characteristics of each type. The second part analyzes how and where cryptocurrencies can be bought, sold, and exchanged. The platforms in which it is possible to trade cryptocurrencies are called exchanges. Different types of exchanges exist. They can be decentralized and centralized. Moreover, the main elements that a user must take into consideration to select the exchange correctly are reported. The opening of an account on the selected exchange is the other element in order to be able to trade digital assets. Most of the exchanges require users to complete an identification process. Finally, a review of the dominant exchanges is reported in order to underline the main differences, strengths, and weaknesses. The various types of fees are described and also the policies of each exchange. The last paragraph of the chapter aims to give an overview of the applications and uses of cryptocurrencies. Cryptocurrencies can be used in different ways. They can be a speculative asset, just used as trading tools. The gain in this case is the difference between the selling and buying price. They can be bought and stored in an e-wallet waiting for an appreciation of its value. Some cryptocurrencies are tools developed DOI: 10.4324/9781003353102-7

72  The Handling of Cryptocurrencies to be used in specific contexts as a payment method. Some cryptocurrencies can be used as payment methods linked to credit and debit cards or to virtual wallets, such as PayPal. The chapter as a whole aims to provide all the useful information related to the management and use of cryptocurrency, looking at their storage systems, their markets, and their usability. 6.2 Holding Cryptocurrencies: The e-Wallets Cryptocurrencies, such as Bitcoin and other altcoins, are decentralized and there does not exist any intermediary and central authority. This means that there does not exist an intermediary which can open an account to store the cryptocurrencies owned by someone. In addition, they do not exist in any other form than the digital one. The only possible way to store and use cryptocurrencies is to have a cryptocurrency wallet. These wallets are known as e-wallets, “electronic wallet”, or “digital wallet”. This is an instrument or an online service, which works as a wallet for cryptocurrencies. Differently from a traditional wallet, which stores cards and cash, a cryptocurrency wallet contains passkeys used to sign for cryptocurrency transactions. So, a cryptocurrency wallet is a program or device which keeps cryptocurrency keys and permits users to access their coins.1 The keys stored in the wallet are two: private and public. They are tools needed to guarantee the security of the cryptocurrency transaction and economy. A unique pair of public key and private key is generated when a user starts the first transaction using cryptocurrencies. Each key is made of a long string of alphanumeric characters. Private key is used to sign transactions and prove the ownership of an address and, consequently, the possession of the funds. It is a tool used to increase the security and help to protect users from unauthorized access to their funds. In other words, private keys represent the ultimate control and ownership of cryptocurrency funds. It is crucial to maintain secret the private key and prevent its loss or alteration. The control and use of cryptocurrency is managed through digital keys and addresses, which represent the control and property of digital tokens. It is possible to deposit cryptocurrencies in any public address by anyone. Although a user has some tokens deposited in their address, they cannot use that fund if they do not have the unique private key. Private keys are used not only to have access to funds but also to sign transactions and show the ownership of a blockchain address. It is used to create a digital signature that can be verified, without showing the private key. So, only the user should know the private key, which works as a user’s digital ID. Moreover, the private key is needed by the user to withdraw, spend, transfer, and manage transactions relating to their account. The public key originated from the private key using a complex mathematical algorithm, and both keys are contained in a digital wallet. It is impossible for the reverse case, from the public key and address to generate the private key. This means that if the user loses its public key, it is possible to recreate it with the private key. Instead, if the private key is lost, it is impossible to recover or recreate it. If a user loses its private key the corresponding address becomes inaccessible, and any cryptocurrencies located in the address are lost forever.

The Handling of Cryptocurrencies 73 The public key is the wallet address, which permits users to receive cryptocurrencies. It is the key needed to verify the digital signature, which proves the property of the private key. The public address is the shortened and compressed version of the public key, which is an extremely long series of numbers. In other words, it is the hashed version of the public key. The public address, which is revealed to the counterpart in order to finalize the transaction, can be seen as a bank account number. Indeed, the sender needs the public address to send funds. A cryptocurrency’s transaction is composed of different elements. User A wants to send coins – such as Bitcoin – to user B. The message is encrypted using the public key of B, but the transaction is digitally signed using the private key of A. The digital signature proves the property of the private key and, consequently, the ownership of the coins sent to the counterpart. At this point, the transaction must be transmitted to the network. Here the distributed nodes verify and confirm the validity of the transaction before finalizing it and adding it on the blockchain. Only once the transaction has been validated, the funds are delivered to the public address of user B. Receiver B receives the funds, so the encrypted message. In order to have access to the funds the recipient must decrypt the message using their own secret private key. So, in this case the message can be decrypted only by the private key of user B. If B has lost its private key, the amount of bitcoin sent by user A arrives at the address of B, but they cannot be used and are not accessible anymore. Private key and public key are stored in a cryptocurrency wallet, which ­allows ­users to access their coins. The public key, the wallet address, is needed to ­receive coins and the private key controls the coins associated with the corresponding ­address. Several different types of wallets exist, with its own characteristics and level of security. Cryptocurrencies are not materially stored; they are bits of data ­associated with the public address of the wallet. A cryptocurrency wallet is used not only for storing virtual coins but also it is needed and allows to transfer money from an account to another one, in any part of the world. These wallets maintain the anonymity of users and guarantee the possibility to make transactions without the identification of users’ names. Each cryptocurrency wallet allows to send and receive money using the cryptocurrency system, which guarantees the anonymity of users. This means that it is not needed to provide all personal data. There are two main types of wallets: noncustodial and custodial. The first type is wallets in which the user is responsible for the security of their keys. This is the type most used by cryptocurrency wallets on devices. In the second type the wallet is hosted by a third party that conserves the keys of the user and it is responsible for them. The third party could be a company that provides security systems used to secure and preserve data. Also, some cryptocurrency exchanges provide custodian wallets to their customers. Moreover, two subcategories exist, hot wallets and cold wallets. Hot wallets are those wallets that can work only with a connection of the Internet to a device that has a connection. This type of wallet, always connected to the Internet, allows to send, receive, and store tokens. Hot wallets are related to private and public keys that simplify transactions and behave as security tools. They are considered more vulnerable to theft and hacks than cold storage solutions, given their connection to the Internet. The hot wallet is the interface for storing and

74  The Handling of Cryptocurrencies accessing cryptocurrency. Many are hot wallets available and some of them have a free download. There are some wallets particularly designed to be used in collaboration with specific mobile web applications; others only work with a specific ecosystem or cryptocurrency. Moreover, some exchanges only accept transfers from and to specific wallets. Finally, some hot wallets require fees while others do not. For example, Coinbase Wallet is the wallet provided by the exchange Coinbase. In this case, it is a separate app that allows to store the keys, send, receive, and spend digital money. An account on the exchange is not required in order to use the wallet. Cold wallets, also known as cold storages, are wallets that work without any connection. In other words, a cold storage is a wallet, which works offline, for managing and storing other cryptocurrencies. This type of wallet is protected from unauthorized access, cyber hacks, and other weaknesses that can interest the hot wallets, which work online. This is the first reason behind the use of cold storage, to prevent hackers and storing tokens in a safer way. Indeed, if a cryptocurrency account or wallet is compromised or hacked and the tokens are stolen, the owner has no possibility to recover their coins. This is because digital currencies are decentralized and do not exist a third party or a central authority as happens in a traditional financial system. In a traditional financial system, if a checking account or a credit card is compromised, the bank has the possibility to refund the loss. Cryptocurrency’s investors must be aware of the safety measures needed to protect their token, in particular the method used to store and protect the private key of the account. Cold storage solves this problem by signing a transaction using the private key in an offline context. This means that this method should not have the possibility to communicate with another device except that it is physically connected to that device when the key is accessed. An online transaction is temporally moved to an offline wallet where it is digitally signed before it is transmitted to the online network. Even if a hacker comes across the transaction, it is possible that they can have access to the private key used for signing the transaction. Transferring from an online to a cold storage device is something that makes the transaction heavier and more complex than a transaction made using a hot wallet. Finally, it is possible to identify three subcategories of wallets: software, hardware, and paper. Each of them can be either a hot or cold wallet. A software wallet is a program installed on pc or smartphone, it permits to store and record the private key and allows to always control the amount of cryptocurrency. Hardware wallet is a cryptocurrency wallet, which stores the private keys on physical device, like a USB device. Finally, a paper wallet is a piece of paper with private and public keys printed. Sometimes, a barcode or QR code is also printed on the paper. The paper wallet is the most basic form of cold wallet. It is a document with the keys written on it. On the document there is also a QR (quick response) code, which can be easily scanned and used to sign the transaction. The risk related to this type of wallet is that the paper can be lost, damaged, or destroyed, and the user is not able to access the address. The hardware wallet, which uses an offline device or smartcard to create private keys offline, is another type of cold storage. Similar to paper wallets, it is important to store the USB device or smartcard in a safe way in order to avoid it being

The Handling of Cryptocurrencies 75

Figure 6.1  Type of Wallets

damaged or lost; that event could cause the loss of the possibility to access the ­account. Some offline software wallets exist, which are similar to hardware wallets but the process to use them is easier. This type of wallet divides the wallet into two platforms. The first is an offline wallet that contains the private key and the second is an online wallet that stores the public key. In this way, the online wallet created the unsigned transaction and sends the address to the counterpart of the transaction. Then the unsigned transaction is transferred to the offline wallet and signed using the private key. The selection of the e-wallet is fundamental in order to manage cryptocurrency funds correctly (Figure 6.1). Independently from the preferences of the users about cold or hot storage, or among the variety of wallets available, the main characteristics of a good wallet should be: • Direct control on money: the best wallets do not allow anyone to see or manage the wallet, and only the user has full control through a password. • Absence of intermediary: possibility to send directly the transaction inside the cryptocurrency’s network, without any intermediary. • Privacy: any transaction must be completely anonymous and not traceable. • Authentication: in order to have access to the wallet more than one password should be required. 6.3 Exchanging Cryptocurrencies: The Trading Platforms The market of cryptocurrencies is a “24/7” market2, so there is not an opening or closing time. With respect to other traditional financial markets, it is possible to exchange, sell, and buy cryptocurrency continuously. The platforms used to trade cryptocurrency are called exchanges. A  cryptocurrency exchange is a platform where it is possible to buy and sell cryptocurrencies. As well as trading services, these platforms offer price discovery through trading activity and storage for cryptocurrencies. In the beginning, before cryptocurrency exchanges appear, users

76  The Handling of Cryptocurrencies could acquire cryptocurrency only through mining activity or organizing transactions in online or offline forums. Nowadays, the most common way to buy and sell cryptocurrencies and other digital assets is using a cryptocurrency exchange. These platforms simplify the exchange of cryptocurrencies for other assets, including other cryptocurrencies, fiat currencies, and NFTs. So, a cryptocurrency exchange is a web service which helps users to exchange money into cryptocurrencies and other digital assets, and vice versa. They are the secure and legal way to acquire cryptocurrencies. Moreover, cryptocurrency exchanges make it easier for a user to buy and sell cryptocurrencies online or using a mobile app, simplifying the access to the cryptocurrencies market. Some platforms offer a variety of products and services, and others just help users to buy and sell digital asset. This makes available for investors many options to build a diversified portfolio of digital assets. There are various types of exchanges. Different from the cryptocurrencies exchange, as a platform, there is the role of ­brokers, who are traditional securities brokers, using no pure cryptocurrency exchanges, acts as intermediaries between the cryptocurrency market and the ­ ­investors, who are interested in investing in digital assets. An online broker can be visited by anyone, that can buy or sell cryptocurrencies at the prices set by the ­broker. This type of solution, so an over-the-counter broker, is generally used when a large order is executed. Traditional cryptocurrency exchanges are platforms that make it easy to buy and sell digital assets based on the market prices of the day. Users can trade and exchange digital assets in a completely autonomous way, without any intermediaries. Users need a connection and to download the app of the exchange or to access the website. Frequently, these platforms charge fees for transactions. Not all platforms allow the same types of transaction. For example, on some exchanges it is possible to trade different types of cryptocurrency and fiat currencies, while on others it is possible to exchange just a few cryptocurrencies or a restricted group of digital assets. Among the cryptocurrency exchanges, there are two typologies of exchanges: centralized and decentralized. Centralized cryptocurrency exchange is characterized by the presence of a third party, similar to the traditional stock exchange. The third party is called exchange operator, which has the role to ensure that users sign up and the trading runs without problems. In this case the word centralized stands for the presence of a third party, which is trusted by the operators and manages their money. These exchanges make easy the use of a bank account or debit card, connecting them to the exchange ­account, to buy cryptocurrencies. Usually, the exchange operators receive fee on the transaction. Moreover, investors can sell and buy digital assets using both cryptocurrencies and fiat currencies on many centralized exchanges. These types of platforms are vulnerable to hacks. Decentralized cryptocurrency exchanges are those exchanges that try to stay true to the philosophy at the basis of the cryptocurrency industry. Cryptocurrency and blockchain were created and developed with the conviction that currency should not have a central authority to govern and manage its movement and usage. In line with this idea, decentralized exchanges lack the presence of a third party. These

The Handling of Cryptocurrencies

77

systems are open source and based on peer-to-peer trading. Often, the use of these types of exchanges requires more technological ability and personal knowledge of cryptocurrency. They are less vulnerable to hacks, but on the other hand, they are characterized by low volumes and low liquidity caused by their low popularity. The cryptocurrency market is a relatively young market, which is evident from the volatility of the cryptocurrencies and the fact that some exchanges were subject to hacking. There is a variety of factors to be considered in the selection of an exchange, including: • Fees: High fee can reduce the return of the investment; it is important to understand the fees applied by the exchange before opening an account. In general, the fees applied are trading fees and withdrawal fees, but there is the risk that some extra fees come up. Trading fees can be a flat percentage of the amount of cryptocurrencies exchanged or they can be charged as a different percentage if the orders are makers or takers. Makers are those orders that increase the liquidity of the exchange; in this case, the fees are lower than the taker fees. There are some apps that declare zero fees, but the charge is in the spread, which is the difference between the rate at which they sell or buy cryptocurrencies. This spread is frequently more expensive than a percentage trading fee. Withdrawal fees are applied every time coins are transferred from the platform to an external wallet or into another exchange. Other fees could be related to the tool used to buy cryptocurrency, generally is more convenient to use cash or wire transfers than credit or debit card, which can be charged by the issuer and by the platform. • Payment methods: Many are the methods accepted by the exchange to purchase cryptocurrency directly. Most of the platforms support wire transfers, but some exchange permit digital asset using debit cards, credit cards, and other digital payment methods. • Reputation: Before opening an account on a crypto exchange it is important to verify the reputation of the exchange, looking at the exchange’s history, customer review, and recent news. • Security: Cyber thefts are common in cryptocurrency exchanges, and for this reason, it is crucial to select an exchange with strong security measures. • Supported assets: Before selecting the exchange, it is important to verify which assets are supported by the exchange. Indeed, some platforms support few cryptocurrencies, while others permit to exchange a huge variety of digital assets. • Trading volume: The user must verify also the trading volume of the cryptocurrency in which he/she is interested in, ensuring the liquidity level guarantees an easy exchange. Finally, it is relevant to verify the characteristics of the platform; some are only mobile platforms, and others require a specialized computer. Opening an account on a cryptocurrency exchange is the first step in order to buy and sell cryptocurrency. In order to start, generally, it is needed to supply an email address and create a password to start the creation of the account. Then, an email is received, which asks to confirm the property of the email address provided.

78  The Handling of Cryptocurrencies Once this phase is completed, it is required to fill in an identification process. This process asks for personal information and uploading a copy of the document. Most of the platforms require also full name, home address, mobile number, and a copy of driver’s license or passport. Some exchanges also ask to verify the identity of the owner of the document uploaded requiring a photo of the user with the document. Once the procedure is finished it is possible to transfer funds in the account u ­ sing the methods supported by the platform. From this point, it is possible to start t­ rading cryptocurrencies. The available number of exchanges, at the current time, is more than 500.3 The following analysis of the main exchanges on the market is based on the data available on Coinmarketcap.com. Coinmarketcap.com scores and ranks exchanges based on liquidity, traffic, trading volumes, and confidence in the legitimacy of the trading volumes declared. Moreover, the trading volume reported is on daily basis. The exchange will be described by looking at their major characteristics, in order to give an overview of the dominant exchanges. All the platforms presented are centralized exchanges except for the last one, which is an example of decentralized exchange. Binance is the first cryptocurrency exchange with $15 billion of trading volume. It is possible to exchange around 387 coins. It is a blockchain ecosystem leader at the global level being the bigger exchange of digital assets. Binance’s mission is to be the supplier of infrastructure services for cryptocurrencies. In 2017, the platform and the related cryptocurrency was launched. Binance Coin (BNB) is the fifth cryptocurrency on the market, and it is used to pay commissions on the exchange. The official wallet of Binance is Trust Wallet, which is a secure and decentralized wallet, with which users can send, receive, and store their digital assets. Moreover, there is also Binance Academy, which wants to offer free education on blockchain and cryptocurrencies. Binance does not charge deposit fees. Customers pay a flat fee to cover the transaction costs of moving cryptocurrency from Binance account. The rates are determined by the network, such as network congestion. Coinbase was started in 2012 with the idea that anywhere, anyone, should have the possibility to easily and safely receive and send Bitcoin. Today, the platform supports more than 200 coins. Their mission is to create a cryptoeconomy, namely a financial system more accessible and fairer, more efficient and transparent, which is made possible by cryptocurrency. The exchange has taker fee and maker fee, which does not require fee to signing up or having an account. However, it requires deposit fee and withdrawal fee, which depends on the currency or system used. It is one of the most trusted cryptocurrency platforms. Coinbase has a crime insurance, which protects a part of the digital assets stored in their systems against losses from theft and security breaches. Their policy does not cover any losses due to the loss of the personal credentials of Coinbase account from users. Coinbase is one of the most liquid exchanges and the trading volume is more than $1 billion. Kraken is one of the most respected cryptocurrency exchanges in the world, and it is active since 2011. It is based in San Francisco and gives to users the possibility to buy, sell, and store more than 200 digital assets. It is the fourth platform on the market. It offers two platforms, the main trading platform and the professional one, Kraken Pro. There are differences among the fees applied on the two platforms.

The Handling of Cryptocurrencies 79 For example, the instant buy fees on Kraken Pro are very low; instead, on the main platform, they are higher than 1.5%. It is the best solution for expert traders; i­ndeed, the platform offers advanced solutions and supports margin and futures trading. Moreover, it is one of the highly liquid exchanges and has a trading volume of $500 million. Kraken has developed its mobile apps in order to simplify the purchasing and selling of cryptocurrency. In addition, it provides a support center to find the answers to the most common questions or it is possible to be supported through a live chat or by email always available. Gemini was launched in 2014 putting its focus on security and compliance. It is based in New York, and it is licensed under regular bank exams. It is subject to the cybersecurity audits managed by the New York Department of Financial Services. Moreover, it is the first exchange that guarantees an insurance against some types of losses from Gemini’s hot wallets. In particular, the insurance is against theft of digital assets that are the result of direct hack of Gemini’s systems, fraudulent transfer by Gemini, or theft by its employees. The platform applies a different fee structure relating to the web, to mobile, or if the user is an active trader, and others. In each group, there are different structures. It is a highly liquid exchange, and the trading volume is about $79 million. However, this platform supports less cryptocurrencies than its competitor exchanges, namely around 100. The strength of this exchange is the high level of security guaranteed by the platform. Crypto.com was launched in 2019 and is the best mobile exchange app. This is ­because it supplies a wide investing and trading ecosystem for digital assets. ­Moreover, access to the platform is very easy and friendly from the smartphone. It supports over 250 cryptocurrencies and delivers a variety of cryptocurrency products. The fees are relatively high and the support for customers is a weakness of this platform. Indeed, fees are relatively high and different if the operation is maker or taker, they are also structured based on different levels. The platform was launched in 2016 and it is available in 90 countries. It provides a large digital asset ecosystem made of its own blockchain and a crypto visa card. Crypto.com puts a lot of effort to develop an app that offers a various range of products. Users using the app can sell, buy, trade, and earn interest on their cryptocurrencies; in addition, they can pay with cryptocurrencies. The platform offers deep liquidity and has a trading volume of $269 million. Bisq is a decentralized exchange, for which data are not available on Coinmarketcap.com. It is a peer-to-peer network and open-source software. It was launched in 2014, with the idea to allow users around the world to trade and exchange a variety of digital assets and tokens in a peer-to-peer way. In order to operate on this exchange, no identity verification is required. All the data are private and are not sent to a central server. Each node of Bisq is hidden. This guarantees a high level of privacy. It is a system with low trading volumes and not designed for active trading. Now, it supports more than 100 digital assets. 6.4 Expendability The word cryptocurrency is associated with other words such as speculative asset, speculative bubble, risk, fraud, and illegal activities. For a long time, Bitcoin and

80  The Handling of Cryptocurrencies other cryptocurrencies were prevalently used as a speculative asset, to implement illegal activities, and many frauds happened. In the beginning, Bitcoins were prevalently used in the Dark web4 as a currency to pay for illegal activities. One of the most famous web markets was Silk Road, which was closed by the FBI (Federal Bureau of Investigation) in 2014. It was an anonymous market, which allows users to buy several types of illegal activities. This market used Bitcoin as a payment method, given its characteristics, such as anonymity and easy cross-border transactions. After few months from the launch of Silk Road, the price of Bitcoin moved from $1 to $30. This was attributed to the attention obtained by the cryptocurrency thanks to this new dark market. At the moment, Monero is the most used cryptocurrency in the dark web5 (Kaloudis 2022). It is an altcoin launched in 2014. The use of cryptocurrency for illegal activities was one of their first applications, due to their main characteristics. Later, they started to be used as a speculative asset. Many are the exchanges developed to facilitate trading activities, so as to make it easy to buy and sell cryptocurrencies. The gain in this case comes from the difference between the buying and selling price. Cryptocurrencies are also stored in wallets waiting for their appreciation. This is a way in order to earn money selling the asset after having waited a period of time, according to a buy-and-hold strategy. At the same time, through the years, there were many cases of fraud around the world. Recently, the Securities and Exchange Commission (SEC) has announced that have identified a platform named Forsage.io based on the Ponzi’s scheme6 developed using cryptocurrencies. Moreover, FBI has discovered a fraud, which some people offered some investment services in cryptocurrency linked to some apps. These apps had the purpose to defraud investors. These apps’ frauds have a value of more than $42 million. A recent event is the FTX case. FTX is a cryptocurrency exchange platform founded by Sam Bankman-Fried. It went bankrupt at the beginning of November  2022. It has a debt of around $ 3.1 billion to its creditors. What happened at the FTX exchange is a consequence of intentional fraud to steal money from users and investors of the exchange. This money was owned by Alameda Research, a company controlled by FTX, and used for financial and real estate investments. The failure of FTX was fast and started with a leak, tokens’ sale, and liquidity crisis. Then a series of accounting, administrative, and organizational irregularities emerged. After the decision of Binance to give up the acquisition of the exchange based on an article published on the specialized website CoinDesk, FTX declared bankruptcy. Bankman-Fried admitted to using billions of dollars of FTX clients to finance the ultra-risky investments of his trading company, Alamed Research.7 In the last few years, some cryptocurrencies are developed to be used as currency in some specific virtual environments. These virtual environments are generally known as metaverse. People can access this environment through the Internet. The metaverse is defined as a virtual world in which users, using avatar, can interact, participate to experiences, build and buy digital things. In the metaverse, it is possible to create and organize any possible events, such as parties, weddings, fashion shows, art shows, job meetings, etc. (Dwivedi et al. 2022). The element of the new metaverse with respect to the past virtual world is the use of blockchain technology.

The Handling of Cryptocurrencies 81 This means that the metaverse works as any other virtual world of video games but with a real internal economy, managed by cryptocurrencies. The virtual objects proposed in the metaverse are NFTs, which can be acquired only using cryptocurrencies. This means that the property of all the objects bought in this context is recorded on a blockchain and is available through your wallet. The use of blockchain technology permits to give a decentralized structure to a Metaverse, in this way the project is managed by users. The ownership of a specific amount of cryptocurrencies gives the right to participate in the governance and to vote on decisions related to the future of the project. The most famous metaverses are Decentraland8, Axie Infinity, and The Sandbox. Each of these ecosystems is based on its own cryptocurrencies.9 The Sandbox is based on Ethereum blockchain and its cryptocurrency is SAND. SAND is one of the most important cryptocurrencies in the metaverse. Each transaction and interaction happen through SAND, which is used to participate in games, to buy tools and accessories to personalize avatars, and to acquire a piece of LAND. A LAND is a piece of territory in this virtual world, and from a technical point of view, each LAND is an NFT. At the moment the value of a SAND is $0.9499. It is possible to buy SAND using US dollars or using other cryptocurrencies. Another example is Axie Infinity, which is made of many small different games, which makes it more similar to traditional video games. The purpose of this metaverse is to collect, look after, and make competitions among small pets, which are in NFT format, called Axies. Axie Infinity is a metaverse play-to-earn, meaning that users have the opportunity to earn cryptocurrencies playing, achieving goals. The economy of Axie Infinity is based on AXS, a token with three functions: payment token, governance token, and token compatible with staking. To participate in the decisions on the project it is needed to stake some of their AXS. In this way, the right to vote is acquired. The value of an AXS token is $14.26. In the last year, many of the market players in the traditional payment industry, such as MasterCard, Visa, PayPal, have made efforts to develop payment methods that allow users to pay using cryptocurrencies. This permits us to look at cryptocurrencies from a different point of view. They started to be not only speculative and investment tools but a new means of payment. So, cryptocurrencies start to be used as a payment tool or a collateral to credit cards. This has a positive impact on increasing the usability of cryptocurrencies. For instance, PayPal started to accept only few cryptocurrencies, Bitcoin, Bitcoin Cash, Ethereum, and Litecoin. With the PayPal app it is possible to buy cryptocurrencies using the funds available on the PayPal account. In case of unauthorized transfers of cryptocurrencies, it is entitled for reimbursement. It is also possible to pay using the cryptocurrencies on the account as a payment method. In this case, cryptocurrencies are directly available as a payment option if they cover the entire amount that the user must pay. Then, PayPal converts the cryptocurrency amount into US dollars or any other fiat currency. Moreover, many exchanges have developed their own debit card. Cripto.com supports over 100 cryptocurrencies and using the prepaid Visa card, users obtain 8% back on purchases when they pay using cryptocurrencies through the Visa card. Coinbase card, a plastic debit card, was launched globally and it permits to spend any

82  The Handling of Cryptocurrencies cryptocurrencies in the portfolio and earn a reward for each purchase. It is a card developed with Visa, which allows users to pay and withdraw cash on ATMs with Visa logo. Crypterium issues both plastic and virtual prepaid debit cards, which can be linked to the Crypterium wallet. It allows users to convert cryptocurrencies into fiat currency and spend it to buy goods and services in any place in which Visa is accepted. It can be also connected to ApplePay. These are just some examples of the multitude of cards developed to facilitate the use of cryptocurrencies as a means of payment in the traditional economy. They permit to connect the cryptocurrencies worlds to the traditional system. These ­allow to increase the usability of cryptocurrencies. Notes 1 Coinbase.com 2 It is open 7 days a week, 24 hours a day. 3 January 2023. 4 The dark web is a term to define the part of the World Wide Web that is only accessible through special software and configuration, that allow users and operators to remain anonymous. It allows users to engage in criminal activities and can be used to violate the privacy of others (Oxford Dictionaries). 5 www.coindesk.com/- “Criminal crypto use is growing but that’s just half the story” (2022) 6 It is an investment fraud. This scheme promises high returns with little risk. It generates returns only for the earlier investors using the money deposited from later investors. 7 CoinDesk.com 8 Described and analyzed in Chapter 4. 9 forbes.com

References Dwivedi, Y. K. et al. (2022). Metaverse beyond the hype: Multidisciplinary perspectives on emerging challenges, opportunities, and agenda for research, practice and policy. International Journal of Information Management, 66. Kaloudis, G. (2022). Criminal Crypto Use Is Growing, but That’s Just Half the Story. www.coindesk. com/ (Last access September 2022) Website Axieinfinity. https://axieinfinity.com/ (Last access September 2022) Website Bisq. https://bisq.network/ (Last access September 2022) Website Bitpanda. www.bitpanda.com/ (Last access September 2022) Website Coinbase. www.coinbase.com/it/ (Last access September 2022) Website Coindesk. www.coindesk.com/ (Last access September 2022) Website Forbes. www.forbes.com/ (Last access October 2022) Website Investopedia. www.investopedia.com/ (Last access September 2022) Website Gemini. www.gemini.com/ (Last access September 2022) Website Nasdaq. www.nasdaq.com/ (Last access September 2022) Website Oxford Dictionary. www.oxfordlearnersdictionaries.com/ (Last access September 2022) Website Sandbox. www.sandbox.game/en/ (Last access September 2022)

7 The Central Bank Digital Currencies (CBDCs)

7.1 Introduction This chapter summarizes the evolution of the central bank’s behavior toward cryptocurrencies. In the last years, central banks have started to actively study and monitor the cryptocurrency phenomenon. They have developed a growing interest on the potentiality of technology innovations such as blockchain and distributed ledger technology (DLT). The attention of central banks is due to the rapid and exponential growth of digital assets and currencies issued by the private sector. Central banks around the world have started to study these new tools and the technology behind them, not only to monitor the evolution of this new phenomenon but also to investigate the opportunities to develop their own version of digital currency. The digital version of a currency issued by a central bank is known as Central Bank Digital Currency (CBDC). This chapter investigates and describes the CBDCs’ phenomenon. The aim of the chapter is twofold. The first is to understand what a CBDC is, and which are the main advantages and weaknesses of this new tool. The second is to analyze the different approaches and projects that are under analysis by the various central banks around the world. The first part of the chapter is dedicated to understanding what a CBDC is, looking also to the literature to find more detailed definitions. Then, it is discussed from an economic and financial point of view what a CBDC is. The CBDC would be a digital currency issued by a central bank, so, a digital version of the national currency of a country. The various motivations and opportunities behind the intention of implementing a CBDC are analyzed, like the stability and efficiency of payment systems, the evolution of cash; the monetary sovereignty, and the international role of CBDCs. Besides the advantages, the implementation of a CBDC presents some issues such as technical problems; negative implications for the financial system’s stability; monetary policy’s problems; and monetary and fiscal policy implications. Then, a section will be dedicated to discussing and analyzing first attempts and approaches of some central banks around the world in order to develop and study the implementation of a CBDC. The analysis is conducted by looking at the approaches of the various countries. The projects of Uruguayan, Swedish, and ­Chinese’s central banks are studying the development of a CBDC to implement DOI: 10.4324/9781003353102-8

84

The Central Bank Digital Currencies (CBDCs)

and improve retail payment services. These countries want to provide a safe means of payment to final users for everyday payments. Then, the projects of Switzerland, Hong Kong, and Thailand focus the attention, respectively, on the potentialities of a wholesale CBDC and a cross-border system based on a CBDC. This part wants to give an idea of the multitude of projects that are under discussion or implementation. Furthermore, they underline the potentialities that a CBDC would have in future financial systems. The other two sections are designed to analyze the approaches and projects of two relevant areas of the worlds. The first is dedicated to the discussion of the attempts and approaches on the CBDC topic by the Federal Reserve (the FED). Currently, the FED is studying and actively discussing about the possibility to develop a U.S. CBDC system. Many are the aspects examined and evaluated to understand the fattibility and usefulness of that project. The study is investigating four different areas: technological experimentation, economic and policy investigation, stakeholder involvement, and international collaboration. The eight objectives that the U.S. CBDC system must satisfy are clearly defined. The analysis highlights the attention on digital payment innovations and on a CBDC by the U.S. government and central bank. However, there are no evidence of a pilot project, and the FED is just exploring and discussing the possibility of a CBDC system. The next section analyze the European Central Bank (ECB) approach to CBDC. The ECB states that a digital euro would be like banknotes but in digital form issued by the Eurosystem (ECB 2022a). The ECB is currently in the second year of the investigation phase of the digital euro project. Many aspects are discussed in these two years such as the potential design and distribution of it. The main motivation behind the implementation of this project is to guarantee access to every citizen to the central bank money in the digital era for daily payments all around the euro area. The chapter ends with some conclusions, to provide a big picture on the state of the art of CBDCs. This topic is quite new and achieving a clear vision of the phenomenon requests particular attention. Moreover, it explores the evolution of the technology which implements and improves the financial system, potentially revolutionizing not only the payment system but also the structure and interaction among private intermediaries and central banks. 7.2 Central Banks and Digital Currencies: Risk and Opportunities In the last decade, the advent of new technologies and the evolution of information systems have strongly affected the functioning of the banking and financial ecosystem. Financial operators have deeply modified their services, through the so-called FinTech phenomenon, and, at the same time, the payment habits of individuals changed, embracing the revolution of digital innovation. In digital innovation, the advent of Bitcoin and other cryptocurrencies was the catalyst for a real revolution. The cryptocurrencies’ phenomenon started in 2008 with the publication of Bitcoin’s white paper, but only in the last five years the number of cryptocurrencies and

The Central Bank Digital Currencies (CBDCs) 85 their markets is dramatically raised, reaching the number and variety that now exist. Today there is a variety of cryptocurrencies with different technical characteristics and developed with various purposes, as discussed in the previous chapters. Blockchain technology has made possible the “tokenization”1 of monetary or physical assets (PwC 2020). Doing so, the physical economy is moving to the blockchain. Based on this idea, the concept of stablecoins arose. Stablecoins are a type of cryptocurrency issued privately and are collateralized with fiat currency, financial assets, or physical goods (ECB 2022b). They are developed with the aim to solve the issue of the high price volatility that usually features cryptocurrencies, such as Bitcoin and Ether. Stablecoins are digital units of value which maintain this value stable relative to one or more official currencies or asset. In the last years the market of stablecoins has significantly grown and remains a market of coins issued by private entities. The main stablecoin on the market is Tether.2 In this framework, a particularly interesting project of a currency issued by a private entity is Libra. Libra is a stablecoin announced by Facebook (now Meta) in 2019 (Sandner et al. 2020). The project was based on a new decentralized blockchain, a low-volatility cryptocurrency, and a smart contract platform that together aimed to create a new opportunity for financial services innovation. The project involved several financial institutions like Mastercard, Visa, and Paypal. However, the project was slowed down by regulatory issues. In the meantime, the name Libra turned in Diem, but the goal to trigger a disruptive innovation in the digital payment industry remains unchanged. The mission of the project is to provide access to the financial system to about 1.7 billion of unbanked3 adults in the world. It should be feasible thanks to a low services cost structure. Later, the project would offer various services, such as the chance to pay bills with a click or to pay for a coffee through scanning a code, without the need to use cash or cards. In 2022, the Diem Association – the consortium created by Facebook in 2019 to realize the innovative payment network –sold its technology assets for about $200 million to a small California bank, which supplies services to company for Bitcoin and blockchain. Facebook has about two billion of daily users, and with this huge number of potential users Libra could have become the most used cryptocurrency worldwide. Moreover, Facebook could take advantage from its own reputation, quite useful for the currency’s adaptation. The potential impact of this project on the traditional financial system could have been revolutionary and destabilizing. The adoption of a currency issued privately and used by billions of users would have created a parallel system, weakening the financial system and the role of central banks. This could have been the biggest risk for the stability of the financial system (as we know it today), but, at the same time, it could be the main strength of a project like Libra. The creation of many private currencies can destabilize and put at risk the international monetary system, reducing and destabilizing the institutional role of governments and central banks. In this context, central banks have started to pay attention and monitor this new phenomenon and explore the potentialities of blockchain technology. Moreover, central banks started to investigate how to maintain their role in the actual context full of innovations. After less than ten years from the first whitepaper and the first

86  The Central Bank Digital Currencies (CBDCs) transaction using a cryptocurrency, the concept of a new form of a fiat currency ­issued by a central bank has arisen. This new form is known as Central Bank Digital Currency or CBDC. The research on this topic has risen in the last few years, due to innovation in digital payments, innovation in digital finance, the growth of blockchain technology, and distributed ledger technologies, which have allowed the exponential growth of private currencies. As it has been already stated, a CBDC is a token based on blockchain technology to represent in digital form a fiat currency of a particular nation or region (BIS 2020). A CBDC is issued and regulated by the competent monetary authority of the country. From a literature review, it is possible to find various and more sophisticated definitions of a CBDC. Engert and Fung (2017), and Bordo and Levin (2017) define a CBDC as a value stored electronically, which could be used to make payments and it is a liability of the central bank. Kumhof and Noone (2018) state that a CBDC is a central bank money that could be accessed more widely than reserves can have more functionalities for retail transactions than cash and could be used for different purposes. CBDCs are, also, defined as a digital form of central bank money, which is a different thing from the balance in settlement accounts or traditional reserves (Ward and Rochemont 2019). Moreover, CBDC is described as a digital type of central bank liability which is available to the general public (Bitter 2020). Kiff et al. (2020), and Ozili (2021, 2022) underline the aspect that it is a digital representation of a fiat currency issued by a central bank or monetary authority. All these authors underline that a CBDC is a liability of a central bank and a digital form of a fiat currency different from cash even if a CBDC has similar function of cash, like to make payments. In this context, it could be useful to understand from an economic and financial point of view what a CBDC is. From a financial perspective, CBDCs are part of the so-called “digital finance”. Digital finance is the term used to describe the impact of new technologies on the financial services industry, which allows new financial products and services generally be delivered through digital devices (European Commission 2020). CBDC can be seen as an evolution of the concept of cash and a new tool in the framework of payment systems. Through the last years, innovation technology has strongly impacted the payment industry making new tools possible, creating new ways to deliver products and services, and fastening the timing of processes, with the result to develop the so-called digital payment system (DPS). From a monetary perspective, CBDC can be the most advanced and innovative tool in the digital payment system, being a new form of digital money issued by a central bank. From an economic perspective, CBDC refers to the monetary economics framework (the branch of economics, which studies various aspects linked to the monetary market and the monetary policy). That framework was developed to study the role of money as a medium of exchange, store of value, and unit of account.4 Additionally, it analyzes money in general, such as its functions and its acceptance in the economic system. Under this branch, CBDC is a new and more advanced type of money. Indeed, differently from the other types of digital money privately issued or cryptocurrencies, CBDC will satisfy all the three attributes needed by a

The Central Bank Digital Currencies (CBDCs) 87 tool to be defined as a currency: to be a store of value, unit of account, and medium of exchange. The CBDC would be a digital currency issued by a central bank. The issuing of a CBDC does not need by definition the use of decentralized Distribution Ledger System (DLT), even if this is one available option, among others. A CBDC is the digital version of the national currency of a country or a monetary area. Being the digital version of national currency, it has all the characteristics of a fiat currency and the juridical status of money. There are various motivations behind the intention of issuing a CBDC (De Bonis and Ferrero 2022). The stability and efficiency of the payment system: at the basis of a good and efficient payment system there is that more people use the same currency in the system, and more people are incentivized to accept it as means of payment (network effects) (BIS 2021). Indeed, payment systems take advantage of economies of scale and network effects. This was the underlying idea of the Libra project, and the network was one of the main strengths of that project. CBDCs want to be an alternative to the risky and unstable currencies issued privately. Evolution of cash: in many countries there was a reduction in the use of cash for payments in the last years, corresponding to an increase in the use of digital means of payment.5 In this context, citizen could have difficulties to access means of payment provided by the public sector. The issuing of a CBDC would allow to offer a secure means of payment as an alternative to the private digital market. Doing so, central banks preserve the stability of payment system and the trust in bank money. Digitalization: since a CBDC would be able to supply payment services not available in the private sector, this could simplify the digital transformation of the economy. Indeed, it would support the improvement of new business models and innovative solutions, in both financial and non-financial sectors. Security and stability in case of extreme events: cyber-attacks, and extreme situations, such as natural disasters, and other risks, can impact the stability of a payment system based on digital currencies. These risks can interrupt payment card services, cash withdrawals from ATMs, and online banking, and such scenarios can damage confidence in the financial system in general. A CBDC would provide a mechanism that guarantees the functioning of the system even when private solutions are not available. Defence of privacy: CBDC would be a solution to preserve privacy and to guarantee the effectiveness of Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) regulations (ECB 2019). Indeed, central banks, different from private payment service providers, has no interest in consumer information. Cryptocurrencies allow anonymous transactions, which makes it difficult to respect AML/CFT rules. Monetary sovereignty and international role of CBDCs: the use of a stablecoin denominated in a currency different from the domestic one can limit the capacity of a national central bank to implement price and macroeconomic targets, therefore reducing the welfare of its citizens. In this way, central banks could lose their control over monetary issues. Central banks CBDC’s issues would reduce the rising of these risks.

88  The Central Bank Digital Currencies (CBDCs) Transmission and conduct of monetary policy: theoretically, a CBDC remunerated would permit to the central bank to influence the economic decisions of citizens directly. Indeed, if central bank decides to change the official interest rate, this would be applied to returns paid on CBDC. Fiscal measures: the idea to develop a CBDC that makes possible government-toperson payments is emerged. This idea would try to solve the problem of reaching unbanked citizens. In this way, not only government could ease the implementation of social measures, but it could also simplify the settlement of payments between citizens and government, in both directions. Besides the advantages discussed earlier, the implementation of a CBDC presents some critical points (Mu and Mu 2022). The main issues are related to technical problems as (1) negative implications for the financial system’s stability, (2) monetary policy’s problems, and (3) monetary and fiscal policy implications. Technology risks: CBDC would be subject to counterfeit and cyber risks. For a CBDC based on a DLT, these risks would be higher than for cash. In this case, a cyber attack to counterfeit CBDC could impact a huge number of users. This aspect must be deeply analyzed by central banks. Also, centralized systems are subject to the same risks, but in this case, there is only a single point of failure. However, a DLT can be modified only by altering the entire history of the chain, which is a very expensive procedure (OECD 2020).6 Risk on financial stability: in the case holding CBDC includes an interest, central banks could replace commercial banks, offering a direct deposit facility as a perfect substitution for bank deposits. Such a disruptive innovation makes the chance of a remunerated deposit account (e-Wallet) managed by central bank very unlikely. The effect of this revolution in the functioning of the financial system could be so big to marginalize the role of banks in the payment system. Moreover, a banking system with no more deposits available will not be able to offer credit products, such as loans and mortgages, to economic agents (e.g., companies, individuals), reshaping the functioning of the financial system even beyond the payment industry. The main pillars of the banking industry include the maturity transformation of deposits and credits, with banks collecting funds issuing deposits and issuing long-term loans. In the case of central bank deposit account (e-Wallets), even if the CBDC accounts are not remunerated, in case of financial turmoil, the chance to deposit money in a central bank account paves the way to a “digital bank run”, with money leaving commercial bank accounts to be deposited in a central bank account. Hence, even if holding CBDCs is remunerated or not, central banks must account for the potential consequences on the functioning of the financial system due to the introduction of CBDC, especially the risk of disintermediation of the banking system. To preserve the risk of competition in the deposits’ markets between central banks and commercial banks, the former could impose a limit on the amount of CBDC that a single individual or entity (e.g., companies, NGOs) could hold, and/or create an incentive structure to discourage the use of CBDC as an alternative to banks’ deposits (e.g., negative interest rates for CBDC deposit that exceed a certain threshold).

The Central Bank Digital Currencies (CBDCs) 89 Consequences for monetary policy’s effectiveness: a CBDC which pays an interest allows easier channel to transmit monetary policy decisions from central banks. During periods of higher economic instability, the possible effect of CBDC on the capacity of banks to finance the economy can limit the effectiveness of the transmission of this channel for monetary policy. Relation between monetary and fiscal policy: a system payment for government-toperson centered on CBDC would be used to implement fiscal measures and settle payments between citizens and government. While the use of CBDC would allow to reach a greater part of citizens, unbanked people included, sometimes the difference between fiscal and monetary policy could be confused, affecting the perceived autonomy of the central bank by the citizens. These are the main issues that central banks have to deal with working on their CBDC projects. CBDCs can be designed in different ways depending on the purposes and benefits that a central bank wants to offer. A CBDC can improve efficiency, trust, and payment functionality based on different players and use cases. First, central banks issue CBDC in order to provide a new alternative for physical, digital, and peer-topeer transactions for retail market. The new option would be a tool that can diversify payment channels and reduce costs. Secondly, nowadays, wholesale payments are based on national payment systems, generally using interbank clearing systems through central banks. CBDC would simplify the access of institutions to wholesale payments and improve the origin of a new wholesale financial infrastructure. Finally, the architecture of the CBDC’s will impact also on the relationships at the international level and the cross-border payment system. The design of a CBDC would determine the possibility to use it only inside the country or cross-borders. A CBDC would improve the cross-border system and establish direct monetary relationships at the international level. It would improve the efficiency of the actual international banking structure, reduce risk, and the inclusiveness of financial markets. In conclusion, CBDCs can provide for the retail payments system, based on the actual financial infrastructures, new functionalities and characteristics for final users, redesign the wholesale payments system, and cross-border system potentially solving many of the current problems. 7.3 First Attempts to Approach Cryptocurrencies and the Blockchain Technology Many central banks around the world are working on (or are evaluating the pro and cons of) launching their own Central Bank Digital Currency. Those central banks are even under pressure by the exponential growth of the private market of cryptocurrencies, making the launch of a CBDC even more timely. The main goal of central banks is to maintain their central role in the financial system, to protect the wellfunctioning of payment system, and to provide a reliable payment tool to final users. This paragraph discusses and analyzes the first attempts and the different approaches of central banks, in order to develop and study the implementation of a CBDC.

90  The Central Bank Digital Currencies (CBDCs) Uruguay

In 2014, the Banco Central del Uruguay (Central Bank of Uruguay) officially ­announced the decision to investigate the chance to issue a Central Bank Digital Currency.7 Hence, Uruguay was the first country to officially start a pilot plan for issuing digital money. Four years later, in 2018, the Banco Central del Uruguay (BCU) issued, put in circulation, and tested in the real world a CBDC called e-Peso. The latter is the Uruguayan Peso (local official currency) in digital form. They made a six-month experiment of the e-peso project. The system is characterized by instantaneous settlement, does not require an internet connection, it is anonymous but traceable, improving the security over cash. At the end of the period, the e-Peso had started to be popular among businesses, private banks, and users (Sarmiento 2022). Moreover, the network of payment was not the subject of any security or technical problems. So, the first results of the experiment showed that the project was developed according to expectations, with no technical failures, and with zero costs for the BCU. The main motivation behind this project was the intention of the Uruguayan Central Bank to be part of the new digital era. Indeed, the BCU wanted to be ready to explore the potential benefit of a digital financial system, investigating new technologies.

Sweden

The Swedish Central Bank (Riksbank) started the so-called “e-Krona project” in 2017, in which it was investigating if the Swedish krona need to be made available in electronic form, the so-called e-krona. The intention was to develop a more rapid payment system with the will to manage all payments’ settlements through Riksbank’s system to safeguard the stability and the efficiency of the market. The idea of the Swedish Central Bank is strictly related to the rapid decrease in cash usage in Sweden. An e-krona would give to the public an access to a digital complement to cash, where a public authority would guarantee the value of the money. The e-krona project started with a dialogue with national and international agents to assess the demand for a CBDC by the market. The outputs were two reports, that analyzed the cash use in Sweden (Riksbank 2022), showing a continuous declining trend in the use of cash. An e-krona would ensure that the general public still has access to a state-guaranteed means of payment. In the report emerges that the alternative to the introduction of the e-krona is to leave the payment market to private agents. This means to accept that in the long term, with the marginal role of cash in the society, even the role of central banks in the payment system will be marginalized. Such a scenario would make it more difficult for the Swedish central bank to promote a safe and efficient payment system. Phase two of the e-krone project included technical tests, and the Swedish Central Bank analyzed aspects related to offline functions of the e-krone, and the integration of external participants – like banks – in the network. However, the project will continue a dialogue with technology suppliers and will collect ideas from different parties in the payment market. The next step, phase three, in which the project is entering, will focus on

The Central Bank Digital Currencies (CBDCs) 91 the requirement needed for an e-krona if the decision is issue it. The project continues to investigate how an e-krona would affect the Swedish Central Bank’s task and Swedish legislation; investigating the need for and effects of an e-krona on the economy of Swedish. China

China’s approach to cryptocurrencies was singular and it has changed over time. China was one of the first countries with people trading and mining Bitcoin.8 In 2011, the first cryptocurrency exchange, BTC China, started. Since 2013, a famous search engine, Baidu, had been started to accept Bitcoin as a payment method for services. Since 2014 China was one of the main preferred locations for mining activities, given the relatively low cost of electricity. Mining activities, as an industry, and popularity of cryptocurrencies among people through 2016 and 2017 were exponentially growing. The government started to pay attention to this new phenomenon and to analyze the risk that cryptocurrencies could replace the Chinese local fiat currency. In 2017, China’s government banned initial coin offerings (ICOs). In 2021, cryptocurrencies were absolutely banned in the country. While China’s government banned the existing cryptocurrencies and all the related activities, they started to investigate the potentialities to issue an official stablecoin. In April 2020, China was the first major economy in the world to pilot a digital currency, called e-yuan (e-CNY) (Aysan and Kayani 2022). The Central Bank of China has been working on this project since 2014. This project wants to be a way to digitalize coins and bank notes in circulation and, also, the digital yuan would be a tool to accelerate the process to a cashless payments system. The government believes that a digital yuan can be useful for financial stability using a system of “controllable anonymity”. Another reason is the idea to increase the competition in payment system, because at the moment China’s payment system is dominated by private companies. The e-CNY owns the three functions of money (means of payment, store of value, unit of account), and it is a legal tender but in digital version. The People’s Bank of China (PBOC) remains at the center of the operational system, it issues e-CNY to commercial banks, which are authorized subjects and supervises the entire life cycle of e-CNY. The e-CNY is a retail CBDC issued to satisfy the daily payment needs of the public. In this way the e-CNY fully satisfies the needs of the public in a modern domestic payment system as the Chinese. The first purpose is to offer and satisfy the demand for digital form of cash and implement financial inclusion of the public. Secondly, e-CNY wants to improve and support the safety and competition of retail payments. Related to a system of “controllable anonymity”, e-CNY system collects few information with respect to traditional electronic payment and that information is not shared with other third parties or agencies. The system wants to satisfy the demand of anonymity for small value transaction, and at the same time, it wants to guarantee that the e-CNY will not be used for illegal activities (People’s Bank of China 2021). The e-CNY was used and spread out to the public during the 2022 Winter Olympic Games in Beijing. This was an opportunity for foreign people to familiarize with this new tool and, also, it was an opportunity to test the new system.

92  The Central Bank Digital Currencies (CBDCs) The approach of the Chinese Government and Chinese Central Bank was unique: while they banned any activities and use related to cryptocurrencies, they studied, developed, and implemented the first CBDC at the world level. These projects are studying the development of a CBDC to implement and improve retail payment services. These nations want to provide a safe means of payment to final users for everyday payments. The following cases are countries that are approaching and studying projects for a wholesale CBDC and a cross-border system based on a CBDC. Switzerland

The Helvetia project was an investigation carried out by the BIS Innovation Hub, the Swiss National Bank (SNB), and SIX, a financial infrastructure operator.9 The project is focused on the integration of CBDC in an infrastructure based on DLT to store and transfer tokenized assets. The project assesses the possibility to offer settlement services using CBDC in the future, where financial assets will be more tokenized, using the DLT technology. The focus is on operational, policy, and legal problems. The project is divided into two phases. The first phase tested two approaches: first, the issue of central bank tokens for financial institutions, wholesale CBDC; secondly, the creation of an interface between an infrastructure based on DLT and the Swiss Interbank Clearing’s payment system. The second phase implements the results of phase one, (1) including commercial banks in the project, (2) integrating wholesale CBDC in the core banking system of commercial and central banks, (3) and finally running end-to-end transactions. Results provided evidence that is possible to make instantaneous payments for an amount between 100,000 and 5,000,000 Swiss Francs.10 The Helvetia project confirms the possibility to regulate international transactions and the settlement of transaction for monetary policy on a platform of tokenized assets. Anyway, some issues remain open, such as the increasing of the complexity of the market and regulation, and the management of liquidity. The project is still experimental. Hong Kong and Thailand

The project Inthanon-LionRock started in May 2019, and it is a combined initiative between Thailand’s Central Bank and the monetary authority of Hong Kong to explore the application of a DLT technology to increase the efficiency of cross-border transactions. The two central banks have started two separate ways to study the prospective of wholesale digital money of central bank in the local context. In 2017, the Hong Kong monetary authority managed some financial institutions to implement the LionRock1 to study the benefits and risks of a wholesale CBDC. In 2018, the Bank of Thailand started a project with the local banks to explore the possibility of implementing DLT to improve the financial infrastructure of Thailand. Once the two national projects were concluded, the next step was to investigate if a wholesale

The Central Bank Digital Currencies (CBDCs) 93 CBDC would improve the efficiency of cross-border payments. The vision of the project Inthanon-LionRock is to use the advantages of DLT to solve the weaknesses of transferring and settling of cross-border transactions, improving the efficiency of the processes, reducing costs, and increasing traceability and compliance of the transactions. The project wants to reduce the number of traditional intermediaries and the improvement of efficiency. Moreover, it explores cross-border real-time money transfers. This project wants to be a connection between two different networks of national wholesale payment systems. All the banks involved in the project have the possibility of directly transferring funds through a CBDC. The cases analyzed in this part represent some examples of ongoing CBDC projects. If CBDC are on the agendas of several central banks, it is likely they will arrive in an operational phase in the near future. The analysis reported in this chapter aims to describe the state of the art of the CBDC initiatives and to highlight the potential evolution in the cryptocurrency markets and the digital payment systems. In the meantime, it is useful to stress even the threats of the issue of CBDC in a traditional financial system. 7.4 The Federal Reserve (FED) Point of View The Federal Reserve in its publication defines a CBDC as a digital liability of a central bank, which is broadly available to the community.11 The establishment of a CBDC would be a very important innovation in American money. Currently, the FED is experimenting and studying digital currencies, CBDC included (Board of Governors of the Federal Reserve System 2022). The project analyzes four different areas: 1) technological experimentation; 2) economic and policy investigation; 3) stakeholder involvement; 4) international collaboration. The FED is testing various limitations and opportunities of the new technologies. Technological Experimentation

Current experiments on technical aspects include (1) the creation of a CBDC that would take advantages from the existing systems and technologies, assessing the opportunity of centralized CBDC, (2) the implementation of a CBDC project that would use new technologies, like blockchain, investigating the possibility to develop alternative platforms; evaluating the application of DLT for wholesale payments, studying how it could be used to support interbank settlement, (3) improving current services implementing application interfaces to support the distribution and use of digital currencies privately issued; research about payments innovation and payments fraud, in order to reduce fraud.

94  The Central Bank Digital Currencies (CBDCs) Economic and Policy Investigation

Economic and policy research on digital currencies is paying attention to financial stability and financial inclusion. In particular, how a CBDC would be planned to implement financial inclusion; or investigate a group of digital currencies problems, such as privacy and monetary policy implications for digital assets and CBDCs. Stakeholder Involvement

The FED, analyzing and studying the evolution of digital payments and CBDC, involves many stakeholders from the private sector, academia, and foreign central banks in order to consider different points of view on CBDC. International Collaboration

The fourth area sees the FED working closely with international organizations and central banks to comprehend the main questions linked to payment innovations and CBDCs. Additionally, the Federal Reserve works and supports the Financial Stability Board to implement cross-border payments. In September 2022 The White House issued the “Policy Objectives for a U.S. Central Bank Digital Currency System”, which underlines the main policy objectives of the United States in relation to digital assets and considerations about limitations and alternatives that should influence the design of U.S.: CBDC system (The White House 2022a). The expression “CBDC system” includes the CBDC itself, the private and public sector components that are assembled to interact with it, and the regulations and laws applied to each component. The term components include various elements such as mobile applications, smart cards, and intermediaries which could have different roles in the CBDC system. The main objectives of U.S. CBDC system are eight. The first is to supply benefits and reduce risks for consumers, investors, and businesses. The CBDC system would include suitable protection from market failures, and fraudulent and illegal transactions, and provide an appropriate divulgation of risks. So, the final users like customers, investors, and businesses must be protected from a financial point of view, but at the same time, they must be also safeguarded from a digital perspective. Second, the CBDC system should be designed to facilitate some policy objectives, such as improving competition and innovation. To do so, the system must be governable and flexible. The CBDC system should be projected to reduce the liquidity risk and runs, and not rise systemic risk. The system should be able to run also in period of adverse circumstances. In other words, the CBDC system should be designed and implemented to support economic activity, the stability of financial system, and smoothly run also under stress. The third objective is the improvement of payment systems. The system should implement the regular functioning of the payment system guaranteeing that CBDC system works efficiently and delivers a good customer experience. Moreover, the system must be projected in a way that the public and final users trust it, namely the system should be safe from cybersecurity attacks and failures, ensuring the integrity

The Central Bank Digital Currencies (CBDCs) 95 of the CBDC and the system as a whole. Another objective is that the CBDC system should be consistent with other policy purposes, such as facilitating transaction with other currencies and systems, like commercial bank deposits. An important objective, the fifth, is the improvement of equity and financial inclusion. The CBDC system should be accessible by a wide range of consumers and users, obviously with some limitations to reduce some specific risks such as liquidity risk, bank run, and money laundering issues. Moreover, the system should be designed to expand fair access to the public also to those individuals without sufficient resources to possess expensive device or internet connection, and to those individuals with disabilities or limitations. The new system should avoid creating new inequities or new barriers to use, like technological one. Additionally, for the U.S. government, it is relevant that the CBDC system guarantees national security, the sixth purpose. The system should be created to collect sufficient information to satisfy compliance with antimoney laundering (AML) and combating the financing of terrorism (CFT) regulations. The CBDC system should support the role of the dollar at the global level, in particular it should be at the forefront of the development of digital assets and improve the new forms of payments. The system should be able to maintain speed, security, and privacy to facilitate users and global transactions, both domestic and cross-border payments, which should be fast, efficient, and convenient. The CBDC system should be projected and used in line with human and civil rights in order to respect human and democratic rights, such as those defended by the U.S. Constitution and the Universal Declaration of Human Rights. Finally, the eighth objective, the CBDC system should protect sensitive financial data and be sustainable. The new system should support privacy and defend against unlawful or arbitrary supervision. The CBDC system should be in line with environmental purposes, such as decreasing U.S. greenhouse gas pollution. Indeed, the system should minimize resource use, gas emissions, and energy consumption. Additionally, the new system should enhance the environmental performance of the traditional financial system. The FED is discussing also technical design choices for the U.S. CBDC system, evaluating the possibility and the opportunities of each alternative (The White House 2022b). The first focus is on the role of the intermediaries in the new system. A less intermediated system allows the possibility of peer-to-peer transactions system which could have lower costs and fees achieving and delivering more cost-efficient services and products. This type of system would also settle cheaply and quickly small-amount retail transactions. Instead, a more intermediate system, meaning that most or all transactions happen involving financial intermediaries, facilitates the i­mplementation of AML/CFT controls, customer service activities, and the ­cross-border exchanges of currencies. An intermediated system could promote and incentive intermediaries to supply new products and services based on the CBDC system. At the same time, a system structured in this way would have a negative impact on financial inclusion, similar to what happens in the current bank sector. Finally, it can reduce the safety of CBDC system, since intermediaries could be ­attractive targets for attacks. The second important focus is on the relationship of the CBDC system with other payment systems. In the case of less interoperability, it could be difficult for a CBDC system to communicate, settle transactions, or

96  The Central Bank Digital Currencies (CBDCs) transfer information with other payment systems. At the same time, the system would be less subject to cyberattacks and operational incidents. A higher level of interoperability would improve the payment systems not only domestically but also by allowing faster and cheaper cross-border payments and funds transfers. One of the last i­nteresting technical aspects is related to governance, in particular if the system should be p­ ermissioned or permissionless. A CBDC system could be run by a set of entities (“permissioned system”) or by a network of participants (“permissionless system”), or a mixture of both. In contexts without trusted entities, the advantages of permissionless systems are evident to guarantee transactions without trusted third parties. In the U.S. context, a U.S. CBDC system will be managed by one or more trusted entities, such as the FED. A system based on a permissioned ­structure ­frequently safeguards better the privacy of sensitive financial information, since transaction h ­ istory is managed by a few numbers of entities, and maintained secretly by o ­ thers. Moreover, this structure simplifies transactions, and the protection of consumers, ­investors, and businesses. A permissionless system must be strongly resilient to ­vulnerabilities, and this could have bad consequences for the security of the CBDC system. Additionally, this system consumes a relevant amount of energy which could be in contrast with the eighth policy objective which establishes that a CBDC system should be sustainable from an environmental point of view. It is clear that the FED, at the moment, is studying and actively discussing about the possibility to develop a U.S. CBDC system. Many are the aspects examined and evaluated by the FED in order to understand the fattibility and the usefulness of that project. At the same time, the objectives are clearly defined. All these elements underline the attention on digital payment innovations and on a CBDC by the U.S. government and central bank. However, there are no evidence of a pilot project or the intention to implement one of them. At the moment the approach of the FED is just at an explorative level. 7.5 The ECB and the Digital Euro The European Central Bank (ECB) affirms that the digital euro would be like banknotes, but in digital form. It would be electronic money issued by the Eurosystem, ECB and national central banks of the euro area, and would be widely accessible to citizens and businesses. The digital euro would complete cash without replacing it. It would be a new tool available as means of payment, which would simplify payments improving inclusion and accessibility (ECB 2022c). From the report “Study on New Digital Payment Methods” (Kantar Public 2022) about the payment habits of citizens in the euro area, clearly emerges the attitudes toward digital payments, in particular for instant and contactless person-to-person payments. In a context of digital innovation, also, retail payments are changing. Citizens prefer to use digital payment solutions and it is essential that they still have access to the central bank’s money. Nowadays, the central bank’s money is available only under cash form, and in a digital world there is the risk that it loses its relevance as a payment method. The digital euro would be a digital payment tool issued by the central bank and accessible in every area of the eurozone. This solution allows

The Central Bank Digital Currencies (CBDCs) 97 maintaining the role of stabilizing of payments system played by the central bank’s money. Moreover, some big economies are already developing possible CBDCs, and their cross-border use could undermine the international role of euro. In this context, the digital euro would preserve the safeguard for the strategic autonomy of European payments and for monetary sovereignty. So, the digital euro would be a fast, easy, and safe tool for everyday payments. It would have the function of public good and would improve financial innovation and efficiency of payment system. The ECB is already investigating a digital euro, and this year the project is entered in the second year of the investigation phase. The project was presented in the publication of “Report on a digital euro”, and in the same period, the first investigation phase started (ECB 2020). The project was started in October 2022 with a duration of two years, so the investigation phase will finish in October 2023. In these two years, many aspects are discussed such as the potential design and distribution of it. Even if the motivations behind this project are strictly domestic, based on the intention to guarantee access to every citizen to the central bank money in the digital era, the ECB recognizes some potential benefits also at the international level, such as cross-border payments using CBDC and the potential effects to supply access to foreign users to domestic CBDC. In this perspective, it is essential to cooperate at the international level on CBDC. The digital euro can have success only if European citizens will use it for everyday payments (ECB 2022d). An important role is played by design characteristics which must give new opportunities with respect to the existing solutions. Even if the final characteristics of digital euro will be defined in more detail in the future, some important considerations have already emerged. To be accepted the digital euro should bring some new benefits to users. Consumers prefer widespread acceptance, easy to use, low cost, speed, safety, and consumer protection. Instead, merchants favor low costs, easy to use, and integration into existing systems. Privacy protection must meet the highest standard and users should be able to decide how much information to make available, but always in accordance with the applicable legislation. Additionally, the wide availability should benefit those groups of population until now excluded from the financial circuit or with poor access to these types of services for making and receiving payments, strengthening financial inclusion. So, accessibility, solidity, efficiency, privacy, and cohesion to regulations are essential elements, which will be useful to define a digital euro. Another important aspect under analysis is the structure and how will be managed the digital euro. Until now, the central banks have supplied the monetary base, like cash, while the private sector has provided payment solutions to clients, such as payment cards. The digital euro will be safeguarded by ECB and, this hybrid model can keep unchanged. Citizen can exchange private money of commercial banks in public money of central bank, using central bank money for payments. The “Report on digital euro” (ECB 2020) presents four models of back-end infrastructure in which the private sector plays a different role, but whatever the approach the back-end infrastructure is ultimately controlled by the ECB. Two approaches are analyzed for the structure of the back-end infrastructure. In the first approach, the system is centralized, and the transactions are recorded in the Eurosystem’s ledger.

98  The Central Bank Digital Currencies (CBDCs) The second approach supposes a decentralized system, in which the transactions are recorded by users or/and intermediaries following rules fixed by the Eurosystem. The main difference between the two approaches is the role of supervised intermediaries. In the first case, they are just gatekeepers, and in the second case, they play a more relevant role. In both approaches, the private sector would be able to improve and develop new businesses and new opportunities based on services related to the digital euro. In the first approach, the centralized one, two hypotheses are developed. The first model supposes a direct access by final users to central bank account. Final users would have the ability to directly access and operate on the ECB infrastructure. The Eurosystem would have the full supervision of the life cycle of the digital euro and any transaction would directly process through its own infrastructure. This solution could be technologically challenging given the number of independent accounts and connections that must be provided and supported by the actual ECB IT infrastructure, which is not designed for this purpose. The second model hypothesizes an intermediated access by final users to central bank accounts. The Eurosystem would interact directly with supervised intermediaries, which would be settlement agents of transaction ordered by their clients. In this case, the Eurosystem still has full control of the digital euro life cycle and still processes transactions through its infrastructure, but the number of connections drastically decreases. Indeed, the connections are limited to the number of supervised intermediaries. From the intermediaries’ point of view, they would include digital euro services in their businesses and could improve their competition in the payment sector using innovative infrastructure. The second approach, the decentralized one, considers two models. The first alternative analyzes a direct access for end users to a bearer digital euro. In this case, the infrastructure permits to final users to transfer the property of the bearer digital euro directly among them without the involvement of a third party. The intermediaries would still be needed and involved as gatekeepers, but this solution is challenging from a legal perspective, in particular regarding compliance with AML/CFT rules. Since, transactions through digital euro would be similar to cash transactions, with the advantage of the highest level of anonymity and without all the physical limitations of cash. The second model supposes a hybrid infrastructure, which allows the use of a bearer digital euro by supervised intermediaries, that act as settlement agents for retail transactions on behalf of their users, and at the same time, they could use the same infrastructure for their wholesale payments. In this case, there is an improvement in the relationship between intermediaries and final users; however, all the transfers would be finally settled in the Eurosystem infrastructure (Figure 7.1). The implementation of the digital euro would have a deep impact on the structure of the financial system and the role played by the private sector regardless of the back-end infrastructure solution that will be selected. The introduction of a digital euro would give to European citizens the opportunity to use central bank money to make digital payments all around the Euro area, like to the current use of cash for physical payments. To guarantee the presence of a money issued by a central bank in the digital era is a natural implication of payment digitalization. In this way, the new tool would preserve the role of public money in

The Central Bank Digital Currencies (CBDCs) 99

Figure 7.1  Model of Back-End Infrastructure for Digital Euro

the payment systems to guarantee the convertibility, coexistence, and complementarity of various typologies of money. Secondly, the digital euro would support the strategic autonomy and efficiency of the economy, providing a European means of payment usable for every digital payment. The digital euro, like the physical version, will have the juridical status of money. Relating to the implementation of the project, the ECB is dealing with how to reduce the time to market, costs, risks, and the environmental impact of the digital euro. This tool would take advantage of the experience of financial intermediaries, not destabilize the functioning of the private payment tools, and preserve financial stability. The investigation is analyzing the potential impact of digital euro on monetary policy, financial stability, and the services’ supply by financial institutions. One of the main problems relate to the introduction of digital euro and financial stability is related to the possibility of converting in digital euro relevant amount of bank deposits in the euro area. This could negatively affect the equilibrium of banks, increasing the fund-raising costs and the liquidity risk. The digital euro should be designed to consider the need to introduce effective tools to prevent its use as an investment tool instead of a means of payment. Two possible tools are available to prevent this risk. First, to set some quantitative limits to the possible amount owned by a single entity (e.g., individuals, companies). Secondly, to avoid the use of digital euro as an investment it is possible to set a negative remuneration if high amount of money is owned, in other words, less convenient rates on more relevant amount. The idea is to implement both tools in the project of digital euro (European Parliament 2022). The purpose of the digital euro is to support the stability and sovereignty at the European level in two ways: first, implementing the development of payment services managed by Europe and then promoting a resilient ecosystem for retail

100  The Central Bank Digital Currencies (CBDCs) payments in euro. It is important that private and public subjects collaborate to realize this digital payment solution. The financial intermediaries would play a fundamental role in the distribution of digital euro. Their experience will be essential for the new project especially in particular sectors such as the acquisition of users, anti-money laundering controls and services in contact with the public. The digital euro would improve service and commercial products allowing services’ suppliers to enlarge their offers and develop new products and services based on the digital euro. 7.6 Conclusion From the analysis conducted in this chapter emerges the relevant and growing interest by central banks around the world on the digital transformation that is impacting on the financial system. The analysis carried out highlights the relevance of CBDC phenomenon. The new approach of central banks to cryptocurrencies and to the technology behind them is due to the exponential growth of the number of digital assets and currencies issued privately in the last few years. The innovation technology and the potentiality of blockchain technology has made possible the tokenization of monetary or physical assets. In this way, the physical economy is moving to the blockchain. Many of the central banks around the world are at least studying the implementation of a digital version of the nation currencies (CBDC). From the analysis, it is possible to conclude that a CBDC would be a new form of fiat currency different from cash even if it would have a similar function, like to make payments. CBDC could be seen as an evolution of cash and the most innovative tools in the framework of digital payment system. Different from a cryptocurrency a CBDC will be issued by a central authority, being a liability of a central bank, and will have the status of fiat currency. From the analysis of the different projects, it emerges that the aims behind these studies differ from county to country. The main motivation behind the project of the Uruguayan Central Bank was to be part of the new digital era and to be ready to explore the potential benefit of a digital financial system. The intention of Riksbank is to develop a more efficient payment system in order to safeguard the stability and efficiency of the market. This idea is related to the rapid decrease in case usage in Sweden. This new tool, e-krona, would give the public a digital complement of cash, which value is guaranteed by the central bank. Moreover, China is the first major economy to pilot a digital currency. The idea behind this project was to accelerate the process to a cashless payment system. The government wants to implement financial stability by implementing a system of “controllable anonymity”. Finally, this tool wants to be an alternative to the private solutions that dominate China’s payment system. The ECB, with the digital euro project, has the purpose of providing a safe means of payment in the digital era for European citizens usable for daily payments. All these studies are focused on retail payments, in other words, these countries want to supply a safe means of payment for daily payments to end users. Different is the approach of Switzerland, and Hong Kong and Thailand projects. The aims of these projects are to increase the efficiency of cross-border transactions.

The Central Bank Digital Currencies (CBDCs) 101 Finally, the FED is studying and paying attention to the evolution of digital payments and on the possibility to implement a U.S. CBDC. However, at the time of writing, there is no evidence of the implementation of a pilot project. In conclusion, many and various are the motivation behind the projects analyzed: the possibility to improve the stability and the efficiency of the payment system; to provide an evolution of cash in countries where decreases the use of cash in favor of digital tools; to improve the digitalization of the economy; to guarantee the protection of privacy and AML/CFT regulations; to increase the capacity of central bank to implement macroeconomic policy and the transmission of monetary policy; based on the structure of a CBDC, it would simplify the implementation of social and fiscal measures from government to unbanked citizens. Beside these advantages, the implementation of a CBDC also presents some issues related to technology risks; negative consequences for financial stability; monetary policy’s problems; issues in the relation between monetary and fiscal policy. The CBDC would be something that could completely change the structure of the financial system, the payment habits of citizens, and the relationship among private and public payment services providers. Moreover, it would open new business opportunities and new areas of competitions in the private sector taking advantages from the new CBDC’s infrastructure. At the same time, it could open new opportunities for cross-bord collaboration. The analysis conducted so far describes the initial phase of this new tool, which will continue to be developed and discussed over the next few years. Notes 1 Tokenization is process of representing digitally an existing real asset on a distributed ledger. (Hileman and Rauchs 2017). 2 See Chapter 5. 3 Describe people that do not have a bank account and do not use financial services. 4 For details, see Chapters 1 and 2. 5 For example, in the total number of payments in the euro area, the use of cash declined from 86% in 2019 to 73% in 2022. Simultaneously, the use digital means of payment increased from 14% to 17%. (ECB). 6 For details, see Chapter 3. 7 cbdctracker.org 8 Coindesk.com 9 Bis.org 10 5,049,400 euros and 5,422,455 US dollars. 11 federalreserve.gov/

References Aysan, A. F., Kayani, F. N. (2022) China’s transition to a digital currency does it threaten dollarization? Asia and the Global Economy, 2. Bank of Thailand and Honk Kong Monetary Authority. Inthanon-LionRock: Leveraging Distributed Ledger Technology to Increase Efficiency in Cross-Border Payments. www.hkma.gov.hk/ (Last access October 2022) BIS – Bank of International Settlement (2021). Central Bank Digital Currencies: Financial Stability Implications. www.bis.org/ (Last access October 2022)

102  The Central Bank Digital Currencies (CBDCs) BIS – Bank of International Settlement (2020). The Technology of Retail Central Bank Digital Currency. www.bis.org/ (Last access October 2020) Bitter, L. (2020). Banking Crises Under a Central Bank Digital Currency (CBDC). www. econstor.eu/ (Last access October 2022) Board of Governors of the Federal Reserve System (2022). Money and Payments: The U.S. Dollar in the Age of Digital Transformation. www.federalreserve.gov/ (Last access October 2022) Bordo, M. D., Levin, A. T. (2017). Central Bank Digital Currency and the Future of Monetary Policy. No. w23711. Cambridge, MA: National Bureau of Economic Research. De Bonis, R., Ferrero, G. (2022). Technological Progress and Institutional Adaptations: The Case of the Central Bank Digital Currency (CBDC). Questioni di Economia e Finanza, Occasional Papers No. 690. Banca d’Italia. https://www.bancaditalia.it/pubblicazioni/qef/20220690/QEF_690_22.pdf ECB – European Central Bank (2019). Exploring Anonymity in Central Bank Digital Currencies. www.ecb.europa.eu/ (Last access October 2022) ECB – European Central Bank (2020). Report on a Digital Euro. www.ecb.europa.eu (Last access October 2022) ECB – European Central Bank (2022a). The Digital Euro and the Importance of Central Bank Money. www.ecb.europa.eu/ (Last access October 2022) ECB – European Central Bank (2022b). Stablecoin’s Role in Crypto and Beyond: Functions, Risks and Policy. www.ecb.europa.eu/ (Last access October 2022) ECB – European Central Bank (2022c). Public Money for the Digital Era: Towards a Digital Euro. www.ecb.europa.eu/ (Last access October 2022) ECB – European Central Bank (2022d). The Case for a Digital Euro: Key Objectives and Design Considerations. www.ecb.europa.eu/ (Last access October 2022) Engert, W., Fung B. (2017). Central Bank Digital Currency: Motivations and Implications. Bank of Canada Staff Discussion Paper 2017–16. https://doi.org/10.34989/sdp-2017-16 European Commission (2020). Digital Finance. https://finance.ec.europa.eu/ (Last access October 2022) European Parliament (2022). The Digital Euro: Policy Implications and Perspectives. www.europarl. europa.eu/ (Last access October 2022) Hileman, G., Rauchs, M. (2017). Global Blockchain Benchmarking Study. Rochester, NY: Social Science Research Network. SSRN 3040224. Kantar Public (2022). Study on New Digital Payment Methods. www.ecb.europa.eu/ (Last access October 2022) Kiff, J., Alwazir, J., Davidovic, S., Farias, A., Khan, A., Khiaonarong, T., Malaika, M., Monroe, H.K., Sugimoto, N., Tourpe, H., Zhou P. (2020). A Survey of Research on Retail Central Bank Digital Currency. IMF – International Monetary Fund – Working Paper No. 2020/14. ISBN/ISSN:9781513547787/1018-5941 Kumhof, M., Noone, C. (2018). Central Bank Digital Currencies – Design Principles and Balance Sheet Implications. Bank of England Staff Working Paper No. 725. Mu, Y., Mu, A. (2022). CBDC: Concepts, Benefits, Risks, Design, and Implications. Rochester, NY: Social Science Research Network. SSRN 4234876. OECD (2020). The Tokenisation of Assets and Potential Implications for Financial Markets: Main Findings. www.oecd.org/ (Last access October 2022) Ozili, P. K. (2021). Central Bank Digital Currency in Nigeria: Opportunities and Risks. Rochester, NY: Social Science Research Network. SSRN 3917936. Ozili, P. K. (2022). Central bank digital currency research around the world: A review of literature. Journal of Money Laundering Control, 26(2).

The Central Bank Digital Currencies (CBDCs) 103 People’s Bank of China (2021). Progress of Research & Development of E-CNY in China. Working Group on E-CNY Research and Development of the People’s Bank of China. https:// www.bis.org/publ/bppdf/bispap123_e.pdf PwC  – PricewaterhouseCoopers (2020). Central Bank Digital Currency. www.pwc.com/it (Last access October 2022) Riksbank (2022). Payments Report. www.riksbank.se/ (Last access October 2022) Sandner, P. G., Gross, J., Grale, L., Schulden, P. (2020). The Digital Programmable Euro, Libra and CBDC: Implications for European Banks. Rochester, NY: Social Science Research Network. SSRN 3663142, 29 July. Sarmiento, A. (2022). Seven Lessons From the e-Peso Pilot Plan: The Possibility of a Central Bank Digital Currency. www.bcu.gub.uy/ (Last access October 2022) Ward, O., Rochemont, S. (2019). Understanding Central Bank Digital Currencies (CBDC). ­Institute and Faculty of Actuaries. https://www.actuaries.org.uk/documents/understanding-centralbank-digital-currencies-cbdc Website BIS. www.bis.org/ (Last access October 2022) Website CBDC Tracker. https://cbdctracker.org/ (Last access October 2022) Website CoinDesk. www.coindesk.com/ (Last access October 2022) Website European Central Bank. www.ecb.europa.eu/ (Last access October 2022) Website Riksbank. www.riksbank.se/ (Last access October 2022) The White House (2022a). Policy Objectives for a U.S. Central Bank Digital Currency System. www.whitehouse.gov/ (Last access October 2022) The White House (2022b). Technical Evaluation for a U.S. Central Bank Digital Currency System. www.whitehouse.gov/ (Last access October 2022)

Conclusion

It has been now more than 15  years since the first cryptocurrency ever  – the Bitcoin – was released. What was originally addressed as an experimental project, with probably no big expectations about its success, and it is now one of the thousands of cryptocurrencies available on the market. This book tried to reconcile the financial interest toward cryptocurrencies with the technical aspect about the blockchain and DLT technology. The concept of money – as we know it today – is the result of a long evolution process, that started in ancient times, with a social agreement about commodities, and that evolved with the use of metal coins first, deposits and banknotes later, until the current concept of fiat money, where the acceptance rate of a currency is based on the reputation of the issuer (the central bank) and its ability to make the currency properly works as a means of payment, a store of value, and a unit of account. A comparison between the long-term evolution process of the concept of money, which ranged across centuries, with the rapid evolution of cryptocurrencies, stresses how cryptocurrencies represent a work in progress area of the financial system. With respect to other innovations in the payment systems, including those adopted to deal with e-commerce, and that already require a solid technology background and infrastructure, cryptocurrencies are a completely different thing, and they shape a completely different scenario. With cryptocurrencies there is not a sophistication in the way payment happens and money is transferred, but it is the inner nature of money – as a currency issued and managed by a central authority – that is questioned. Thus, with respect to e-payment options – that already use technology to facilitate payments and money transfer – cryptocurrencies do not represent an improvement of the previous payment systems, but they propose a global reshaping of the monetary system that is clearly in competition with its current functioning. In the last few years, cryptocurrencies ceased to be a niche phenomenon, whose use was limited to “computer geeks”, becoming more and more popular. News about cryptocurrencies is now frequently on broadcasting media, and the number of individuals that has (at least once) owned a cryptocurrency is big enough to make cryptocurrencies a social phenomenon in most of the developed countries. The use of cryptocurrencies for speculative purposes, the potential misperception about the risk of investing in such assets, and the subsequent risk of fraud (especially for less DOI: 10.4324/9781003353102-9

Conclusion 105 financially literate individuals) suggest studying the cryptocurrency phenomenon and to assess its potential evolution. Rephrasing a Warren Buffet sentence, the fact that trading on cryptocurrency is easy does not mean that it is simple. The lack of an underlying asset makes the value of even the most liquid cryptocurrencies floating, with a high volatility that should discourage trading by risk-adverse individuals, but that seems to show sometimes heading-behaviors and typical bubble-shaped trends. In the meanwhile, Governments and regulators struggle to regulate cryptomarkets, due to their cross-border inner nature and the anonymity guaranteed by cryptocurrencies. Central banks are working on project to develop Central Bank Digital Currency (CBDC) with the aim to keep their pivotal role in the financial system. However, all the projects of the main central banks seem to be far from the implementation of a CBDC. Of course, central banks  – with respect to cryptocurrency private ­networks – must deal with several issues, including the risk of money ­laundering, the risk of a system failure and the consequent reputational damage that could ­affect even the paper money, and the awareness that the architecture chosen to issue money in a digital format represents a strategic decision able to affect the functioning of a central bank in the long term. At the same time, the so fast evolution of the ­cryptocurrency markets makes the need for actions by central banks urgent. The aim of this book was to provide the reader all the contents needed to understand, assess, and correctly approach the cryptocurrencies phenomenon, ­ ­taking the point of view of a financial decision-maker as the reference point. Of course, the future of cryptocurrencies is not an easy guess. Whether central banks will be able to fill the gap with the private sector, providing reliable and competitive alternatives to Bitcoin and other cryptocurrencies by the implementations of CBDC, is still not clear. At the same time, it is hard to predict if the future of the financial system will see the co-existence of both CBDC and private (crypto-) currencies, or if ­Big-Tech companies will decide to be active in the payment industry issuing their own crypto-assets. What seems more clear is that the cross of the financial system with the ITC (Information and Communication Technology) is here to stay, and cryptocurrencies are not a temporary fad.

Index

algorithm (or algorithms) 33 – 34, 36 – 40, 49 – 52, 64, 66, 72 Amazon 2, 43 anonymity 102 Apple 2, 61 ApplePay 20, 82

Digital (or digital) i – iii, vi – vii, ix, 2 – 3, 21, 23 – 24, 36, 37 – 41, 43 – 45, 58 – 61, 63 – 66, 68 – 74, 76 – 80, 83 – 103, 105 Distributed Ledger viii, 2, 25, 49, 87, 101 DLT viii, 2, 25, 42, 83, 87 – 88, 92 – 93, 104

banknotes 1, 9 – 11, 13 – 14, 16 – 19, 21, 37, 84, 96, 104 Bitcoin vi, ix, 1, 3 – 4, 15, 39 – 40, 44, 45, 49, 51, 53 – 70, 53 – 55, 57 – 59, 63, 68 – 70, 72 – 73, 78 – 81, 84 – 85, 91, 104 – 105 Blockchain (or blockchain) i, vi, viii, 1 – 2, 21, 23 – 25, 23 – 45, 29 – 30, 32 – 38, 41 – 43, 45 – 47, 49 – 51, 55, 57, 59, 61 – 69, 72 – 73, 76, 78 – 81, 83, 85 – 86, 89, 93, 100, 102, 104 bubbles 60, 70

EBA 40, 44, 60, 68, 70 ECB vii, 12 – 13, 15, 19 – 20, 22, 44, 53, 55, 68, 70, 84 – 85, 87, 96 – 102 Ether 3, 62, 85 Ethereum vi, ix, 54 – 57, 61 – 68, 70, 81 Eurosystem v, 12, 15, 84, 96 – 98

Cardano 64 – 66, 70 cash 15 – 16, 57, 66, 81 CBDC (or CBDCs) i, vi, 2 – 3, 43, 83 – 84, 83 – 103, 86 – 89, 94, 97, 105 China vi, 91, 100 – 101, 103 CNY 91, 103 Coinbase 44, 64, 74, 78, 81 – 82 CoinDesk (or coindesk) 55, 68, 80, 82, 103 coinmarketcap 60, 63, 65, 68 – 70 cryptoassets 13, 40, 57 cryptocurrencies (or cryptocurrencies or cryptocurrency) i, ii – iii, vi, 1 – 4, 6, 9, 13, 16 – 17, 23 – 82, 37 – 43, 42 – 48, 45 – 53, 50 – 52, 54 – 59, 56 – 69, 61, 63 – 65, 67, 71 – 86, 74, 76, 89, 91 – 92, 100, 104 – 105 cryptography (or cryptography) 2, 23, 29 – 30, 32 – 35, 38, 42 – 43, 44, 58 – 59 cryptomarkets 51, 105

Gemini 55, 70, 79, 82 Google 2, 61, 64 Government (or Governments) v, 5, 9 – 10, 92, 105

Facebook 2, 85 Federal Reserve (or FED) v, vii, 10 – 11, 13 – 15, 22, 80, 84, 93 – 96, 101, 102 Fintech 22, 55 FTX 80

hashing 30 – 31, 33 – 35, 38, 43, 55, 64 hash rate 47 – 48, 53, 55 IMF 49, 55, 102 Kraken 70, 78 – 79 Libra 85, 87, 103 Litecoin ix, 64 – 65, 67, 81 LTC 64 MasterCard (or Mastercard) 18, 21 – 22, 61, 70, 81, 85 Metaverse 81 – 82

Index  107 Miners 46 – 48 mining vi, 45 – 55, 91 NFT (or NFTs) 42, 44, 62, 67 – 68, 76, 81 PayPal 20, 72, 81 PoS 50 – 52, 55, 62, 65, 67 PoW 50 – 53, 55, 62 Proof of Stake see PoS Proof of Work see PoW Ripple 64 – 65, 69 – 70 Satoshi Nakamoto 57, 68, 70 Seigniorage (or seignorage) 8 – 10, 12, 15 Solana 67

sovereignty 83, 87, 97, 99 stablecoin (or stablecoins) 40 – 41, 63 – 64, 85, 87, 91 Tether 56, 63 – 64, 69 – 70, 85 trading vi, 75, 77 unbanked 18 – 19, 65, 85, 88 – 89, 101 VISA (or Visa) 18 – 19, 21 – 22, 53, 61, 70, 81 – 82, 85 Wallet (or wallets) 3, 21, 71 – 75, 77 – 82, 88 yuan 64, 91