Beyond Bitcoin

CRYPTO-CURRENCIES ARE ONLY THE BEGINNING

By Sviatoslav Rosov, PhD

The protocol underlying Bitcoin (also known as the crypto- In the United States, the Securities and Exchange Com-
OHGJHURUGLVWULEXWHGOHGJHULVIDUPRUHH[LEOHDQGDGDSW- mission (SEC) is increasingly concerned with these possibly
able than its well-known crypto-currency application may unregulated securities issues. Most providers of the software
imply. This fact is becoming increasingly evident. used to perform crowdsales argue they are simply provid-
Crypto-currencies are virtual payment systems that do ing tools that can be used for any number of activities
not rely on a central authority to generate currency supply legitimate or otherwise. Crypto 2.0 businesses that actu-
or to verify, track, and record transactions. Instead, crypto- ally conduct crowdsales also stress that their issued coins
currencies rely on a distributed ledger to determine, verify, are not marketed as securities, meaning they fall outside
and track ownership of monetary units without the need for the SECs jurisdiction. As with the more general phenom-
DFHQWUDOFOHDULQJHQWLW\0RVWQDQFLDODVVHWVWRGD\H[LVW enon of crowdfunding, crypto-coin offerings are currently
merely as digital records with a tiered structure of clear- a case of investor beware.
ing institutions culminating in the central bank. The tech-
nology behind the crypto-ledger enables the bypassing of
this centralized clearing structure to record the ownership
THESE CRYPTO-CURRENCY OFFERINGS
RIQDQFLDODVVHWV LOOK A LOT LIKE TRADITIONAL
The umbrella term for technologies and applications based
on the Bitcoin crypto-ledger protocol is second-generation SECURITIES OFFERINGS BUT WITH ONE
(or crypto 2.0) technologies. The majority of development
in this sphere is occurring outside the Bitcoin ecosystem, EXCEPTION: THE LATTER ARE STRICTLY
which is now too large to be a proving ground for untested
innovations. There are many examples of these second-
REGULATED IN MOST JURISDICTIONS TO
generation smart contracts or smart properties that enable PROTECT INVESTORS FROM FRAUD.
any application involving property rights to be traded using
the Bitcoin crypto-ledger principle.
The most obvious alternative use of a crypto-coin is that
of a token, sometimes known as a colored coin. A token is The New York Department of Financial Services is also
DGLJLWDOFRLQWKDWLVLVVXHGWRUHSUHVHQWDVSHFLFDVVHWVXFK discovering the complications of crypto 2.0 and is scaling
as real estate, art, or a commodity. An innovative application back regulatory proposals for creating a BitLicense for
of crypto 2.0 technology involves smart contracts. For exam- Bitcoin companies as the range and variety of potential
ple, a homeowner and a tradesman agree that the home- crypto-ledger businesses threaten to become unmanageable.
owner will deposit the payment into an escrow account that Initially, the BitLicense was a set of proposals focused on
will be released when both parties agree that the trades- anti-money laundering and know-your-customer regulation
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ple sees software developers fund a new product by issu- crypto 2.0 businesses with coins representing non-currency
ing appcoins that are necessary to access and use the soft- value (e.g., tokens) or existing only to drive other, primary
ware or app. functions (e.g., appcoins) has sent regulators back to the
drawing board. Bitcoins, as it turns out, were only the tip
REGULATORY HEADACHES of the crypto-iceberg.
The creation of tokens or colored coins via initial coin offer- Sviatoslav Rosov, PhD, is an analyst in the capital markets policy group
ings or crowdsales has been greatly facilitated by the rise at CFA Institute.
of decentralized exchanges that increasingly allow users
to quickly and easily create and trade their own crypto-
coins representing either a virtual currency or some other
FINANCIAL
asset. Crypto 2.0 is causing headaches for regulators, who
are already struggling to devise policies for crypto-curren-
FAJ ANALYSTS
JOURNAL
cies, such as Bitcoin. The initial coin offerings/crowdsales
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Cast your vote for your favorite Financial Analysts
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Journal article in 2014 in the Graham and Dodd Readers
look a lot like traditional securities offerings but with one
Choice Award: http://bit.ly/FAJRCA2014.
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tions to protect investors from fraud.

Jan/Feb 2015 CFA Institute Magazine 37