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Asset-Backed Digital Currencies: Advantages and Challenges

Asset-Backed Digital Currencies - Barnea law firm

Virtual currencies have dominated investment conversation in the past two years, and the world is intrigued by this new trading method. While most of today’s cryptocurrency investors are sophisticated or “main street” investors, we are seeing more and more sophisticated investors (investment funds, financial instruments, and private accredited investors) entering the crypto market.


The ICO market to date has been characterized by high volatility and instability, and perceived as a high-risk investment. One of the reasons for this is that a digital currency’s value is determined partly by its technology, but primarily by the confidence the currencies’ buyers give to those behind the venture, the currencies’ trade liquidity, and even the volatility in the Bitcoin exchange rate (although this is not directly related to the said digital currency).


While the cryptocurrencies market remains speculative, and competition between cryptocurrency entrepreneurs continues to rise, entrepreneurs are consistently trying to create a unique and stable cryptocurrency fit for the use and investment of “main street” investors. The hope is that a stable cryptocurrency will add a layer to the accredited investors’ financial instruments and maybe also increase such cryptocurrency’s ability to be used as a method of payment.


The race to develop a new, unique and reliable digital currency with low volatility has prompted entrepreneurs to scale the link of blockchain technology and mainstream investments, thus creating a new wave of cryptocurrencies backed by commodities or assets.


Backing digital currencies with commodities (such as oil, gold, diamonds, etc.) or fiat (such as US dollars, euros, etc.) has many advantages. It reduces price volatility and opens the blockchain to a new kind of investors and traders (without even touching on the use of such digital currencies as actual methods of payment).


For example, ZrCoin created the first commodity-backed digital currency by pegging its value to the company’s production of industrial materials (Zirconia – ZrO2). Other entrepreneurs quickly followed and released their own asset-backed cryptocurrencies to raise capital funds (such as Cedex and Carats for diamonds and Tether for USD). In addition, entrepreneurs are also trying to make the bonds market (a market inaccessible to most private investors) available in the US and Europe by means of a currency backed by such bonds. This will make the market accessible to investors all over the world, without them having to contact a broker and meet minimum conditions to purchase such bonds.


Digital currencies backed by actual assets also receive their full value on the day of the ICO. This reduces the uncertainty of whether or not the future platform will be useful, since these currencies are backed by the tangible value of the asset. In addition, such digital currencies may be a decent replacement for traditional investments in today’s capital markets (since due to smart contracts, the execution of a transaction is faster and easier, and also reduces the costs of capital markets middlemen).


However, with the creation of asset-backed digital currencies, certain material legal issues have arisen. Commodity-backed digital currencies may be considered financial products and thus require the approval of the relevant financial regulator. On the other hand, fiat-backed digital currencies may be considered as actual currencies that need to be supervised by a central bank.


The regulatory challenges of developing a new crypto that will connect mainstream and sophisticated investors to the blockchain market, as well as a crypto whose value is dependent on tangible assets, should be considered before initiating such fascinating venture.


In order to adjust this new blockchain technology to traditional law and regulation, creative legal solutions are necessary to ensure such a venture is both innovative and successful.


Source: barlaw.co.il

Tags: Blockchain