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Are Asset-Backed Cryptocurrencies a Myth ?

 11 min read / 

In the search for the holy grail of cryptocurrencies, many start-ups have embarked on an elusive quest to create a stable coin, preferably backed with a real-world asset and which can be used for everyday purchases. In simple terms, asset-backed cryptos are coins with a good sales pitch but without much substance.

Many noble ideas abound, the crypto world is full with asset-backed coins ranging from gold-, diamond- and commodity-backed all the way to digital-asset backed coins, backed by things like music and gaming rights.

Uninnovative Innovations

Cryptocurrencies are digital assets, that are founded on some form of crypto-economic model that incorporates incentives and disincentives to create consensus amongst non-related participants in a network.

“There is basically no reason to build a crypto currency that is asset backed. It’s useless.”

Aleksandar Svetski, Blockchain Training Institute

At last count, there were 1595 cryptocurrencies traded on 10778 markets across the globe, and it appears that newcomers are not in short supply, it’s only a question of cool product design, finished off with a touch of flair.

It is almost as if there is a branding team on site for when coders decide to mine a new coin with some kind of speciality of sorts.

But hold on, there is a new kid on the block – XYO Network – The mother of all coins, or so it claims. And the list of the newest, most innovative coins in the world goes on and on ad infinitum….

Legal Tender or Legal Claim ?

There are many definitions of the term “legal tender”, however the following illustrates it clearly:

 

Money that is legally valid for the payment of debts and that must be accepted for that purpose when offered.

Merriam-Webster

So where do asset-backed cryptocurrencies fit in? Officially, nowhere.

Unless a coin or token is accepted (or backed) by a government, such as the case with Japan and Australia, it is not “legal tender” but only a far-fetched “legal claim” in accordance with the terms of a smart contract on Ethereum. In other words, in case of any dispute, a claim in relation to a coin or token can only be pursued in a court of law. And that alone is a challenge on many fronts because of a decentralised coin or token being “borderless”. That is, it only exists on top of a blockchain protocol that in all likelihood will be Ethereum. The question then is, which courts or jurisdiction apply.

It is perhaps for this exact reason, that Bitcoin and its 1600 clones are flooding the markets like a tsunami, there is no redress in court and no central bank control. Also, there are no banks, brokers or intermediaries, just two parties to a transaction agreeing upon the fair value of the exchange.

The DAO

The Digital Autonomous Organisation (or DAO as it is simply called) was an idea that swirled through the community not long after bitcoin was released in 2009. The thought is that if bitcoin can do away with financial middlemen, then maybe companies and other organizations can one day operate without hierarchical management.

 The plan was for participants to receive DAO tokens, then vote for which projects to fund. For selecting projects to invest in, it relied on the wisdom of crowds. It’s easy to see why “unstoppable code” could pose a security problem.

DAO is an organisation that is run by rules encoded in smart contracts created by coders and digitally enshrined in the form of governance by its community. However, the legal status of this type of business or organisation is unclear.

In other words, there is nobody, physical or virtual, to be held accountable when things go wrong.

And that is where the problem begins and ends. 

Real World Problems

In real life, lawmakers pass laws for the common good of their citizens. Laws, in general, serve to safeguard the rights and interests of the common person and in some cases, safeguard the rights and interests of corporates, lobbies and special interests groups such as the controversial National Rifle Association of America. 

The judiciary of a country makes sure that laws are respected and followed. Suitable punishment or retribution can be handed down to the violating defendant. It works in most cases, but when it fails it is due to the inherent flaw of mankind. We are simply prone to make mistakes.

Which is exactly the problem a DAO wants to solve, self-governance without the possibility of error. This sounds great in theory, but it is difficult in practice.

The Wild Web

A prime example of this problem surfaced when the crowdfunded “The DAO” was hacked upon launch and drained of the equivalent of $50m in cryptocurrencies. In the weeks that followed, the hack was reversed and the stolen money restored through a “hard fork” on Ethereum. This hack reversal was made possible by a majority vote of the blockchain, but it drew a lot of contempt from the global crypto community. 

If a company or a group of companies issue coins such as the “J-coin” (backed by a consortium of major Japanese banks), then there is recourse in a court of law. That is, the damaged party can file a lawsuit or for a claim in a court and after judgement, can have that claim enforced. 

The same applies to a foundation, if there is a justified claim, it can be pursued through the courts and in the end, the assets of the foundation can be seized and sold to satisfy that claim.  DAOs however are a different cup of tea. These do not exist anywhere except for on a blockchain protocol of which the ledgers are irreversibly updated throughout the world. This simply means that nothing can be seized and nobody can be held accountable. 

It even goes one step further. How can the coder of the smart contract be found and held accountable for any flaw or coding error? If there is nothing or no one that can be addressed, then no claim whatsoever can be secured or satisfied. This applies to every single cryptocurrency in the world.

The Repo Man is coming  

Crazy, or even noble, ideas for asset-back cryptos all fail on this premise, there is no one to be held accountable and as such, there is no claim that can be secured anywhere. Even if for some strange reason someone has a claim against Bitcoin, that person could not go to Mt. Gox or any exchange to claim their rights or seize assets to satisfy their claim. 

Satoshi Nakamoto, even if this person or entity does exist, cannot be held accountable for Bitcoin. It is the Bitcoin protocol of incentives and disincentives that creates consensus amongst its participants, the Bitcoin miners. Even if a coin or token is backed by assets, then what is the fair value of that asset? And who will determine that value? And what happens when the value of an asset such as gold, oil or real estate fluctuates?

The questions are endless, the solutions seem non-existent. 

The Petro is an example of a very poor attempt by a shaky government to issue a coin back by the country’s most precious resource: oil. Even though the Petro is backed by a sovereign government, Venezuela, it flopped on every front and has become the laughing stock throughout the world and the subject of many discussions by crypto fanatics and academics alike. 

Other Challenges

Coins that are backed by real estate face even bigger challenges. In case of default, who is going to go to court to claim and which courts or jurisdiction is applicable, who will value the property and how will a claim be enforceable and who will be the beneficiaries in the eventual case of a successful sale of the assets ?  

For commodity-backed cryptocurrencies it gets even trickier. Some coins claim that every single one of its coins is backed by real physical gold and that just sounds great. But from a practical point of view, who will pay out that real gold? Where can it be collected or where will it be delivered? And how to prove the rightful ownership is the next problem, after all the coins, which are part of the exchange, are virtual, whereas the gold is physical. 

At this point, there must be someone or some authority to intermediate and that goes against everything that the decentralised cryptocurrency world stands for. On top of that, there is the possibility that a sudden spike in demand outstrips the supply of a particular commodity (gold, silver, diamonds, etc.) that is part of the asset-backed cryptocurrency. 

Imagine an asset-backed cryptocurrency that is backed by gold and that that particular cryptocurrency enjoys the same meteoric rise such as Bitcoin, there probably would not be enough physical gold available, at least not in the short term, to satisfy a sudden spike in demand for gold should there be a sudden flight from Bitcoin (or any other cryptocurrency for that matter) to the “safe haven” of gold. 

This actually happened on August 15th, 1971 when President Richard Nixon unilaterally suspended the convertibility of US dollars into gold and by doing so, effectively ended the Bretton-Woods agreement. 

The world was in shock and in particular the French did not take this lightly, the then French President Charles de Gaulle actually sent a French warship to New York harbour and demanded that the US Federal Reserve hand over it’s gold reserve in exchange for the US dollar foreign reserves of France. 

This cannot happen to cryptocurrencies but the problem is real, should there ever be a sudden “run” on a particular commodity of an asset-backed cryptocurrency, then supply could be severely constricted. 

In Blockchain We Trust 

So, is there any hope for asset-backed cryptos? By all means yes. 

Anything that is backed by something is the first step towards integrity and transparency. 

It helps when a government, consortium or a group of major banks and  financial institutions (such as with J-coin) back their commitments with assets and their established reputation as opposed to empty words and vague promises.  

However, then there is always the issue of valuation and recovery. If these two factors are not or cannot be determined upfront or immediately after the facts, then the problems grow exponentially.  

It is therefore important that the exact parameters of the term “asset-backed” are stated and how it can be enforced. Also, stating who will be in charge of the coin governance and execution of it’s code protocol is a must. In the real world, these functions are carried out by central banks and enforced through the courts of law. In the crypto world, it’s governance by code protocol and consensus.  

At present, one of the most successful asset-backed cryptocurrency is DGX which is under the DigiDAO governance model. It features almost all the attributes of real money. It is one of the most stable cryptocurrencies currently available so it can be used as a store of value as well as a medium of exchange. In due time, it will be able to function as a unit of measure at which time it could achieve wide-spread distribution and adoption.  

Bitcoin is another prime example of how a community-driven consensus, safeguarded by immutable code on distributed ledgers creates a coin that is globally accepted and has turned the financial world on its head. Asset-backed cryptocurrencies can do the same, as long as the underlying value that is created is safeguarded through transparency, consensus and good governance.

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