The COVID-19 pandemic has impacted a wide range of industries and the digital asset space has not been immune.
Digital assets are typically thought of as resistant to some of the market pressures that cause volatility in investment securities and were initially expected to behave countercyclically to equity markets. But surprisingly, cryptocurrency prices have trended with overall stock market volatility throughout this pandemic. Investors are reallocating their portfolios as part of what can be considered a temporary ‘flight to quality’ to stablecoins like the USDC and away from more volatile cryptocurrencies like Bitcoin and Ethereum. Volumes of stablecoins have surged – in the case of the USDC, by 50 percent over the last three weeks in March alone.
COVID-19 has also slowed technology manufacturing throughout the world, limiting the availability of hardware needed by miners in proof-of-work (PoW) blockchains. This has caused price volatility, lower network participation and decreases in the hashrates, or level of “effort” required for a miner in solving the mathematical puzzle needed to create a block in the PoW blockchains of popular cryptocurrencies such as Bitcoin. These issues have weakened the long-term viability of PoW blockchains that place high demands on the global energy infrastructure – some estimate that Bitcoin mining requires as much energy as the total energy consumption of the Czech Republic, a country of 10.6 million people.
Broadening the appeal of decentralization with proof-of-stake concepts
Unlike PoW blockchains, proof-of-stake (PoS) consensus mechanisms and other emerging means of establishing consensus on blockchains are expected to further promote decentralization by allowing greater network participation in establishing consensus. PoS shifts the focus of establishing consensus away from computing power and energy costs to a focus on network investment and participation. This is a dramatic departure from classic PoW consensus technologies that are currently used by the vast majority of blockchains, including the most widely used, Bitcoin and Ethereum.
The success of PoS consensus on newer blockchains has led to the planned adoption of PoS mechanisms by Ethereum in version 2.0, expected sometime in 2020. PoS has led to new and more innovative ways to determine consensus and allow greater participation in the network by its users. Delegated PoS (DPoS) and Liquid PoS” (LPoS) are newer means of consensus built on the foundation of PoS. Two of the top ten cryptocurrencies by market cap, EOS and Tezos, use consensus mechanisms derived from PoS concepts. In particular, DPoS allows holders of qualifying digital asset classes such as Tezos and EOS to earn additional income by indirectly participating in the network validation process.
An alternative to traditional lending and finance
The global economic system never experienced such swift and dramatic changes, with governments spending trillions of dollars to help their citizens and businesses impacted by the global economic downturn. Early drafts of the Stimulus Bill proposed by the House of Representatives in response to COVID-19 reportedly included references to using a means of distributing “digital dollars” as aid to those impacted by this pandemic. The former head of the Commodity Futures Trading Commission (CFTC), through the Digital Dollar Project, is lobbying for the research and discussion of advantages of digital dollars in both the private and public sectors.
The shift in thinking by governments and regulators, coupled with changes in the way we source and distribute funds, gives prominence to another development. The Decentralized Finance (DeFi), or Open Finance, movement promises a global, open alternative to traditional financial services – including lending, saving, trading and insurance. The goal of DeFi is to make these services accessible to anyone in the world who has a smartphone and an internet connection.
DeFi protocols built on existing blockchain technologies, such as the Ethereum solidity smart contract language, are emerging to provide additional means of liquidity to cryptocurrency users. Some of these DeFi protocols allow for peer-to-peer lending without a centralized authority in a way that is cryptographically secure. New products and services are being developed to take advantage of these decentralized peer-to-peer technologies.
Prepare for new developments now
It is essential for companies with blockchain technology infrastructures to prepare for newer digital asset classes and consensus technologies with forward-looking features. Platforms must be designed to scale with these new technologies to support expansion and growth. Also, engineering and security teams need to conduct research on the feasibility and security of these new cryptocurrencies – and a company’s product committees should review and approve them before they are put into production.
Partner, Practice Leader, Digital Asset & Partner in charge of the Northeast Financial Institutions Practice
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Director, Business Risk Services
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Manager, Digital Asset Practice
+1 415 365 5481