At least the succession to Salisbury was seamless. Arthur Balfour was the obvious choice, partly thanks to the accident of consanguity but also because his political career (since joining the Commons in 1874) suggested real political ability. At the time of his elevation to the premiership, Balfour had been piloting through parliament an Education Bill which began to extend previous provision of elementary schooling to the secondary level, entrusting responsibility to county and borough councils. Generally regarded nowadays as a sensible measure, at the time it aroused furious opposition from Protestant dissenters who, through compulsory local taxation, would have to cover the costs of teaching in Anglican (or Catholic) schools. Nonconformist objections to the proposal had been overridden by well-placed Anglican lobbyists, notably Salisbury's eldest son (who in 1903 was promoted to the cabinet alongside two cousins ‒ Balfour and his brother Gerald ‒ and his brother-in-law the Earl of Selborne). Equal opportunities were still a distant dream for progressive educationalists, but no-one could deny their existence within the Salisbury clan.

The terms of the Act were deeply unsettling to Joseph Chamberlain – a unitarian who owed his Birmingham powerbase to his identification with Protestant dissent as well as his charisma and business acumen. In its dealings with Chamberlain, the Conservative Party was not well served by the substitution of the dilettante Balfour for the Delphic Salisbury. If the succession had been determined on the grounds of political ability and seniority rather than the nepotism immortalized at the time by the phrase “Bob's your uncle”, Chamberlain would almost certainly have been the choice. As the Boer War came to its inglorious close, Chamberlain might not have been an ageing man in a hurry; but he was always a man with a plan. After dining with a group of young Conservative MPs in the spring of 1902, he confided that tariffs “are the politics of the future” (Gilbert 1991: 148).

Chamberlain was referring to a project that had been canvassed, particularly in imperialist circles, for many years, under various names – “tariff reform”, “fair trade”, “imperial preference”, etc. At its most basic, the idea envisaged protection of British products by means of import duties, which would be reduced (or waived entirely) in relation to trade within the empire.

Exactly when the “crypto winter” began is a matter of some dispute. Some date it to January 2022, when the price of Bitcoin fell from its peak of $67,566 on 8 November 2021 to $36,800, down 45 per cent. Cointelegraph described it as the worst January since 2018.1 Cointelegraph readers and others may have thought their troubles were over when the price rose again to $47,063 in March 2022, but the rally was followed by further disappointment when the price fell to $18,673 on 19 September.

Some analysts predicted a sell-off in equities and cryptocurrencies in both markets due to the anticipated tightening of monetary policy by the Federal Reserve. Similarly, the IMF argued that a “sharp decline in Bitcoin prices can increase investor risk aversion and lead to a fall in investment in the stock markets”.

The surge in equity and crypto investment during the enforced leisure and uncertainty of the Covid-19 pandemic led many to fall prey to the temptation to get rich quickly, enticed by the endless advertising of Bitcoin and other cryptoassets. Other investors were simply looking for better returns on their savings in a low interest market environment. The price of Bitcoin increased by 300 per cent in the first year of the pandemic.

Many in the crypto world argue that the “crypto winter” simply reflects the cyclical nature of the market downturn in the stock markets, as inflation has increased, interest rates are set to continue to rise and the magnitude of the economic destruction of the lockdowns becomes clearer. But the fall in Bitcoin's price is not part of the downturn in the equity markets, because Bitcoin does not have the same possibility of recovery as the capital markets. Bitcoin's value only depends on passing sentiment. It is not related to anything in the real world. The stock market has crashed or suffered periods of low returns throughout its lengthy history, but its recovery depends on economic growth and the ability of most, but not necessarily all, companies to recover.

This chapter examines some of the major cryptocurrencies that have sprung into existence following Bitcoin. Bitcoin continues to dominate this landscape but it did not remain alone for long, as many sought to improve on Bitcoin, whilst others saw opportunities for making a quick profit by offering new altcoins (alternatives to Bitcoins). Investors poured money into the various offerings, selling real-world assets, dreaming of becoming millionaires overnight. We shall consider the top altcoins in terms of market capitalization and examine how their structures differ, the impact of hard and soft forks and their defences against hacking. We shall see that Nakamoto's dream of “honest” nodes working together to record transactions in an immutable and transparent blockchain did not last very long, even for Bitcoin.

BITCOIN, SPEED AND HARD FORKS

The slow and expensive process of transferring Bitcoins from one person to another led to technical changes that sought to address Bitcoin's transaction processing capacity. One such development adopted by mining pools and companies was a soft-forking change, “segregated witness” (SegWit) the process by which the blockchain limit on a blockchain is increased by removing the signature data from transactions in order to provide more capacity so that more transactions can be added to the chain. The plan to further upgrade the Network to SegWit2x (a hard fork) was presented at the 2017 Consensus conference in New York, and was expected to be introduced in November by the Digital Currency Group with the support of some 58 companies, including wallet providers, exchanges, other businesses providing goods or services providing goods or services in the cryptocurrency space (but only seven miners). But by mid-November, a number of companies began to withdraw from the agreement in order to focus their resources on Bitcoin cash, but none of the miners formally withdrew from the agreement. Some thought it was too soon to upgrade the Bitcoin Network up to SegWit2x three months after it had been upgraded to SegWit.

Despite the adoption of SegWit Bitcoin was still experiencing congestion problems for transactions, which led to high transaction fees and slow confirmation. SegWit2x proposed to increase the size of the block from 1 megabyte to 2 megabytes.

The regulatory responses to stablecoins were at a national level in the first instance. But the advent of Libra triggered the intervention of the international standard setting bodies. Some crytpocurrency enthusiasts like to claim that national and international regulatory authorities are seeking to stifle innovation and are nervous about the potential threat to traditional fiat currencies. That is unfair. Regulatory authorities must clarify the nature of the business conducted by the stablecoin's ecosystem and apply the relevant existing regulations to the stablecoin arrangement on the principle: “same activities, same risks, same regulations”. That is entirely reasonable: if it is the same business, with the same risks, then there is no justification for exempting cryptocurrencies from the same rules.

The responses of individual jurisdictions have inevitably varied from one to another. Yet they are insufficient to handle the risks involved in the use of global stablecoins or smart contracts that apply across jurisdictions. Hence global international standard setting bodies have stepped in to establish standards for the challenges and risks for public policy, oversight and regulation. The first step, however, was to identify the risks from global stablecoins. This became an urgent issue after the publication of the Libra White Paper in June 2019.

THE COMMITTEE ON PAYMENTS AND MARKET INFRASTRUCTURE

The Committee on Payments and Market Infrastructure published its report in October 2019. It points out that recent stablecoin initiatives have highlighted weaknesses in cross-border payments and access to transaction accounts. Cross-border payments have remained slow, expensive and opaque. For stablecoins to do all they claim is only possible using their new technologies, they still have further requirements to meet. If the providers of the global stablecoins really do intend to serve the needs of the unbanked and underserved, then they must provide a safe store of value, and protection and legal certainty for their users, as well as being compliant with all the relevant regulations.

The Report sets out certain general principles to which the design of stablecoins should conform, whatever their design may be.

In this chapter, we shall examine in detail the initial launch of Facebook's Libra on the world. It illustrates all the issues involved in attempting to provide an alternative to a fiat currency and the need for safeguards.

In June 2019, Mark Zuckerberg's White Paper introduced Libra to the world. The original proposals have subsequently been watered down considerably and this chapter will explore the reasons for that.1 Libra was intended to be a global stablecoin, tied to a basket of currencies, instead of being tied to just one fiat currency or asset. The plan was to back Libra with a collection of low volatility assets, such as bank deposits and short-term government securities in currencies from stable and reputable central banks. For each Libra issued an equal value of such currency, or highly liquid government bonds would be placed on deposit with a reliable repository. But given the basket of currencies approach, it is inevitable that the value of the basket would fluctuate over time in response to developments in trade and their economies. Although Libra acknowledges that the value of the stablecoin fluctuates with the value of domestic or international trade currencies, it did not explain how the exchange rate would be calculated and made transparent to Libra holders. This is especially important for local currencies, where an increasing use of Libra could lead to another kind of “dollarization” of the currency, which in turn could lead to a depreciation of the local currency.

The governance of the Libra blockchain and Libra reserve is in the hands of the Libra Association, an independent, not-for-profit membership organization based in Geneva. The Association itself would include any entity that operates a validator node and holds a sufficient stake in Libra, the minimum being $10 million, which provides the investment entity with one vote but the same entity cannot present itself twice. Some of the founder members included Visa, Mastercard, Spotify, Paypal, Uber, Lyft and Vodafone, but Visa, Mastercard, Strip, eBay and Paypal since pulled out.

By April 2018, just over 82 per cent of initial coin offerings (ICOs) created their tokens using the Ethereum platform. Other platforms followed suit, including Waves, a Russian-based project founded in 2016, the second most popular platform after Ethereum, NEO (or Antshares), a Chinese platform NEM, and Stellar, claiming to be the best choice for ICOs that do not require a smart contract, as most do not. The ICO is a method of raising capital, using blockchain technology as part of their business model to provide a particular product or service. Sometimes, tokens are granted for the purpose of gathering a group of individuals interested in blockchain technology, or for social media or marketing reasons. Buyers are led to believe that their tokens will increase in value, or that they will become developers of the project, blockchain providers or used in marketing purposes.

When a cryptocurrency start-up wants to raise money, it usually publishes a “White Paper” which sets out details of the project, how much funding is required, and the length of the funding campaign. During the campaign investors buy some of the new tokens with fiat or digital currency. If the funds raised do not reach the minimum level required by the firm, the monies raised may be returned to the backers and the ICO will be regarded as unsuccessful. The ICOs are advertised on the internet and social media as well as through the blockchain community and its publications. The popularity of ICOs grew steadily from 2013 onwards, reaching its peak in 2017 through to the first half of 2018.

Between 2016 and 2017, over 3,000 ICOs raised billions of dollars, with estimations ranging from $3 billion to $75 billion with more funds raised in the first six months of 2017 than in the previous three and a half years. The first expected mega ICO took place in 2018: Telegram raised over $1.7 billion in two separate private token sale rounds, followed by EOS unexpectedly attracting $4.1 billion.

Telegram Open Network (TON) was launched in 2018 but it was not until June 2019 that details of the project were published by a Russian research agency. The project was developed by the Durov brothers, who later fled from Russia to reside in Saint Kitts and Nevis.

Satoshi Nakamoto published the paper, “The Peer-to-Peer Electronic Cash System” in October 2008 and in 2009 he mined the first Bitcoin on the Bitcoin blockchain, now known as the Genesis Block. Bitcoin's aim was to replace banks with a new currency without financial intermediaries of any kind. It was launched at a time when trust in the traditional banking system and central banks had been sorely tested after the global financial crisis. This “new” form of money created great excitement. It promised a way forward that escaped the dominance of the central banks over the supply of money, and of transferring value from one person to another person without expensive intermediaries.

The use of the word “coin” is misleading in the case of Bitcoin, as it is completely digital. It does not represent notes, bills or coins. A person who owns Bitcoins has a long series of numbers, the “private” key, which is the key to the place where Bitcoin is stored in the one and only Bitcoin “bank”. Using that key, a person can transfer Bitcoin to another person, that is, to the key known to that person. The transactions are recorded in an ever-growing ledger, holding all the Bitcoins ever created and all the transactions which have ever taken place. The many transactions are stored in a block and all the blocks are linked together in a chain, with the first block, the “root block”, holding the first Bitcoin ever created. The ever-lengthening chain of transaction-holding blocks, the blockchain, are stored on many computers, all networked, so that even the loss of dozens of computers would not cause a problem. A block is only added to the chain when most of the computers agree that everything about the new transactions in the block is correct, after which all the computers store the newly lengthened chain of blocks. The miners are paid with newly minted Bitcoins in exchange for their work.

Nakamoto announced that his electronic transfer system does not rely on trust in any intermediary.

As the world of digital currencies continues to develop, so has the work of central banks and other institutions seeking a deeper understanding of the benefits and risks involved in digital currencies, particularly the use of DLT to provide a faster and more efficient means of payment that might benefit the public. A number of pilot test projects, or proof-of-concept projects, using a consortium of financial institutions under the auspices of the regulatory authority were instigated in 2016. One such project is Project Jasper launched back in 2016 by the Bank of Canada, the Toronto Stock Exchange and the R3 Group.

Project Jasper consisted of three phases: Phase I, from March to June 2016, was designed to investigate the use of central bank-issued receipts for deposited currency to support settlement on a DLT developed and built by the Project Jasper team. Phase II, from December 2016 to April 2017, was a private–public initiative to explore a wholesale payment system, using DLT, which found that a stand-alone payments system was not as useful as a centralized payments system in terms of core operating costs. Phase III was concerned with an integrated payments and securities infrastructure. Project Jasper concluded that the proof-of-concept was too limited, since it did not apply to exchange-traded equities after novation and netting by the Canadian Depository for Securities. Instead, it created a loose integration of the large transfers system and the CDS for equities. Andrew McCormick, Vice President of Payments and Technology at Payments Canada, commented that “it is less about the technology … it's more about the regulatory, the legal and the monetary issues”.

Project Ubin, set up by the Monetary Authority of Singapore (MAS), was a collaborative project in 2016 to explore the use of DLT for clearing and settlement of securities and payments. Its report concluded that the key technological issues had been resolved for clearing, settlements and payments processing for domestic payments and could become “more efficient, if only common standards and common platforms were in place”. But a key challenge in achieving a common international platform for cross-border payments is the “question of governance and ownership”.

In simple terms a smart contract is a self-executing contract with the terms of the contract between the buyer and the seller being directly written in lines of code. The code and the implied agreements run on a blockchain platform and cannot be changed. These contracts were first proposed by Nick Szabo in two articles in 1996 and 1997. In his first article, he stated that “new institutions and new ways to formalize the relationships that make up these institutions, are now made possible by the digital revolution … I call these new contracts ‘smart’ because they are more functional than their inanimate paper-based ancestors. No use of artificial intelligence is implied. A smart contract is a set of promises, specified in digital form, including the protocols within which the parties perform on those promises.” The contract itself is a software programme written in one of the new languages, such as Solidity. The code itself can be either the sole expression of an agreement between two parties or it might be in addition to a traditional written contract, implementing certain elements.

In his second article, Szabo described smart contracts as combining protocols with user interfaces to formalize and secure relationships over computer networks. The objectives and principles for the design of these systems would be derived from legal principles, economic theory and theories of reliable and secure protocols. He claimed that by using cryptographics and other security measures, it would be possible to secure many algorithmically specifiable relationships from breaches by principals, eaves dropping or malicious interference by third parties. This would reduce the “mental and computational transaction costs imposed by the principals, third parties or their tools”. His comments about the use of the word, “smart” together with the rejection of artificial intelligence is important, since it makes it clear that they are only “smarter” than traditional paper-based contracts because they can automatically execute certain preprogrammed steps. Smart contracts at present are fairly basic, because they have to be absolutely specific – if x, then y – and unalterable. Szabo's typical analogy of a smart contract is a vending machine. Once the buyer has fulfilled the terms of the “contract” and put the coins into the machine, then the machine automatically fulfils the terms of the unwritten agreement and delivers the bar of chocolate.

This review of the decade or more of cryptocurrencies has demonstrated that the dramatic “revolution” promised with the emergence of Bitcoin has not occurred, nor is it likely to occur. Bitcoin continues to exist as a rather dubious investment for the foolhardy, a useful means of conveying value, mainly for nefarious actors. In spite of the limitations of Bitcoin, its emergence and along with the whole panoply of stablecoins, continues to reverberate with central banks, particularly in the provision of cross-border payments, which remain slow, expensive and opaque. This is said to be especially burdensome for the 1.7 billion people globally without a bank account or with very limited financial services. It was at first assumed that cryptoassets and the technological innovations they embodied would overcome the problems. But as we have seen the original cryptoassets were too volatile for these purposes. Stablecoins were introduced to provide “stability” by linking the price of the “coin” to a specific currency or to a basket of assets. But, if stablecoins could ever fulfil the role of a reliable means of exchange, especially for cross-border payments, then a series of significant risks would have to be overcome. Generally, stablecoins have been unable to handle the risks involved, or have been unwilling to do so. The “wild west” era of initial coin offerings did not help. Nor, on the other hand, did Libra, but from an entirely different angle. Indeed, some see Facebook's formal introduction of Libra to the world on 18 June 2019 as a key moment, marking a threat to central banks monetary authority and their role as providers of fiat currency and prompting their interest in central bank digital currencies.

The response to Libra was indeed a “tipping point”, and the reasons for the reaction to Libra will be explored more fully in the following chapter. The focus of this chapter will be on the role of cash (notes and coins). Many central banks are concerned about cash: either the costs of its production and distribution in some locations or the decline in its use. If the use of cash is in decline, then the case for introducing CBDC is stronger than it might otherwise be.

The regulatory response to the initial coin offerings of 2017–18 proceeded slowly and varied considerably between one jurisdiction and another. This was in part because there was no agreed classification of cryptoassets. Depending on how they were used by the issuer they could be construed as a means of exchange, a store of value, or investment tokens, supposedly providing ownership rights, or dividends. And utility tokens provide access to a specific product or service. The situation is even more confusing because some cryptoassets fall into more than one category.

Similarly developments in the cryptocurrency world also led to further changes in the approach to regulation. The differences in approach meant that companies in the virtual asset or currency business could select the jurisdiction which best suited their purposes. The fact that cryptocurrencies have become multibillion-dollar industries has, of course, attracted investors in every part of the world.

THE UNITED STATES

The United States regulatory structure enabled the regulatory authorities to accommodate cryptoassets with ease. On 1 December 2017, the CFTC first approved trading in Bitcoin futures and then later virtual currencies. This might seem odd at first, but the Commodity Exchange Act gives such a broad definition of “commodity” that it can cover “all services, rights and interests … in which contracts for future delivery are presently or in the future dealt with”.1 The CFTC's focus is on the risk transfer markets and derivatives, which are largely traded by big institutions, not on the retail market, which is the SEC's concern. The then chairman of the CFTC, Chris Giancarlo was a well-known advocate of virtual currencies. The CFTC has jurisdiction when a virtual currency is used in a derivatives contract or if there is fraud or manipulation involving a virtual currency traded in interstate commerce. The CFTC issued a statement supporting interpretive guidance on actual delivery of virtual assets in March 2020. The CFTC concluded that an actual delivery has occurred when the customer has the ability to take possession and control of the “entire quantity of the commodity” however it was purchased (e.g. using leverage) and is able to use “freely in commerce” no later than 28 days from the date of the transaction.

In previous chapters, we have explored some of the major motivations for central banks considering the introduction of CBDC. One such consideration was financial inclusion, making banking services available to the unbanked. In the United States approximately 7.1 million households were unbanked in 2019. There are, however, much simpler ways of providing bank account access to those on low incomes than via a CBDC and it is something many other countries have been addressing. The UK, for example, introduced in the mid-1990s by agreement with some of the leading banks what were then called “basic bank accounts”. These were (and still are in the newer version) a simplified form of a current account, providing direct debit facilities, a debit card, access to ATMs, and over-the-counter (OTC) banking, but no overdraft facilities. These accounts do not attract any charges. In 2014, the EU Directive extended the provision of fee-free bank accounts to each member state (which applied to the UK then as well), which led to the expansion of such provision in the UK, following its implementation. By the middle of 2016, 4 million new bank accounts had been opened in addition to the 3 million existing “basic bank accounts”. By September 2020, the number of the unbanked had fallen to 1.2 million. The remaining the lack of take-up is thought to be due to language barriers and, lack of ID for the KYC requirements. Provision for the unbanked does not require the introduction of CBDC accounts, but the introduction of “free banking” for those on low incomes.

The other motivation for CBDC is faster payments. In a recent article, Sir Jon Cunliffe, Chair of the Committee on Payments and Market Infrastructure, explained that it can still take as long as ten days to transfer money to some destinations at a cost off 10 per cent of the transaction, if it has to pass through correspondent banks and through a number of currencies for certain jurisdictions. 2 However, not all international transfers take as long as that. The Society for Worldwide Interbank Financial Telecommunications’ (SWIFT) timeline for international transfers is one to four business days.

The short turbulent history of cryptocurrencies demonstrated several key issues, central among them the lack of trust and extreme volatility. These made Bitcoin and other cryptocurrencies only useful for speculative investment and not as a means of payment. There were two periods of boom and bust with Bitcoin: the first in late 2013/early 2014, that ended with the high-profile hack of the Mt Gox exchange and the second in late 2017/early 2018, when the market capitalization of Bitcoin, Ether and other cryptoassets peaked at $830 billion before crashing. It became clear that the extreme volatility of existing cryptocurrencies meant that they could not be used as a means of payment, a store of value, or a unit of account. The introduction of stablecoins directly addressed the need to reduce volatility by tying digital assets to more reliable, that is, more stable assets such as the US dollar, gold and oil. They were intended to offer the best of both worlds: instant processing, security and privacy of payments and the stable valuations of fiat currencies.

We can breakdown stablecoins into three main types based on how they work: collateralized, crypto-collateralized and non-collateralized. Collateralized stablecoins are linked to a fiat currency, such as the US dollar. Other forms of collateral can include precious metals, or commodities such as oil. Most in fact are linked to US dollars on a one-to-one basis. The reserves are supposedly maintained by custodians and are regularly audited. Crypto-collateralized stablecoins are backed by other cryptocurrencies. Since the reserve currency is very likely to be prone to volatility, these stablecoins are over-collateralized by maintaining a much larger number of cryptocurrencies as a reserve for issuing a lower number of stablecoins. For example, $2,000 worth of Ether may be held as a reserve for issuing $1,000 worth of crypto-backed stablecoins, allowing for 50 per cent swings in the reserve currency. They are supposed to have more frequent audits and monitoring to ensure price stability. Most of these stablecoins use an approach called collateralized debt positions (CDP), a complicated approach that involves the user of the stablecoin opening a CDP by depositing digital assets into a service provider's smart contract, such as Zig.