Your Ultimate Destination for Blockchain Knowledge
Harvard Mason Scholar Chuanwei Zou: The Ultimate Fate of Bitcoin, Tokens, and the Challenges of Blockchain Finance
Harvard Mason Scholar Chuanwei Zou: The Ultimate Fate of Bitcoin, Tokens, and the Challenges of Blockchain Finance

Harvard Mason Scholar Chuanwei Zou: The Ultimate Fate of Bitcoin, Tokens, and the Challenges of Blockchain Finance

Economics issues related to blockchain and digital cryptocurrencies

1. Can bitcoin futures stabilize the price of bitcoin?

Bitcoin futures from the CBOE and CME went live in December 2017, providing price discovery and risk management functions to some extent:

Source: CNBC, data updated to January 13, 2018

Looking at the general situation in commodity markets, futures trading does not necessarily reduce the underlying asset’s volatility. Bitcoin price volatility has not decreased significantly since bitcoin futures went live:

Data source: Yahoo Finance

Bitcoin futures are not traded in large volumes. As of January 13, 2018, CBOE January bitcoin futures had an open interest (open interest) of 2,918 lots and CME January bitcoin futures had an open interest of 727 lots, both corresponding to around 3,000 bitcoins, while there are currently over 16.79 million bitcoins in circulation. This suggests both that bitcoin actually plays a very limited role as a risk hedge and that institutional investor interest in bitcoin futures is still minimal.

2. The feasibility of a Stable token

The volatility of the bitcoin price is too high to be suitable as a medium of exchange or to develop bitcoin denominated cross-period financial transactions. Over the past 5 years, the annualized volatility of the Bitcoin price has been 190%, while the annualized volatility of the S&P 500 has been only 9%. Considering the liquidity and transaction costs of large-cap U.S. stocks, the S&P 500 index fund is a better medium of exchange than even Bitcoin. Some practitioners are experimenting with stable tokens (Stable token), and there are two representative approaches. The first is Tether, which claims to issue a token, USDT, at a 100% reserve, 1:1 exchange rate to the U.S. dollar, which is equivalent to adopting a currency board system. The market cap of USDT is now close to $1.5 billion (Coinmarketcap website data as of January 13, 2018), but it is not known if there is a full reserve of $1.5 billion. If investors realize that stable tokens like Tether do not have full reserves, a run will occur quickly. The second, Basecoin and MakerDAO, are still in development and both claim to mimic central bank open market operations, controlling the supply of digital cryptocurrencies by issuing and recycling digital cryptocurrency denominated bonds, thereby maintaining the exchange rate of virtual currencies against fiat currencies. For stable tokens, the “impossibility triangle” also holds, which means that at most two of the three goals of fixed exchange rate to fiat currency, free convertibility with fiat currency, and independent monetary policy can be achieved simultaneously. The stabilization tokens currently being tested adhere to the first two goals, which means abandoning the goal of an independent monetary policy. Not only that, these stable token experiments, all of which attempt to implement monetary policy through algorithms, amount to a complete abandonment of camera choices. In terms of human history, this would be the first time that a fixed exchange rate has been experimented with based entirely on rules.

3. fork (fork) normalization

The fork was initially seen as a serious challenge to the blockchain consensus mechanism. in April-May 2016, after the DAO financing project on ethereum was attacked, the organizers of the DAO financing project chose to abandon the project, thus causing the first fork of the ethereum blockchain. In August 2017, Bitcoin forked to create “Bitcoin cash”. Since then, various forked coins have emerged. In theory, anyone can create a forked coin as long as they have the computing power to back it up. There is usually a cap on the number of forked coins, part of which is “pre-mined” by the founders, part of which is given to the holders of the original coins, and part of which is reserved for the development of the forked coin community, which is equivalent to the “primary market” of forked coins. In the “secondary market”, fork coins are traded independently of the original coins. In terms of economics, the relationship between fork coins and original coins is equivalent to the replacement of old and new currencies, in which the new version of the currency is already available for use, but the old version is still in circulation. This effectively causes an increase in the issuance of currency and weakens the binding nature of the upper limit on the number of original coins. If there is no restraint in forking, there is a possibility of currency abuse. There is competition between various original and forked coins, close to what Hayek said about private currencies competing with each other. The digital cryptocurrency that wins the competition will have the following characteristics: 1. low transaction costs and high efficiency; 2. high security of infrastructure such as wallets and trading venues; 3. more stable prices, thus better assuming monetary functions such as medium of exchange and store of value. Because of the inherent network effect of cryptocurrency, only a few digital cryptocurrencies are expected to win out.

4. The unanswered question of ICO

The economic connotation of the tokens given to investors by ICO is unclear. Are the tokens equity certificates in the balance sheet sense, a voucher for access to future products or services, or something else? In terms of the functions achieved, ICOs and crowdfunding are very similar – ICOs that issue tokens as equity vouchers are close to equity crowdfunding; ICOs that issue tokens as vouchers for products or services are close to commodity crowdfunding. However, the economic connotations of tokens are not fully revealed or discussed in many ICO projects. SEC Chairman Jay Clayton, in an open letter dated December 11, 2017, argued that some ICOs have the characteristics of a securities offering ( ) Unlike crowdfunding financing , many ICOs occur afterIf the tokens are traded on the secondary market, especially on some virtual currency exchanges, then they can be traded on the secondary market. In theory, if a token is a certificate of interest, product or service, its valuation should be “anchored” to some fundamental factors. In reality, however, many tokens have been speculated to be priced well above the fundamentals. Some tokens are even speculated in the pre-sale phase (presale or pre ICO) before the ICO. The secondary market for tokens gives the ICO project team a channel to liquidate the tokens they hold, at a time when the ICO project may still be at the whitepaper stage. In traditional VC, entrepreneurs have a much longer time between getting VC investment and IPO. the ICO quick cash out mechanism, can distort the incentives of the project team. Token holders are in a more ambiguous position in the governance structure of ICO projects and lack strong measures to ensure that the project team is aligned with their interests in the long run. ICOs are difficult to ensure investor suitability. iCO projects are all at an early stage and very high risk. However, some ICO projects are effectively open to the public through virtual currency exchanges and do little to assess whether participants have sufficient risk identification and affordability. in December 2017, the SEC called off several ICO projects because they were allegedly offering securities to the public without approval. ( ) ICOs and the positive feedback mechanism of digital cryptocurrencies. ICOs generally charge top-ranked digital cryptocurrencies such as bitcoin and ethereum, which increases the demand for bitcoin and ethereum and pushes up their prices; and the bitcoin and ethereum prices, in turn, often become the benchmark for valuing the tokens issued by ICOs. In this way, a mutually reinforcing positive feedback mechanism is created between ICOs and digital cryptocurrencies. This is a major reason for the rise in prices of digital cryptocurrencies since 2017. However, once the prices of bitcoin, ethereum, etc. enter a downward path, this positive feedback mechanism will cause the prices of digital cryptocurrencies to fall at an accelerated rate.

5. Token Economy (Token Economy)

The token economy represents a promising class of blockchain application projects. In these projects, there is a real demand for trading behavior, but these trading behaviors were originally constrained by incentives, transaction costs or payments and other constraints to carry out effectively; by introducing tokens, these projects not only solve their own financing problems, but also alleviate the incentives, transaction costs and payments and other constraints faced by the trading behavior. It remains to be seen what successful projects in this area will be. A prominent issue at the moment is that the tokens issued by projects may be speculated to high prices through ICOs and virtual currency exchanges, despite the fact that the projects are not yet successful.

6. Regulation of digital cryptocurrencies

There is a distinction between over-the-counter and off-the-counter trading of digital cryptocurrencies. China has shifted many transactions to OTC since it clamped down on digital cryptocurrency exchanges and ICOs in August 2017 (in January 2018, our government began calling a halt to OTC trading and “offshore to domestic sales” of digital cryptocurrencies). Japan, on the other hand, is very tolerant of digital cryptocurrency exchanges. Exchanges provide liquidity for digital cryptocurrencies, so once listed on an exchange, the price of digital cryptocurrencies generally increases significantly, which is essentially a liquidity premium. (Coinbase’s launch of Bitcoin Cash trading in December 2017 did this to the price of Bitcoin Cash: ) Because the time it takes to confirm transactions on the blockchain is so many digital cryptocurrency exchanges effectively maintain a “cryptocurrency pool” and some transactions occur in the “cryptocurrency pool” rather than on the blockchain. These digital cryptocurrency exchanges can bear significant liquidity risk. Some digital cryptocurrency exchanges also provide leverage to investors. The low liquidity and high leverage of digital cryptocurrency trading can further amplify the downward trend through positive feedback mechanisms once digital cryptocurrencies experience a generalized and significant decline. Transactions in digital cryptocurrencies are agnostic as to the identity of the participants in the transactions even if they are recorded on the blockchain, coupled with the fact that many digital cryptocurrencies are held in very concentrated amounts (for example, according to Bloomberg, about 40% of Bitcoin is held by 1,000 people ( 12-08/the-bitcoin-whales-1-000-people-who-own-40-percent-of-the-market); the “pre-mining” mechanism of ICOs and forks can also result in a concentration of token holdings), making market manipulation possible. This makes market manipulation possible. The typical technique of market manipulation (also known as “pump and dump”) is that a number of large token holders conspire to drive up the price of tokens to attract retail investors to enter, and then the large investors concentrate on reducing their holdings, and those retail investors who do not “escape the top” will suffer losses. The retail investors who do not “escape” will suffer losses. Digital cryptocurrencies have been associated with illegal or gray trading from the very beginning. The early Silk Road website is a prime example. Digital cryptocurrencies have been used to circumvent capital controls, and in December 2017, The Economist reported that marijuana growers in California planned to launch a token, PerksCoin ( must-work-vulnerable-crooks-cops-and-even-combustion ). PerksCoin would both help them trade without banks and be safer than cash, gold, etc. in the event of a California mountain fire. Digital cryptocurrencies objectively also provide a boost to ISIS terror financing ( and North Korea. According to many reports (, http://, cyberatt), North Korea has not only been involved in “mining” but has also attacked several digital cryptocurrency exchanges and even the WannaCry bitcoin ransomware diseaseThe driving force behind the toxicity. The Bitcoin network already consumes more electricity in a year than the entire country of Ireland, and it’s growing rapidly ( ). Considering the pollution caused by thermal power generation (for example, the large number of bitcoin “mining pools” in Inner Mongolia, which consume a lot of electricity generated by burning coal), the bitcoin network is actually causing serious environmental pollution. China has taken a very cautious and necessary approach to regulating digital cryptocurrencies. However, many countries have very weak regulation of digital cryptocurrencies, particularly Japan and South Korea. Various departments of the U.S. government currently do not have a unified position on the regulation of digital cryptocurrencies: the U.S. Treasury Department is mainly concerned with issues such as tax evasion and illegal transactions caused by digital cryptocurrencies ( bitcoin-becoming-next-swiss-bank-account ); the SEC is very cautious about both ICOs and Bitcoin ETFs ( -dance-1515812258 ); after the U.S. Commodity Futures Commission (CFTC) allowed two major exchanges, CBOE and CME, to go live with bitcoin futures through a self-certification process (self-certificate) in early December 2017, it was met with industry organizations such as the North American Securities Administrators Association (NASAA) and the Futures Industry Association (FIA) The self-certification process is scheduled to be discussed at a special meeting on January 31, 2018 ( ). The pending regulation of digital cryptocurrencies includes:

to control electricity consumption and environmental pollution from “mining” (in January 2018, our government requested an orderly exit of mining companies in China, and some “mining pools” are preparing to move to Canada) );

taxation of digital cryptocurrency transactions;

Know Your Customer (KYC), anti-money laundering and anti-terrorist financing requirements for digital cryptocurrency wallets and trading venues;

ICOs involving illegal securities activities;

to combat market manipulation;

to protect investors’ rights (including investor suitability management);

the exchange link between digital cryptocurrencies and legal activities. This is the area where regulatory authorities should and are most capable of strengthening regulation. But Ken Rogoff, a professor of economics at Harvard University, notes ( ) that this area area needs to be regulated with greater global coordination, and as long as there are countries like Japan that are lenient with digital cryptocurrency trading venues, these countries will objectively provide a “gateway” for illegal transactions based on digital cryptocurrencies.

7. Central bank digital currency

Central bank digital currency is an electronic currency issued directly by the central bank to the public, which is a form of legal tender, can pay interest and serve as a medium of payment, and is interchangeable with cash and commercial bank deposits. In terms of economics, central bank digital currencies do not necessarily take blockchain. However, the system flexibility and stability provided by distributed ledgers are the most important considerations for the use of blockchain for central bank digital currencies. Public chains (free entry and exit) and workload validation, as represented by the Bitcoin blockchain, result in a waste of social resources (mainly computing power and electricity consumption). Therefore, central bank digital currencies tend to take the form of federated chains, where the central bank maintains the distributed ledger together with some specific institutions. Central bank digital currencies would constitute a new monetary policy tool – central banks regulate the macroeconomy by regulating the supply of digital currencies and interest rates. Central bank digital currencies could pay negative interest rates, thus helping central banks break through the zero interest rate floor and increase monetary policy stimulus during economic crises. Negative interest rates, on the other hand, are not possible while paper money is still in circulation because the people will withdraw their bank deposits and hoard paper money. A central bank digital currency will have a big impact on the payment clearing system. Instead of necessarily going through the secondary bank account system, payment clearing would be done directly on the central bank’s balance sheet. Thus, a central bank digital currency would help to strip commercial banks of their special status in the payment system and the resulting “too big to fail” problem. But it could also create instability in bank deposits, which people could withdraw and exchange for a central bank digital currency. This was one of the main considerations for the Bank of England in January 2018 when it said it would not experiment with a central bank digital currency ( ).

8. Blockchain in financial post-trade settlement

(This section is cited in Benos, Evangelos, Rodney Garratt, and Pedro Gurrola-Perez, 2017, “The economics The economics of distributed ledger technology for securities settlement”, Staff Working Paper No. 670, Bank of England. This report is the clearest I’ve read on the use of blockchain in finance (other than digital cryptocurrencies). (except for digital cryptocurrencies) is the clearest one I have read.)

There are 3 main components of post-trade settlement in finance: trade order management (including trade validation), clearing (i.e., calculating the financial obligations of both parties to the transaction), and settlement (i.e., the final transfer of assets). Central Security Depositories (CSDs) play a key role in settlement, undertaking 3 main functions, including: authentication (impartial and trusted maintenance of records of issued securities), settlement (transfer of ownership of securities from the seller to the buyer), account maintenance (creation and updating of ownership records of securities(Record). Sometimes the central securities registrar also performs functions such as securities custody, asset servicing, financing, reporting or securities lending. In financial post-trade settlement, multiple intermediaries are involved in a single transaction. Each intermediary uses its own system to process, send and receive trade orders, reconcile data, manage errors, etc., and maintain its own transaction records. The data standards used by each intermediary are also not uniform. All of this can incur significant costs. Blockchain technology can help create and maintain shared, synchronized accounts and simplify the transaction reconciliation process. Currently, the settlement industry is discussing the introduction of private, access-limited blockchain systems in post settlement of financial transactions. In this case, each node plays a different role and has different permissions to read information on the blockchain, and a group of trusted participants takes on the authentication function. The potential benefits of blockchain for financial post-trade settlement include:

simplifies and automates post-trade settlement through a distributed, simultaneous, shared record of securities ownership, reducing transaction reconciliation and data management costs;

shortens the time required for settlement and reduces settlement risk exposure;

facilitates post-trade settlement because information related to the transaction is shared by both parties.

promote automatic clearing because the information related to the transaction is shared between the two parties;

shorten the custody chain so that investors can hold securities directly, reducing the legal and operational risks and intermediation costs borne by investors;

have good traceability and transparency;

decentralization and multiple backups improve system security and stress resistance.” The challenges of

blockchain applications in financial post-transaction settlement include: How does

implement authentication functions? Although blockchain can guarantee the accuracy of a distributed ledger, a trusted authority is needed to ensure the authenticity of information about issued securities.” How does

implement the depository function? In particular, how can assets held by custodians and depositories be transferred to the blockchain. One possible solution is to use digital tokens to represent assets that are not on the blockchain, but a trusted authority is needed to ensure the correspondence between the token and the asset.” How does

enable Delivery versus payment (DvP)? This requires the blockchain to be able to handle cash accounts at the same time.” How does

ensure settlement finality? For example, the Bitcoin blockchain system can only ensure settlement finality in a probabilistic sense (although the probability tends to 1 over time) because of the existence of forks.

Can a record on the blockchain constitute proof of ownership in legal terms?

Transaction matching and error management. Blockchain faces a number of hurdles in comparing different dimensions of data and dealing with contractual mismatches and exceptions.

How to ensure the confidentiality of transaction information with multiple parties involved in verification. One option is that only a trusted institution and both parties to the transaction can participate in the consensus mechanism associated with the transaction. Another option is to distinguish between transaction data and the data required for validation. Zero-knowledge proofs (ZKPs) are also a possible solution tool.

identity management.


interoperability with existing processes and infrastructure.

The logic and issues to be solved in the application of blockchain in the registration, confirmation, and transaction of property rights are very similar to the financial post-transaction settlement. This reflects the general challenges that blockchain currently faces for large scale applications outside of digital cryptocurrencies. “Author of

, Chuanwei Zou, his public number: NIFIReview.