How to Address the Disruption Generated by Cryptoassets

In 2009, the international financial system experienced one of the worst episodes of distrust in its history. The preponderance of moral hazard –opportunistic behavior in transactions with asymmetric information– in some of the most important financial institutions in the world brought the economy to the brink of collapse.

In response, governments implemented multimillion-worth bailouts with public money in order to keep the payment system operating. However, citizens made their anger heard: from signs of rejection of the central authorities to movements such as Occupy, serving as a social feeling thermometer. Time has cured most of the bitterness and ideologies in favor of abolishing the current financial system, but one idea has managed to hold its own and proliferate to this day, producing a disruptive phenomenon that has awakened enormous interest in all and sundry: cryptoassets.

Blockchain as a trigger for cryptocurrencies

Originally presented as an electronic payment method, bitcoin was a revolutionary breakthrough in various areas of economics, finance, and computer science. In contrast to the centralized payment system, where a regulatory authority is in charge of recording electronic transfers from one account to another, the blockchain system operates under the peer-to-peer (P2P) principle. In this model, users form part of a network where each node stores a copy of the transaction log.

Oddly enough, the same kind of moral hazard that beleaguers today's financial system is reappearing in blockchain. The incentive to record apocryphal transactions –also known as double-spending– made it impossible to implement a decentralized recording system. This is where the value of cryptoassets really comes in: the use of encryption technology greatly reduces (although never to zero) the probability of presenting these counterfeits.

The blockchain system is designed in such a way that the aggregate computational capacity of the entire network cannot solve a numerical problem in less than the allowed time. If the processing power increases, the algorithm becomes more complicated to guarantee that the block creation frequency is more or less constant. In this way, the opportunity cost of trying to falsify a transaction is so high that the rational response is to stick to the rules.

Inspired by this innovative data recording mechanism, the new assets generate value not only from a balance sheet between accounts, but also the encrypted information can now include, among other things, contracts, public information, campaign promises, and works of art. Together with the open-source principle with which this technology began, the proliferation of these assets has been exponential over the past few years. Therefore, it is worth examining the ethical and moral issues of these new technologies within the socioeconomic context, particularly in Latin American countries.

The urgency of cryptoasset regulation

Historically, these assets have been dealt with in a variety of ways in the legal and regulatory arena, with a spectrum that ranges from utter indifference to absolute prohibition by the authorities. It can be argued that technological development has nothing to do with morality, since the agents of and the use given to these tools can be beneficial or detrimental to society. Hence, there is an unquestionable need for regulation in order to capitalize on the advantages and reduce or eliminate the vices that could arise from the incorporation of these assets into the international financial system.

In most of the countries considered underdeveloped (or developing), the economic and political elite relies on the local population to accumulate wealth, as they did in the colonial era, taking advantage of the opacity provided by social structures. As a result of this situation, the incorporation of P2P technologies can contribute to the transparency of public accounts, giving citizens the power to protest against corruption, while contracts and public tenders could attract foreign investment.

Moreover, emigration has proliferated in Latin America in recent decades. The economic motivation behind this phenomenon is to obtain a higher remuneration for work than in the country of origin. However, extending the analysis to households, migration takes place to improve the well-being of those left behind: entire families that, unable to support their basic needs, depend on the extra income that comes from abroad. At present, remittances pass through the international financial system by means of intermediaries. The result is that a large part of the wealth generated does not end up in these households. In the case of bitcoin technology, it is possible to make transfers in regular 10-minute frequencies, thereby eliminating the need for an intermediary.

However, these payment methods have been used to access black markets without any record of the transactions carried out. Apart from exporting labor, the region’s countries are characterized by drug trafficking, meaning that international payment systems without intermediaries will reduce operating costs for criminal activities as well. Absolute unregulated implementation could benefit households with members working in other countries, but it would also foster the emergence and consolidation of international criminal organizations.

Another recent aspect is rising inflation. This phenomenon is characterized by the loss of purchasing power of the local currency which, increased by expansionary monetary policies, is one of the causes of society’s impoverishment. In response, the acquisition of a stable-coin-type cryptoasset could offer an alternative to savings accounts, since these assets operate by maintaining an exchange rate against a more stable currency, such as the US dollar. In the face of an inflationary event, cryptocurrencies can function as a haven asset.

However, financial openness without adequate regulation could accelerate and enhance these episodes. Speculative attacks against a country's currency or capital flights owing to distrust, would leave public finances and the banking system in ruins. Serving the purpose of supporting the population’s purchasing power, the risk of the collapse of the financial system makes the openness and acceptance of these policies questionable. For this reason, and as occurs with remittances, legislation is needed that considers the advantages these technologies offer, without overlooking the risk their adoption implies for macroeconomic stability.

The digital revolution has brought about a paradigm shift in different areas of human interaction. On the part of economics and finance, the most relevant phenomenon has been the development of electronic assets with a value based on cryptography. The capacity of these new technologies to increase the efficiency of information and resource exchange and validation processes represents an unquestionable advantage.

However, as with other developments, the discussion goes back to the ethics implied by its use. Faced with this dualism, the answer cannot be found in the extremes of unquestionable adoption or complete prohibition, but  rather in the study and development of a regulation that would make it possible to obtain the greatest social benefit at the lowest possible cost.

*The content of this article is based on a chapter we wrote on the challenges and complexities of the disruptive monetary phenomenon, included in the book Data Analytics Applications in Emerging Markets (Springer 2022).

The authors are graduate of the Ph.D. in Financial Sciences, EGADE Business School, and professor at the School of Business of Tecnológico de Monterrey (Mario I. Contreras) and researcher at the School of Business of Tecnológico de Monterrey (Daniel Cerecedo).