What is cryptocurrency and how is it used?

As an introduction to a webinar series this month on cryptocurrencies from a trust and divorce perspective, Lucinda Brown and Virginia Szepietowski examine how cryptocurrency is used as a digital currency and how transactions take place on the blockchain, creating a foundation for its use in wider industry, particularly in the Channel Islands.

Why cryptocurrency was created

Cryptocurrency originated from three key movements:

• the desire to remove governmental power and control in favour of an anonymous online community;
• the theory of decentralised digital cash, free from financial institutions; and
• the invention and implementation of the distributed ledger technology which made it possible.

What is cryptocurrency?

Cryptocurrency is a decentralised digital medium of peer-to-peer value exchange that uses technology, called blockchain, to verify transactions.

How does cryptocurrency work?

Bitcoin, for example, has no central governing body, so mathematical algorithms are used to control the creation of ‘tokens’ and verify the transfer of tokens documented on the ‘ledger’. At the very heart of cryptocurrency lies the idea of decentralisation. The blockchain is a public chronological chain made up of single transactions (blocks) which have taken place on the bitcoin network. So transactions are anonymous not private.

So, what happens on the blockchain when a bitcoin transaction is made?

• a new transaction is entered;
• the transaction is transmitted to a network of peer-to-peer computers scattered across the world;
• the network of computers then solves equations to confirm the validity of the transaction;
• once confirmed to be legitimate transactions, they are clustered together into blocks; and
• the blocks are chained together creating a long history of all transactions that is permanent; and
• the transaction is complete.

How is cryptocurrency used in practice?

Individuals store their crypto in a digital anonymous ‘wallet’ denoted only by long series of numbers and letters, like a digital Swiss bank account. If you lose your wallet keys, the funds are irrecoverable, as they are completely anonymous. This also means that authorities have no way of tracking transfer of cryptocurrency from one user to another, digital footprints are only made when you exchange your crypto for fiat currency, eg dollars or pounds.

The most popular way to buy cryptocurrency or exchange a crypto coin for a fiat currency is via a third party exchange. This is usually an app which links your fiat bank account, eg Barclays, with your online cryptocurrency wallet. This bridge between crypto and fiat is an ideal target for regulation, where regulators try to implement anti-money laundering regulations and attempt to monitor the transfer of funds to track tax evasion and facilitation of other criminal activity.

Cryptocurrency in the Channel Islands 

The Channel Islands have proved themselves to be pioneering and cryptocurrency-friendly jurisdictions, demonstrated by the world’s first regulated Bitcoin investment fund being approved and launched in Jersey, proving the Channel Islands to be a popular destination for investment and fintech funds, token issuers, and exchange vehicles, such as ‘Binance’.

The overriding concern for many cryptocurrency users is the lack of recourse available in the event of theft or lost keys, this is by no means specific to the Channel Islands and remains a global issue as the lack of central authority underpins the very nature of the anonymous currency. Whilst no cryptocurrency or blockchain-specific legislation has yet been introduced in the Channel Islands, regulation of the various cryptocurrency-related areas, such as Initial Coin Offerings and exchanges in Jersey, is sufficiently covered by Jersey Financial Services Commission (JFSC) Guidance and wider financial legislation, such as the Financial Services (Jersey) Law 1998 (FSJL).

BDB Pitmans will be hosting two webinars on cryptocurrencies from a trust and divorce perspective. We will be joined by an expert panel of speakers for two interactive sessions which will provide essential guidance for trustees and their advisers. Please click here for more information and to RSVP.