In 2008, a series of financial missteps – both accidental and intentional – culminated in a global economic meltdown that saw individuals and small businesses suffer the most. The response came in the form of Bitcoin, a cryptocurrency that was aimed squarely at the traditional financial system’s inability to protect its citizens’ wealth. The subsequent growth of this new paradigm of money has since been a source of concern for governments around the world.
Initially serving nearly exclusively as a tool to sidestep regulators and trade illicit goods, Bitcoin matured into a legitimate (but volatile) store of value that has inspired thousands of other cryptocurrencies in its wake. The ecosystem is now brimming with innovation, leading to all manner of financial applications that operate and thrive in an unregulated environment.
While these applications are currently being used by a relatively small number of people, they have the potential for astronomical growth, causing what could be a major upset for unwitting regulators.
Augur, an Ethereum-based application, allows users to create and bet on all manner of predictions. These predictions could be about the outcome of a football game or the weather in Toronto in 10 days time and everything in between.
With enough money flowing through these markets (liquidity), Augur expects forecasters to benefit by providing an unprecedented “wisdom of the crowd” that is sourced from anyone anywhere in the world, allowing for the creation of unique insurance products as well as the ability for individuals to monetise their knowledge by predicting outcomes correctly.
Unfortunately, prediction markets have a strong overlap with sports betting, a form of gambling that the USA has placed in a regulatory stranglehold for nearly three decades. While the grip of regulators is loosening, this type of unchecked activity could worry regulators in the coming years.
It is expected that Augur, which is due to launch a major overhaul in the coming weeks, will find itself facilitating tens of millions of dollars in betting for the 2020 Presidential Election. It may, at this point, draw fire from regulators in the USA.
Prediction markets are one thing but what about traditional casino games? In most western countries, gambling is well regulated, ensuring that casinos act honestly and users avoid heavy financial losses. However, by using a decentralized platform like Ethereum, it is possible to create a gambling game that avoids regulatory oversight.
At this point in time, the throughput capacity of the Ethereum blockchain only allows for a few dozen transactions per second and blocks take roughly 15 seconds to confirm. This means that a user who wished to use a decentralized slot machine would need to wait 15 seconds after every spin before knowing whether they had won or not.
However, with the introduction of “Optimistic Rollups” and a major network upgrade for Ethereum that begins rolling out later this year, it will be possible for casino games to allow for immediate results with the capacity for many thousands of transactions per second.
This type of unfettered gambling will add to an already enormous list of Bitcoin casinos and no doubt frustrate regulators along the way. However, there is a significant upside to this type of betting — software running on Ethereum is immutable (cannot be changed), transparent and auditable by anyone in the world. A well functioning gambling game on Ethereum would be more secure and more trustworthy than anything that came before it.
Bitcoin has been great for users wishing to untether from the traditional financial system, however those holding BTC are limited to simply storing or transacting the currency. This is far removed from Ethereum, whose ETH token holders can partake in a vibrant ecosystem of decentralized finance (DeFi).
DeFi applications allow users to lend, borrow, save and trade (amongst other things) without a centralized third party. This type of functionality has led to incredible innovations such as decentralized stablecoins, the Dai Savings Rate, Flash Loans and a host of other applications.
While Bitcoin can be regulated at the point between the physical world and the virtual world (exchanges), Ethereum users need not interface with the physical world once they enter into the system. It is possible to move between ETH and stable currencies without any oversight, and borrowing or lending can be done through smart contracts without discrimination.
The DeFi ecosystem is growing at a rapid pace with innovations that are creating huge benefits to the network’s users. As usability improvements make their way to ETH and DeFi moves into the mainstream, the existing financial infrastructure and its regulators may find themselves struggling to maintain their grip on monetary policy.
While not a typical cryptocurrency in the sense of Bitcoin or Ethereum, Libra has signalled a sign of what is to come when a network has the potential for onboarding millions (even billions) of people.
Since its conception, Libra has faced enormous criticism from the US and Europe alike, with many raising questions over whether the Libra Association (the gatekeepers of the network) can be trusted.
However, Libra also revealed what may be governments’ greater concern – the threat that decentralized currencies pose to monetary policy. Libra, which hoped to digitize the dollar, euro, pound and others inside a stable basket of currencies, found themselves attacked for their potential to destabilize economic powers by dampening the effect of central banks and governments.
What Libra has shown is that – once large enough – decentralized finance may face the same questions and attacks from governments and regulators the world over.
Can these markets be regulated?
Any fear or worry that regulators might have may well be impossible to act on. The decentralized nature of Bitcoin and Ethereum means that any attempt to censor or stop transactions is futile. The amount of resources required to carry out such an attack would be enormous with no guarantee of success – potentially only going so far as to strengthen the resilience of these networks.
It is more likely, then, that regulators will aim to facilitate and build upon these platforms, allowing users to more easily comply with regulation without the need for heavy handed, innovation-stifling regulation that could backfire in extraordinary ways.
*This is a guest post by Nick Hawke, of The Bitcoin Strip.