The new "digital currencies" have been known to a mass audience at the latest since they went through the roof in 2017 and floor-traded derivatives (bitcoin futures) were introduced. One thing before we start: No, companies do not have to rush out tomorrow and swap their cash for bitcoin reserves, nor do they have to switch all their payment transactions to cryptocurrencies.
Large companies such as Volkswagen, Bosch, BMW and Santander are jumping on the "crypto-bandwagon", launching cooperative ventures and their own service offerings in order to do so. Yet the ongoing discussion about cryptocurrencies could not be more controversial: The kaleidoscope of opinions ranges from a bubble to a snowball system to the revolutionising of the monetary system and the abolition of centralistic structures. So, what importance should corporate treasuries attach to cryptocurrencies?
The new "digital currencies" have been known to a mass audience at the latest since they went through the roof in 2017 and floor-traded derivatives (bitcoin futures) were introduced. One thing before we start: No, companies do not have to rush out tomorrow and swap their cash for bitcoin reserves, nor do they have to switch all their payment transactions to cryptocurrencies. This article is simply an attempt to bring light into the darkness of the rapidly changing and constantly expanding crypto-universe. Aspects of what we say here may be rendered obsolete within a few months. But that is precisely why we need to take a careful and critical look at developments. Doing so shows us that visionary projects such as the replacement of today's predominant monetary system are not the only issues at stake. As things stand, there are about 1,500 different cryptocurrencies, of which bitcoin, Ripple, Ethereum and IOTA are the four most important. Interestingly, though, adherents of cryptocurrencies are pursuing goals that are almost diametrically opposed to each other. They range from ideology-driven do-gooders to confidence tricksters riding the wave of hype in hopes of making a fast fortune, not to mention profit-oriented fintechs keen to establish their services within the regulatory framework of the existing financial system. All of which means that there are cryptocurrencies and cryptocurrencies… But, first things first:
The European Banking Authority (EBA) defines cryptocurrencies or virtual currencies (VCs) as "…digital representations of value that are not issued by a central bank or a public authority, nor are they necessarily pegged to a fiat currency. Virtual currencies are used by natural or legal persons as a means of payment and can be transferred, stored and traded electronically." According to this definition, the principal differences between most cryptocurrencies and paper money (fiat currencies) are therefore:
As with "traditional money", one pivotal characteristic of cryptocurrencies must be that they guarantee protection from forgeries and prevent individual units of money from being issued more than once. Most cryptocurrencies share a distributed ledger approach (based on a digital, distributed and normally public register of transactions). Distributed ledgers are realised using blockchain technology. "Blockchain" is defined as a continuously growing chain of records ("blocks") which are linked and secured using cryptographic methods, and which are executed and stored in a decentralised network (the distributed ledger). Distributed ledgers thus provide a transparent record of every detail of all transactions between parties. The network used for distributed ledgers consists of a large number of computers, all linked together over the Internet. There is thus no central instance to which information is transmitted. The information is known to all computers which participate in the network. For example, if a transaction is completed between parties A and B, the network verifies its truthfulness – based on historic account statuses and the transaction in the distributed ledger. A new block containing the information about the newly added transaction is then attached to the blockchain, which accordingly grows longer. Storing what are known as cryptographic, unique assets which are known to all participants in the network guarantees the integrity of the data, as does the unique and irreversible sequence of information blocks in the blockchain and, hence, the historical order in which transactions were processed.
Bitcoin is one of the first and best-known cryptocurrencies. Its market capitalisation of over USD 120 billion is currently the highest of all cryptocurrencies. The currency is created on a decentralised basis through a process known as mining. In this process, network participants are rewarded – with freshly minted bitcoins – for making computer processing power available for the processing and verification of bitcoin transactions (leading to what is called a consensus decision). Simply put, mining consists of solving a mathematical task that can be only be done with huge processing power. Though hard to perform, it is subsequently very easy to verify the correctness of completion. Whichever miner solves the tasks first makes their solution available to the other network participants, who confirm the correctness of the solution. Lastly, a new information block is added to (and extends) the blockchain for the correct result, which also contains the completed and now-confirmed transaction.
Assessment and importance to corporate treasuries: From the corporate and treasury perspective, bitcoins are not necessarily the focus of attention. One of the few possible application scenarios is for transaction processing in developing countries where corruption is rife and the currency system is unstable. Demand for bitcoins has, for example, risen sharply in Zimbabwe on account of hyperinflation. Be that as it may, one of bitcoin's essential aims is to become a genuine alternative to the established monetary and financial system. That, however, is still a long way off. Apart from numerous legal issues (such as liability and consumer protection), the fundamental attributes of money (e.g. universal acceptance and the obligation to accept it as a means of payment and exchange and as a store of value) are not given to a sufficient degree. Nor should we forget that governments and central banks are not about to give up their monopoly of money creation just like that. Bitcoin currently also "suffers" from technical and scaling problems. As things stand, the bottom line is therefore that, among known cryptocurrencies, bitcoin plays a pioneering ideological and technological role and demonstrates that cryptocurrencies are essentially technically feasible.
Ripple: Comparing Ripple with bitcoin is like comparing apples with pears. The private company behind Ripple has no aspirations to use blockchain technology to replace the payment transaction platform as we know it. Their aim is to use it to execute low-cost and secure (international) financial transactions in real time, and to do so significantly faster than bitcoin, for example: four seconds per transaction, according to the company itself. Ripple thus sees itself as a direct competitor to SWIFT and its Global Payment Innovation Initiative (SWIFT GPI). Industry heavyweights like Santander and SEB are already part of the platform. Alongside tech giants of the calibre of Google, they also participate as investors.
Ripple is based not on a publicly accessible distributed ledger – and hence not on a public blockchain, like bitcoin – but on an internal blockchain referred to as an "enterprise blockchain" ledger. In effect, it is also a kind of blockchain for "I owe yous" (IOUs) and supports transactions for a wide range of (fiat and crypto) currencies. Ripple requires neither the mining of coins (unlike bitcoin), nor complex, energy-intensive computing operations to verify completed transactions. Instead, the supply of Ripple coins created from the beginning is used by platform participants to pay transaction fees and as a bridge currency for exchange into other currencies. Ripple's security is based on the mutual trust of participants (usually financial institutions), which is rooted in bank-specific KYC and AML processes. When two contractual parties agree to issue IOUs to each other, this information is stored in the Ripple blockchain. Of crucial importance is the fact that permanent consensus must be reached between all parties in the network that are involved in a transaction. The Ripple system can store liabilities, but it cannot enforce them. Ripple users therefore have to state which other users they trust to honour stored IOUs in which currencies and up to what amounts. Where there is no direct relationship of trust between the sender and the recipient, the network attempts to find a user path along which each user has sufficient trust in the next user to enable payment to be forwarded. In this way, payments "ripple" though the social web of trusting relationships. The register clears all these payments against each other, and individuals can settle their reciprocal net debts outside the Ripple system. Ripple aims in particular to revolutionise international payment transactions and to compete with the SWIFT network. In the traditional payment transaction environment in place today, processing an (international) payment via SWIFT takes between two and four days or even longer, because the payment path passes through a number of fixed stations (mostly four to six) within the network of correspondent banks.
Assessment and importance to corporate treasuries: The Ripple solution can be a serious alternative to execute real-time payments at comparatively low cost. It is currently in the beta phase with 75 banks, and its success depends heavily on the extent to which it is adopted by the banking sector at large. At the same time, other competitors too are working hard to undermine SWIFT's dominant position. These include the Linux Foundation's Hyperledger project, the R3 consortium, a leading provider of blockchain-for-bank solutions, and indeed SWIFT itself, with an update to its own network. It can definitely do no harm to keep a close eye on developments in the Ripple payment infrastructure.
Ethereum serves not so much as a pure digital currency, but primarily as a platform on which two parties can enter into smart contracts. Smart contracts are digital protocols whose aim is to supersede analogue, paper-based contracts. The platform can thus be used to create, manage and exercise contracts, including a suitable array of optional rights and provisions. Known as ether, the currency itself serves merely as a "secondary means of payment" in the network for the purposes of transaction processing. As with bitcoin, transactions are validated on the basis of consensus decisions and the proof-of-work method.
Assessment and importance to corporate treasuries: There are all kinds of potential application scenarios for smart Ethereum contracts, and a number of companies are already using them. They range from logistical processes to the insurance trade and financing matters (such as project and trade financing). In the treasury context, trade finance, for example, is a popular candidate. Here, smart contracts can solve the inherent problem of trust during the transfer of goods, triggering related payments automatically and eliminating paper-based processes.
IOTA is one of the most innovative cryptocurrencies at the present time. Its stated aim is to become the established currency on the Internet of Things (IoT) for autonomous payments between machines, and for the associated exchange of goods and services. In the future its progenitors envisage, every car, parking meter or refrigerator will have its own account. The idea is to facilitate the extremely fast processing of mass (micro) payments while keeping computing and costs to a minimum. Volkswagen and Bosch are two of several companies that have recently announced cooperative ventures with the IOTA Foundation. Compared to the cryptocurrencies discussed above, IOTA requires far more transaction processing for which "conventional, sequential blockchain technology" is not sufficiently scalable. IOTA is therefore based on a development that goes beyond the traditional blockchain approach and uses what it calls the Tangle. In pure mathematical terms, the Tangle is a directed acyclic graph (DAG) – a method that again gets by without miners. To be able to complete its own transaction, every "user" (read: machine or object) must validate two other randomly selected transactions. Each participant thus makes a direct contribution to consensus building on the network. Unlike in the conventional blockchain, multiple transactions can be validated and executed in parallel in the IOTA Tangle. This means that the IOTA network can process more transactions simultaneously, and can do so faster than with the other cryptocurrencies.
Assessment and importance to corporate treasuries: Unlike the cryptocurrencies discussed above, IOTA is still in the test phase and has yet to prove itself in practice. If it does so, however, the potential applications are many and varied. The typical autonomous machine-to-machine (e.g. car-to-parking-meter) payment process often cited in relation to IOTA can, for example, also be applied to the (internal) production and (service) clearing process for products in a company. That in turn has a knock-on effect on intercompany finance, associated demand for the sourcing of liquidity and, overall, the lead time for cash conversion cycles.
Bottom line: What should corporate treasury departments do? Clearly, the world of cryptocurrencies is highly nuanced. At least at the present time, there is no question of the established monetary system being replaced. That said, it is evident that a "serious crypto-community" is taking shape whose ambition is to bring cryptocurrencies out of the shady, highly speculative niche they have occupied to date. From a corporate perspective, it is equally clear that analysis should focus rather on the technologies that underpin the cryptocurrencies. Blockchain technology, smart contracts and the like will create new ways to make existing processes faster, more efficient and less expensive. They will also minimise – and ideally eliminate – the associated risks inherent in trust. Even though some of these technologies are not yet sufficiently mature and have yet to prove their capabilities, it is apparent that the developments outlined above will soon have a major impact on core treasury processes such as payment transactions, cash and liquidity management, FX trading, financing activities and investment activities. But what must corporate treasuries do in response? As explained in the article on "digitisation in the treasury", treasuries must first and foremost assess their own digital maturity and ensure that they are getting the most of the (treasury) solutions that are already available. Only then does it usually make sense to think about how new technologies might be deployed. It is advisable to perform this inventorying exercise without delay, though. Why? Because, as this article powerfully underscores, technological development is advancing in leaps and bounds – and the gap between the leading edge and the status quo is widening all the time.