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FINANCIALLY AESTHETIC · GUIDE 33/37
CRYPTO FUNDAMENTALS: BLOCKCHAIN, COINS, TOKENS & TOKENOMICS
FA-7.1 · Crypto & Digital Assets
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RISK FRAME
Crypto mixes networks, assets and incentives; if you can't separate them, the marketing wins.
What Are Cryptoassets?
Cryptoassets are digital assets - intangible assets whose value is determined by supply and demand - that use cryptography (a method of securing data, hence the term “crypto”) and a peer-to-peer network - a computer network in which computers are directly connected to one another. Information is therefore transmitted directly from one computer to another without going through a central server, and a digital distributed ledger system to record transactions. A distributed ledger uses independent computers (called nodes) to record, share, and synchronize transactions.
According to the Banque de France, a cryptoasset is “a digital asset created using cryptographic technologies. They are so named because they resemble financial assets and are created and used via encryption technologies.” Broadly speaking, cryptoassets are virtual assets stored on an electronic medium that allow a community of users who accept them as payment to conduct transactions without having to use legal tender.
According to the Financial Action Task Force (FATF), a virtual asset (or crypto-asset) is a digital representation of value that can be exchanged or transferred digitally and used for payment or investment purposes. This definition encompasses various forms of assets, such as Bitcoin, tokens issued during initial coin offerings (ICOs), and stablecoins, which are virtual assets (VA) designed to maintain a stable price relative to a reference value.
Bitcoin is the largest and best-known crypto.
- Unlike legal tender, Bitcoin is not issued by a government or a central bank;
- Generally speaking, Bitcoin is traded when a transaction between two parties is added to the blockchain;
- Transactions on the blockchain take place without the involvement of an intermediary.
In addition to Bitcoin, there are many other cryptos, such as Ether (Ethereum), XRP (Ripple), and Litecoin (Litecoin). None of them are legal tender.
Although certain cryptoassets (cryptocurrencies) can be used as a form of payment or a medium of exchange, they are not legal tender in Canada. In Canada, only the Canadian dollar is legal tender.
Under French law, a cryptoasset is not a currency: it is not backed by any institution, does not have legal tender status - which makes it difficult to assess its value - and cannot be saved as a store of value. According to Article L111-1 of the Monetary and Financial Code (CMF), “the currency of France is the euro.” It is therefore the only currency that is legal tender in France. Thus, while a business may agree to accept payment in cryptoassets, nothing prevents it from refusing them either.
Bitcoin as a Native Asset: Issuance and Programmed Scarcity
Bitcoins are created out of thin air (they are referred to as native assets) and then traded through a decentralized network of computers (the term “decentralized” is used because there is no easily identifiable central controlling body). The price of Bitcoin is not determined by any institution but by the forces of supply and demand, noting that the Bitcoin blockchain’s computer protocol limits the total number of Bitcoins in circulation to 21 million, which creates an artificial scarcity effect.
What is traded on this system are not euros or dollars, but digital assets called Bitcoins. These Bitcoins are created out of thin air (they are referred to as “native assets”) and then traded through a decentralized computer network. The security of these transactions relies, among other things, on cryptographic techniques (from the Greek “crypto,” meaning hidden, and “graphy,” meaning writing). This is why Bitcoin is part of the “crypto-assets” family. While Bitcoin is the most widely publicized and highest-valued crypto-asset, as of mid-2023, there are more than 25,000 such assets worldwide, including Ether, Ripple, and others.
Bitcoins cannot be classified as currency because they do not fulfill any of the following three essential functions:
- unit of account: due to their extremely high volatility, crypto-assets cannot be used to reliably express and compare the value of everyday goods and services. In practice, very few goods or services are priced in crypto-assets;
- medium of exchange: crypto-assets are not legal tender, so there is no obligation for merchants, businesses, or government agencies to accept them as payment, unlike euro coins and banknotes, which are the only payment methods that are legal tender in France;
- store of value: the value of crypto-assets is not stable enough for holders to be certain that their wealth will be preserved over time.
Some Market Figures
Market capitalization
Market capitalization is calculated simply as:
price per unit × number of units in circulation = market capitalization
A purely arithmetic example: if an asset is worth $20 and there are 10 million units in circulation, its market capitalization is $200 million. This formula alone says nothing about the quality, liquidity, or security of the asset.
- Annual electricity consumption of the Bitcoin network (equivalent to the annual consumption of Vietnam or Norway): 125 TWh
- Conservative estimate of the number of recorded crypto-assets (June 2023): 25,000
- Total market capitalization of crypto-assets (June 2023): $1,180 billion
- Bitcoin’s market share among crypto-assets (early 2023): 42%
_Sources: CoinMarketCap and the Cambridge Center for Alternative Finance_
There are several types of cryptoassets (nearly 25,000 assets in circulation as of mid-2023, Banque de France). And despite their success, first-generation cryptoassets, such as Bitcoin and Ethereum, are not legal tender and have no intrinsic value. They are therefore speculative and highly risky assets.
The stablecoin, or stablecoin token
A “stablecoin” (a cryptoasset pegged to a value) is a digital asset programmed to achieve greater value stability compared to other cryptocurrencies (such as Bitcoin or Ether). Depending on their type, some stablecoins peg their value to an asset such as a currency (e.g., the U.S. dollar) or a basket of assets and are backed by reserves of assets whose value is often expressed in fiat money (e.g., U.S. dollars). In practice, under certain conditions, an investor should be able to exchange a stablecoin for the asset to which it is pegged. Other stablecoins use algorithms that trigger purchases and sales to stabilize their value. Like Bitcoin, stablecoins are not legal tender.
Some stablecoins have failed to deliver on their promise of stability and have experienced sudden and significant price drops. Even though they promise less volatility than other crypto tokens, stablecoins remain risky.
Stablecoins can be backed by various types of assets: fiat money (e.g., USD, EUR), commodities (e.g., gold), other digital assets, and algorithms.
Blockchain Technology
Blockchain is a technology for storing and transmitting information. It operates in a decentralized manner without a central controlling authority. One of the main use cases for this technology is in the field of crypto: it records and updates crypto transactions for all participants in a secure manner through cryptographic verification.
A blockchain can be compared to an accounting ledger or a digital general ledger that is replicated across a computer network (nodes) rather than stored in a single location. In the context of blockchain, a node is a computer that holds a copy of the blockchain and maintains it through its interactions with other users. Each node ensures compliance with the consensus rules necessary for the system’s integrity. When a crypto transaction is recorded in a blockchain, a peer-to-peer network of users validates it and then adds it to a list of pending transactions that form a transaction block.
A block is the digital equivalent of a page in an accounting record and is immutable. Once complete, the block is linked, in chronological order, to the previous block in the blockchain. This action is irreversible and visible to everyone on the network. Since a computer network validates and maintains the blockchain, it is virtually impossible to falsify the information that has been stored.
There are several types of blockchains, and some cryptocurrencies have their own protocols and rules for their blockchains; this is particularly the case with Bitcoin and Ether, which use the Bitcoin and Ethereum protocols, respectively.
The technology used is blockchain (or “transaction ledger” in French), which makes it possible to keep track of a set of transactions in a decentralized, secure, and transparent manner. More specifically, blockchain allows its users - connected via a network - to share data without an intermediary.
How a Transaction Is Validated: Miners and Transaction Blocks
Blocks are validated by what are known as “miners.” A miner is a person who makes their computer available on the computer network used by the blockchain. The various available computers verify that no one has attempted to commit fraud and that the cryptoasset transaction is indeed valid.
Once the transaction is validated, it is encrypted (converted into computer code) and timestamped so it can be added to the blockchain. Miners, also known as “nodes” on the network, are compensated with cryptoassets for each block “mined” (validated, encrypted, and added to the blockchain).
Once created, these cryptoassets are stored in a digital wallet on the user’s computer, tablet, or smartphone, or even remotely (for example, in the cloud). They can then be transferred anonymously over the Internet between members of the community.
Proof of Work
People who operate nodes (computers) on the Bitcoin blockchain and validate crypto transactions are called miners. When they validate and add transactions to the blockchain, miners are rewarded with bitcoins and transaction income. This is how new bitcoins are issued.
This validation mechanism is called “proof of work.” The mathematical equation is very complex, requiring very powerful computers dedicated exclusively to mining to solve the equation as quickly as possible. It is virtually impossible to mine Bitcoins using a conventional personal computer.
Proof of Stake (Staking)
Other validation mechanisms exist, notably proof of stake, which is used by the Ethereum blockchain. Instead of attempting to solve a mathematical equation as quickly as possible, crypto holders who wish to validate transactions via proof of stake can delegate a portion of their crypto holdings (a stake) to third parties who act as validators. Validators combine the stakes from all holders and then stake these cryptocurrencies on the network according to the hard-coded rules of the blockchain protocol. The validators then compete to forge (validate) the next transaction block. The winner is selected based on factors such as the amount staked, the time elapsed since the stake was placed, and chance. The winner is usually rewarded with crypto.
Coins, tokens, and smart contracts
Native Coins and Tokens: A Useful Contrast
The Banque de France explicitly refers to Bitcoins as “native assets,” while the PSAV guide defines a token as a “unit of value issued on a blockchain” that can represent a financial asset, a right of use, or a governance right.
In this guide, the practical distinction is therefore as follows: a native coin is integral to the operation of its blockchain; a token is a unit issued on a blockchain and can represent various rights or assets. This distinction is used as an educational reference point, without claiming that every crypto project fits perfectly into a single category.
Token: A unit of value issued on a blockchain; it can represent a financial asset, a usage right, or a governance right.
Tokenomics: The science of token design (issuance, distribution, incentive mechanisms) to ensure the economic viability of a blockchain project.
Ethereum and smart contracts: The launch of the Ethereum blockchain has enabled not only the exchange of assets but also the deployment of automated programs (smart contracts) capable of executing actions without human intervention. This has significantly expanded the possibilities for digital assets, paving the way for applications in finance, real estate, and many other sectors.
Secondary and competing blockchains: The development of secondary blockchains, such as Polygon, which are connected to Ethereum, and other competing blockchains such as Solana, has expanded the available functionality. These blockchains, whether private or public, have introduced new options in terms of speed, transaction fees, and security.
Financial investments in cryptoassets do exist. The best known are what are called Initial Coin Offerings, or ICOs. An ICO is a fundraising effort (request for funding) that will ultimately lead to the creation of a new cryptoasset.
Wallets, Public Keys, and Private Keys
A digital wallet is used to exchange and store crypto. It is protected by two keys consisting of strings of letters and numbers:
- The first key is “public key.” It identifies your account on the network. You can share it to receive crypto. This key allows you, among other things, to verify the number of crypto units held in your account.
- The second key is “private”; it must be kept secret. The private key acts as a secret code that allows you to make transactions from your account. If you use a crypto trading platform, the private key will be held by the platform on your behalf. You should be aware of the security measures the platform uses to ensure the safety of your cryptocurrencies.
Risks Associated with Crypto
Often, the value of a cryptoasset depends largely on public interest, the interplay of supply and demand, and certain market events. As a result, the price of a cryptoasset may be driven by fleeting speculative demand, which can cause dramatic fluctuations in the value of your investment. The value of a cryptoasset can rise or fall by several thousand dollars, even within a matter of hours. You run the risk of losing a significant amount of money.
Volatility Risk: Media coverage of a cryptoasset can have a significant impact on its value over a short period of time, with no organization - including a central bank - regulating this fluctuation. Different platforms may offer the same cryptoasset at different prices.
Liquidity Risk: Exchanging a cryptoasset for legal tender can be difficult. Not all exchange channels, such as trading platforms, are regulated by official regulatory bodies or central banks. Speculation on cryptoassets can widen the bid-ask spreads.
Technological and Operational Risk: Crypto currencies may be vulnerable to hacking and theft. The security of digital wallets and crypto exchanges and trading platforms is not guaranteed. Users are at risk of theft and total loss of their assets.
Risk of Involvement in Criminal, Terrorist, Fraudulent, or Money Laundering Activities: Crypto currencies have sometimes been associated with fraud, money laundering, and criminal activities.
By investing in cryptoassets, you may face the following risks, among others:
- speculative bubbles: the prices of cryptoassets are highly volatile and expose buyers to potentially very significant financial losses,
- cyberattacks (hacking): storing cryptoassets offers no protection regarding the security of your assets,
- money laundering: due to their anonymous nature, cryptoassets facilitate the circumvention of anti-money laundering rules or may contribute to the financing of terrorism or criminal activities.
From a macroeconomic perspective, the circulation of virtual assets can reduce the effectiveness of monetary policy, weaken public finances, undermine the effectiveness of foreign exchange regulations, and increase the volatility of capital flows. Virtual assets also pose risks to financial stability, particularly due to their volatility, the concentration within the sector, and poorly managed implications for banks. Finally, they raise issues regarding consumer protection and the integrity of the financial sector. This type of unregulated virtual asset has already facilitated the creation of Ponzi schemes and can facilitate fraud.
Due Diligence and Best Practices
If you wish to invest in cryptoassets, here are five practical tips from the AMF:
1\. Check the AMF’s blacklists before investing,
2\. Use a service provider registered with the AMF,
3\. Ensure your cryptoassets are stored securely,
4\. Never lose or disclose your private key,
5\. Always verify the accuracy of a public address.
A list of registered crypto-asset trading platforms is available on the AMF’s website, in the “Records” section.
SURVIVAL RULE
Identify what the asset does, who controls supply and upgrades, and which assumption makes it valuable.
CURRENT-RULES CHECK
Legal protections, tax rates, reporting duties, deadlines and product rules change by country and over time. Use the jurisdiction labels in this guide and check the linked official source before acting.
- Investor.gov - Crypto assets - United States - crypto-asset risk.
- Investor.gov - Crypto-asset custody basics - United States - custody.
