Since Bitcoin’s launch in 2009, cryptoassets have proliferated, with Ethereum, Litecoin and Ripple among others (collectively referred to as ‘altcoins’) well known amongst the thousands now available. The technology that enables cryptoassets is becoming increasingly attractive in the financial services sector as businesses evolve new services and operating models.
Cryptoassets, or just ‘cryptos’, are a digital or virtual currency (and payment system) that are currently not usually issued by any central regulating authority (i.e., banking, financial or governmental institutions), or reliant on them to verify transactions – so are outside the traditional financial services industry.
They use cryptography to secure transactions, relying on a decentralised peer-to-peer network system based on a distributed ledger technology ‘DLT’, to record transactions. The technology relies on the peer-to-peer network and a consensus algorithm to disseminate the ledger across the different users, using ‘nodes’ which are algorithmically linked by cryptographic processes, to develop a blockchain.
Unlike traditional distributed database payment systems, DLTs have no central administrator in the blockchain: data verification/reconciliation is carried out by the consensus algorithm and peer-to-peer network. This design principle makes DLT resistant to data modifications, providing a high level of security and safety, so that when currency units are bought, sold or transferred, the transaction is recorded securely on the blockchain ledger. The cryptoasset is stored and spent via digital wallets which act as keys that enable the movement of the unit.
Trends and developments
Mainstream financial services businesses, including Visa, Mastercard, and PayPal, are starting to adopt cryptoassets and enabling crypto payments. Beyond cryptos themselves, the potential for using blockchain technology for other financial services applications is driving developments. The future use cases of crypto-based transactions could include the trading of bonds, stocks, and other financial assets. Talking blockchain blog
Another general trend that could impact the adoption of cryptoassets includes the emergence of ‘Non-fungible Tokens’ (NFTs). Although their adoption is mainly seen in the art and gaming industry, there are emerging use cases for NFTs in enabling financial transactions such as Decentralised Finance (De-Fi) transactions where “lenders” receive NFTs in exchange for lending tokens, as well as streamlining Know Your Customer processes - read more here.
Possible future developments that could have an impact on the financial services sector include:
- De-Fi – This is an emerging financial technology concept based on secure distributed ledgers where financial services are built on public blockchains, such as Ethereum. Several De-Fi projects are emerging in the financial sector, and could be a key driver in the increased adoption of cryptoassets for the storage of assets digitally, and as a new unregulated way of lending that is only reliant upon a peer-to-peer network.
- Crypto-specific tax regulations – With the increased, although varied, adoption of cryptoassets across different countries and regions globally, there is expected to be a push towards more standards and regulations to oversee crypto-based activities and transactions, including calls for introducing crypto taxation guidance. In the UK, for example, HMRC has now published guidance on De-Fi lending and staking in addition to its cryptoassets manual, i.e., the lending, borrowing or transfer of control of cryptoassets.
- Central Bank Digital Currencies – With the introduction of more standards and regulations overseeing crypto-based activities, plus its growing adoption, central banks are becoming active in this area, with the introduction of an electronic record or digital token of their country's official currency, referred to as ‘central bank digital currency’ (CBDC). For example, China and Venezuela have already launched their own digital currencies, while India recently announced it is launching one by 2023. Other countries like the USA and UK are exploring the creation of their own CBDC, although they are yet to decide on its introduction.
- Widescale roll-out of 5G networks - Higher connectivity speeds, addressing any network (and possibly cost) issues related to the mining process of generating coins, is expected to remove some associated barriers to adoption. Alongside Ethereum, there are a number of eco-friendly crypto projects such as Nano and Cardano that are approaching this in a different way, by moving to a proof of stake concept for approving transactions, which should also save energy costs and therefore increase take up.
- Multichain-based projects – These are widely regarded as the future of blockchain, enabling interoperability and easy transfer of cryptoassets across several blockchains.
Realising the potential
Making the most of the huge potential to use cryptoasset and blockchain technology in the financial services sector means resolving many technical challenges, both to increase adoption and integrate systems. Some of these technical challenges include scalability, security, privacy, latency, network congestion, energy consumption, interoperability, token price stability, general user experience, etc.
For example, a leading developer of toolkits for building blockchain-based applications services has developed a new type of DLT, with its own proprietary consensus algorithm and operating protocols to enhance computational efficiency, processing speed, security, flexibility and interoperability. Our specialist Financial Services and Software R&D teams helped them claim R&D tax relief to support the cost of the project.
How we can help with your next project
Most projects that harness this technology are likely to involve some level of R&D that would qualify for R&D tax relief. The majority of our R&D team are software developers, engineers, and technical specialists, and we have significant experience of working with clients in the banking, FS, fintech, hedge funds, quant and derivative trading businesses, so we can help you identify what will qualify, and how to build a successful claim.
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Source BDO UK