Murray Bender: RBC Investor & Treasury Services is pleased to present insights on the future of asset and payment services across the globe. Coming up on today’s podcast is Karim Hamasni, Director of Crypto Asset Innovation at RBC Global Asset Management, who will be helping us to decrypt the increasingly talked about but still widely misunderstood topic of cryptocurrencies. Welcome, Karim.
Karim Hamasni: I’m pleased to be here today, Murray.
Murray Bender: Karim, to start, exactly what is crypto?
Karim Hamasni: Well, Murray, crypto, as a short form for crypto assets or cryptocurrencies, are units of value that are entirely digital. And that’s not that dissimilar to what cash is today. Now, if you look at cash, most cash is digital. I can’t remember the last time I paid for something in physical cash. Most cash today is tracked on a series of centralized ledgers, usually maintained by commercial banks and various other institutions.
Now just like a bank, Bitcoin, Ethereum, and other cryptos are tracked on ledgers that keep track of accounts and balances. Now the difference between the bank ledger and, say, the Bitcoin ledger is that the Bitcoin ledger is multiplied and distributed across several computer systems spread throughout the world. In fact, there are over 10,000 computer nodes that run that particular network.
Murray Bender: So we often hear about a blockchain. How does a blockchain relate to cryptocurrencies?
Karim Hamasni: Yeah. Well, blockchain’s most simple definition is the ledger itself. It’s a kind of digital data structure that keeps track of the accounts and balances and transactions and so much more. And it’s designed in such a way that makes decentralization possible and viable.
Now maintaining a decentralized ledger was always thought to be impossible. There were lots of well-studied math problems in the past that tried to find a solution to decentralize ledgers but always failed. And essentially, getting a network or a system of independent computers or systems to synchronize the same data is incredibly challenging.
Now, I can illustrate this with an analogy. If you had a room full of people and the goal was that you wanted all of them to agree to the same statement, you could have one person announce the message to everybody, but that’s centralized.
Instead, if you got them all to whisper the message to each other, and then eventually everyone in the room has the message, that can go terribly wrong. In fact, we probably all remember the game of broken telephone that we always used to play as kids, and the end message was almost never the same as what it was when it started.
The blockchain network, on the other hand, is a system that ensures that you have a decentralized network and you’re able to synchronize the correct message without any central authority. And it does this based on its unique property of the blockchain data structure and the processes, and it allows everyone to agree on the same message in a reliable way with no central authority.
This is pretty profound because a solution to this was explored for several decades, and it wasn’t until the very first blockchain, the Bitcoin blockchain came out, that a viable solution presented itself. And that’s profound and has the potential to have far-reaching implications on the way we do business.
Murray Bender: So, can you a little bit more specifically talk, then, about the blockchains and how they’re related to cryptocurrencies?
Karim Hamasni: Yeah. So the blockchain does maintain the ledger of accounts and balances. And so, when I want to transfer a unit of crypto, let’s say Murray I wanted to send you a unit of Ethereum, I’m sending a message to the network and asking them to update the ledger to transfer one unit from my account to your account. And that’s very similar to transferring assets with a bank. If I want to transfer $1 from my account to your account, I send a message to the bank to do that.
Now the ledger itself, though, the Bitcoin blockchain, is that decentralized network. And eventually, all of them will upgrade their ledgers to reflect that transaction, and they’ll come to consensus on the final state, which means my account is one unit poorer and your account now is one unit richer.
But the ledger on blockchain can store a lot more than just digital assets or digital units of value. More modern blockchains can store computer code. And that computer code is distributed across the entire ledger and sitting on every single node.
And this has some profound implications as well. Traditionally, we’ve always had to rely on code deployed to centralized data centres like Amazon or AWS or Microsoft Azure. But today, blockchains like Ethereum are able to run that code that sits in the ledger in a decentralized way. And that can have some profound impacts.
I can illustrate with an example. So today, if I want to sell tickets to, say, a concert or a show, I have to rely on a ticket-selling agent, which is a centralized party, to manage the sale of those tickets. So when a fan logs on to the ticket agent’s website and pays with their payment card, the payment processor sends a message to the bank and the bank will eventually rebalance their ledger to reflect the transaction. And then the bank will inform the ticket-selling agent that the payment has gone through, and then the ticket selling agent generates a ticket and releases it to a fan.
What I can do on the Ethereum blockchain is I can draft the code set called a smart contract that governs the business logic to selling those digital tickets. I then deploy that contract to the blockchain, and it sits in the blockchain ledger on thousands of computers spread around the world. So now when a fan sends me payment, the contract will govern the business transaction.
And the contract essentially states, if somebody sends me enough payment, then the contract will generate the digital ticket and release that to the fan. And it does this in a decentralized way. And because that code is spread across thousands of computers around the world, it’s extremely secure in its operation, meaning, as long as enough payment was sent, that contract will almost definitely generate the digital ticket and release that to the fan.
And that essentially removes a lot of intermediaries or middlemen from business processes all around the world. And my example illustrates how we can disintermediate ticket sales, but this can be applied to lots of different industries and business use cases, including many of the financial applications offered by traditional banks and financial services.
And we’re starting to see this today in the emerging world of DeFi or decentralized finance, where you have code sets that live on blockchains that are stepping in as the intermediary between financial uses, such as decentralized exchanges, which will pair sellers of tokens with buyers of tokens and facilitate the transfer without the need of a stock exchange; or you have decentralized lending protocols which allow people to put a collateral in the form of one token and take out a loan in the form of another. And all of this is done without a bank and without any traditional financial infrastructure. And it’s quite profound.
Murray Bender: So from a very practical perspective, how does one actually use cryptocurrencies?
Karim Hamasni: Yeah. So the most important capability needed in order to use cryptocurrencies is to have a wallet. You need a way to store your crypto assets in a secure way.
And so, if I’m an individual user of crypto, I might have a wallet on my phone or on my computer. And what that’s doing is it’s holding onto my account password or my private key and allows me to transact with that password. So much like you send a message to the bank to transfer money and you authorize your transfer using your banking password, I send messages to the blockchain, and I authorize those transfers of assets using a private key to do something called a digital signature.
And so private key management, really, is the number-one capability needed to interact with the space. And there are hundreds of wallets out there—consumer wallets, institutional wallets, varying wallets of different types that allow you to store your private keys in varying levels of security.
And so, if, let’s say, I want to send money to a decentralized lending platform in order to earn interest on a deposit, I have to transact using my wallet to send the assets to that smart contract in order to reap the benefits offered by that DeFi contract.
And so that’s how you interact with blockchains. First, you need a way to manage your private key. And then second, you send messages much like you do sending messages on the internet today, but this time, they’re signed by that private key.
Murray Bender: So how is crypto currently being regulated?
Karim Hamasni: We’re still trying to find our footing on regulation globally when it comes to crypto assets. It’s a permissionless world, especially on these public blockchains. And so it introduces a lot of variance. And you have platforms that have sort of proven themselves, but then you have other platforms that are extremely risky. And as a result, there have been countless examples of where investors have lost money, they’ve lost value simply because these platforms couldn’t necessarily be trusted.
And it is catching the attention of regulators all around the world. Regulators are starting to notice that investors, individual investors, retail investors are losing a lot of value due to the uncertainty of the blockchain.
And so they’re trying to figure out exactly how to regulate this asset class. And it’s very different because there’s no central company that they can go to in order to regulate these assets. When a contract lives on the blockchain, it lives on the blockchain in a decentralized way, and there’s no company that typically runs it; whereas in traditional finance, if there’s a bank that’s doing nefarious activity, the regulators know who to target, but on the blockchain, it’s not quite as black and white. They often—or they try to figure out if they should go after the development team who originally coded the contract, find out who the beneficiaries are. And currently, there’s no guidance as to exactly how that should happen.
There are regulators all over the world that are looking to come up with frameworks on how to regulate this asset class. In the United States earlier this year, Joe Biden signed an executive order trying to get the different regulatory bodies in the United States to work together to come up with a comprehensive crypto regulatory framework. And they’re currently in discussions as to what that framework may look like.
In Canada, we’re a bit more advanced when it comes to regulation. Crypto asset exchanges are regulated by the various securities regulators from across Canada, from the various provinces. And cryptocurrencies that are traded on exchanges are seen as securities, and they are regulated as such.
And so cryptocurrency trading platforms in Canada are currently being encouraged to register with the various securities regulators, and we have more clarity as to how this regulatory landscape is going to evolve in this country.
There’s still some areas that we’re not certain on for regulation, that are continuing to evolve. But nonetheless, we are about a step or two ahead of the United States when it comes to crypto regulation.
Murray Bender: What about the environmental impact of crypto? Can you talk a little bit about that?
Karim Hamasni: Yes. So, there are certain crypto assets that run on a protocol called Proof of Work. And what that does is it helps to secure the network and ensure that the transactions are recorded in a proper and secure way. And, unfortunately, one of the side effects of the Proof of Work consensus algorithm is that it uses a tremendous amount of electricity.
The network itself is made up of these nodes, and many of them are miners. And miners around the world are burning a tremendous amount of energy in order to perform the activity required to secure the network. And they do so because they want to earn a reward in the form of a block reward and that’s paid out in cryptocurrency for doing that job.
And so the Bitcoin blockchain today uses a tremendous amount of electricity. In fact, many people compare the amount of energy used to run the Bitcoin blockchain to that of Argentina and how much that country uses.
And so the question is, where is that energy coming from? Is it coming from fossil fuels? Is it coming from renewable sources?
And so there are lots of studies and there’s lots of research out there that tries to pinpoint exactly what environmental impact a cryptocurrency like Bitcoin has, or other Proof of Work cryptocurrencies like Ethereum in its current state. And they’re trying to figure out just how much CO2 it’s contributing to the environment.
Now, the answer is, today, it is contributing a lot of CO2 to the atmosphere because a lot of Bitcoin mining still uses fossil fuels. Up until last year, China was a huge centre for mining. And although they have lots of hydroelectric power in China, during the dry season, a lot of these miners were switching their operations to consuming energy produced by coal and other polluting sources.
Now China has since banned crypto mining within that country, and most of the miners have left and gone to other places. And we’ve seen some miners come to Canada, where they are using cheap hydroelectric power in Northern Quebec, but we’ve seen other miners that have gone to countries like Kazakhstan, which still also heavily rely on fossil fuels. So what we hope to see is a trend that more and more mining will be done using renewable power, but it’s too early to say exactly if that trend will materialize.
What we do hope for is that Bitcoin provides a conduit for new green energy projects to spring up. Because let’s say a utility company wanted to create a hydroelectric power plant in the middle of nowhere, that wouldn’t necessarily be economically viable because they would often have to build it over capacity in anticipation for future use.
But today, if they built at a high capacity, Bitcoin mining can consume that excess capacity until that power would be needed by the general public. So it provides a new way for utility companies to profit off of their green energy projects in the short term as they wait for that capacity to be redistributed to the general population.
And that is one angle that a lot of people are hoping evolves in the crypto space. But once again, it’s too early to tell if Bitcoin mining will actually act as a conduit to green energy or if it’ll continue to be a net polluter.
Murray Bender: Finally, Karim, if you could look into your crystal ball just for a moment, what, in your view, does the future hold for crypto?
Karim Hamasni: That’s an interesting question. And my best prediction is that I feel like blockchains are going to introduce all new kinds of tokenized assets that are going to exist on blockchains or distributed ledger technologies.
If you think about the internet in its early days, the internet was just a new channel amongst others. You had television, you had radio, and you had the internet, and newspapers.
And what ended up happening was the internet became the rail or the backbone to all of those channels. You now have online TV and online streaming; you have online music and radio; you have online news. And so the internet actually became a delivery mechanism and it introduced new frontiers, such as e-commerce and modern communications techniques and so much more.
Today, people are looking at crypto as just an asset class that sits amongst other asset classes. But blockchains and the distributed ledgers that are housed on blockchains, they could start to log all kinds of assets, such as cryptocurrencies, crypto commodities, tokenized securities, crypto art, which we’re starting to see with NFTs.
And we’re even seeing new constructs start to emerge, like decentralized autonomous organizations, which are smart contracts that govern organizations and take out the need for human leadership.
And so that’s how I see it evolving. I see it becoming more of a rail or a backbone to emerging delivery methods for all kinds of assets and all kinds of decentralized computing and so much more.
Murray Bender: Thanks for helping us to better understand this new world of crypto, Karim. We really appreciate your time today.
Karim Hamasni: It’s my pleasure, Murray. Thanks for having me.
Murray Bender: For additional insights on topics relevant to corporate investors and financial institutions across the globe, including our previous podcasts, visit rbcits.com/insights. I’m Murray Bender. Thanks for listening.
This content is provided for general information and does not constitute financial, tax, legal or accounting advice, and should not be relied upon in that regard. Neither RBC Investor & Treasury Services nor its affiliates accepts any liability for loss or damage arising from use of the information in this podcast.