BRIEFING

Understanding crypto assets

An overview of blockchain technology's
uses and challenges
SUMMARY
Blockchain and its applications, in particular cryptocurrencies, have grabbed the headlines, but
many people still do not know how they work. This briefing provides an overview of the uses and
challenges of this technology, based on published information.
Blockchain originated as part of the enabling digital ledger technology (DLT) developed at the end
of the 20th century. DLT works as a digital database containing information (as a record book or
ledger) that can be simultaneously used and shared through a network (as a shared digital ledger).
The technology is considered to render the recorded elements unchangeable (immutable) and the
process open (decentralised) by using a publicly accessible network. However, in practice, the
outcomes can differ from the initial technological design.
Virtually anything of value (assets) can be tracked and traded on a blockchain. Blockchain works with
tokens (values in the digital ledger), tokenisation (using the blockchain for existing assets) and smart
contracts (computerised and pre-specified conditions that self-execute when they are met).
Currencies and assets can be exchanged and traded in both the 'real' and virtual world. The use of
blockchain for currencies originated from an analysis of shortcomings in the traditional financial
environment. Crypto assets range from tangible to non-tangible assets, and to understand them
one must look into their substance and the conditions attached to them in their digital definition.
After more than a decade, a number of challenges have appeared, ranging from the protection of
citizens to the preservation of the legal economy and the carbon impact of crypto assets. This
briefing looks at both the implementation of blockchain technology over this period and at whether
it has delivered the expected outcomes.

IN THIS BRIEFING
 Introduction
 The enabling technology: Blockchain
 Range of tokens, from money to other assets
 Virtual meets reality
 Challenges

EPRS | European Parliamentary Research Service

Author: Cécile Remeur
Members' Research Service
PE 757.580 – December 2023 EN
EPRS | European Parliamentary Research Service

Introduction
Cryptocurrencies have grabbed the headlines as they have boomed and dwindled. However, many
people do not know what lies behind them and how they work. And their ups and downs are a
reminder of how asset values can fluctuate and of the volatility of markets.
Cryptocurrencies, like any crypto asset, rely on digital ledger technology (DLT), 1 of which blockchain
is probably the most widely known example. Blockchains, combined with electronic money,
resulted in the launch of cryptocurrency, the most well-known example of which dates back to 2008.
Blockchain has many uses, and is not limited to money; virtually anything of value (assets) can be
tracked and traded on a blockchain. Indeed, some blockchain advocates believe that the real
potential of blockchain is only now being discovered, while others stress that 'crypto innovation' is
no longer in its infancy. Recent research by academics and public and private stakeholders has
aimed to provide an understanding of how the latest blockchain technology (such as Web3 – see
also the box on page 4) functions and the challenges it brings.

The enabling technology: Blockchain

Blockchain is a way to reach agreement within a network of computers. In the late 1980s and 1990s,
computer scientists came up with a consensus model that overcame this by means of a 'signed chain
of information used as an electronic ledger for digitally signing documents in a way that could easily
show none of the signed documents in the collection had been changed'. In other words,
blockchains are essentially databases which, instead of relying on a centralised authority to update
them, use a consensus mechanism to decide who gets to add the transactions to the database.

Overview of blockchain technology

Blockchain has been defined as follows: '... distributed digital ledgers of cryptographically signed
transactions that are grouped into blocks. Each block is cryptographically linked to the previous one
(making it 'tamper evident' – see the box on page 4 for an explanation) after validation and
undergoing a consensus decision. As new blocks are added, older blocks become more difficult to
modify (creating 'tamper resistance'). New blocks are replicated across copies of the ledger within
the network, and any conflicts are resolved automatically using established rules.' 2
A distributed ledger is a network where every participant can communicate with one another
without going to a centralised point. It allows network participants to establish a shared and
immutable record of ownership and to share a database of electronic records and build consensus
regarding the validity of transactions through cryptographic algorithms. In other words, it is a
synchronised database stored by all active participants in the network (peer-to-peer, or P2P).
DLT 3 technology has four characteristics:
1 it includes a ledger: a collection of transactions providing a full transaction history,
meaning that the transactions and values cannot be over-ridden (this is known as an
'append only' ledger);
2 it is cryptographically secure: data in the ledger has not been tampered with and is
attestable (through hashing, i.e. converting data into a fixed-length string of letters
and numbers);
3 the ledger is shared among multiple participants (transparency);
4 it can be distributed: more nodes (a node being an individual system within the
blockchain) reduce the ability for a bad actor to impact the protocol governing the
consensus mechanism.
Blockchain technology uses a pair of keys: one public, one private. The private key must be kept by
users, who can store it manually or through software (referred to as a 'wallet', which can store more

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elements). Special hardware or private escrow services can be used to ensure security of private
keys.

Variations in the implementation of blockchain

A key question is determining which user publishes the next block in the chain. The system can work
without prior knowledge between parties ('permissionless', whereby anyone can create an account
anonymously), or with more access controls ('permissioned', where there may be some trust
between participants). 4
Permissionless blockchain networks are decentralised ledger platforms open to anyone who can
read and write a ledger, which brings the risk of malicious users disrupting the system. This risk is
often addressed through trust and an agreement between users that requires them to expand and
maintain resources when attempting to publish blocks. Non-malicious behaviour is generally
promoted by rewarding the publishers of blocks that conform with the protocol with a native
cryptocurrency.
Permissioned blockchains are ones where users' publishing blocks are authorised by some
authority (either centralised or decentralised). They involve more trust and more transparency,
which can be a disincentive to committing fraud (since the user can be identified). It requires fewer
resources, is quicker, and is less expensive in terms of computation.
The consensus model aims to determine which user publishes the next block, which must be valid
and can be verified by each network user on the basis of the initial state of the system (the 'genesis
block'). The way to achieve this varies, depending in particular on whether the blockchain is
permissionless or not. For permissionless blockchain, there are usually many publishing nodes
(which know each other only by their public address) competing at the same time, which implies
computation. Generally, as the level of trust increases, the need for resource usage diminishes.
There are several consensus models, in particular proof of work (PoW) and proof of stake (PoS). In
the PoW, a user publishes the next block by being the first to solve a computationally intensive
puzzle, the solution to which is the proof. The PoS is based on the idea that the more a user has
invested in the system the less likely they are to subvert it. This can operate through random
selection of 'staked' users, multi-round voting, or delegate systems, with reputation being one of
the incentives not to act maliciously. Another consensus model is related to real identity, namely
proof of authority or proof of identity.

Some typical features

Blockchain technology in itself does not operate according to a unique model. The technology offers
a range of variants, which have different and even opposite features. Some experts have placed
decentralisation and immutability, in particular, in a category of 'accidental characteristics of
blockchain', meaning those features that it 'may have but might lack'.
Blockchain ledgers are described as immutable (unchangeable). In some particular situations,
however, the chain cannot be considered as fully immutable.
A blockchain network can be open to all when it is decentralised and no users enjoy control through
centralised power, as in the case of permissionless blockchain. Permissioned blockchain, when an
authority or founders do enjoy specific rights over the software and management, are not open to
all users but to those selected by the authority; they present varying degrees of centralisation.
Actual functioning and governance (ownership or control) may be less clear-cut: permissioned
blockchains are often set up and run by an owner or a consortium. Permissionless blockchains are
governed by network users, publishing nodes and software developers, and the level of resources
needed can lead to them operating in a rather concentrated format.

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Other features derive from the fact that blockchain networks are essentially made up of transactions
added to the database. Blockchain functions in a way that is complex (e.g. hashing), automated
(resulting in possible rigidity due to self-executing codes) and highly interconnected. It also
requires an intense level of computing and software creation, the capacity for which is not widely
available among the population at large. These specific capacity requirements lead to the existence
of concentrated pools of users that have the necessary IT resources (and computing power).

DLT terminology (non-exhaustive)

DAO: Decentralised autonomous organisations.
Forks: Changes to a blockchain network. These can be backward-compatible ('soft fork'), but when this
is not the case they are referred to as 'hard fork', the consequences of which can be the splitting of the
blockchain.
Governance tokens: These give their holders voting powers on the direction of a blockchain project.
Mining: The act of solving a puzzle within the PoW consensus model.
Nocoiner: A sceptic who does not own any cryptocurrency and doubts their value.
Tamper evident: A process that makes alterations to data easily detectable.
Tamper resistant: A process which makes alterations to data difficult, costly or both.
Web3: This refers to a decentralised online ecosystem based on the blockchain where platforms and apps
are not owned by a central gatekeeper, but rather by users, who will earn their ownership stake by
helping to develop and maintain those services.

Range of tokens, from money to other assets

Before looking into the large range of uses, it is helpful to clarify the concept of tokens resulting from
the use of blockchain.

Tokens, tokenisation and smart contracts

In general, a token is an object that represents another object (either physical or virtual), or an
abstract concept. A digital token is a unit of value represented in the ledger. Some commentators
see them as 'the linchpin of the new digital economy ... connecting the digital world with assets and
services existing in the physical world'. In computing, there are a number of types of token.
Tokens can perform multiple functions. Smart contracts play a key role in linking the numerical value
(the token) to assets or services, which can either be virtual or not. Tokens differ from electronic
documents due to the use of cryptography and their integration in a database; in other words, they
are a subcategory of electronic record. Tokens can represent commercial instruments, including
instruments designed for the transferring and exercising of rights in commercial and financial
transactions and documents of title. As such, they can be seen as a different technique through
which to exercise and transfer rights.
Tokenisation means using blockchain technology for existing financial or tangible assets. It occurs
when an existing asset is recorded on a blockchain platform and represented as a token in order to
improve processes around trading and transfer of the asset. Native tokens are intangible, non-
physical assets that derive their value from the blockchain platform (online or virtual assets). Non-
native tokens are those that represent tangible, intangible and/or financial assets that exist
elsewhere, representing rights of property over an asset (off-line assets or services). However, assets
recorded through blockchain could be recorded with another technology.
Among existing token taxonomies, the functional taxonomy identifies tokens according to the
function assigned by parties. Payment tokens are accepted by parties for the settlement of

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obligations between them, security tokens perform the same function as traditional securities,
such as bonds or shares, while utility tokens can be similar to vouchers. Utility and payment tokens
are based only on the actual usages by market participants. In addition, all tokens are flexible and
can perform multiple functions.
An alternative classification for tokens is based on fungibility. Fungible tokens provide the same
rights and are replaceable with other assets of the same category (for instance, commodities),
whereas non-fungible assets each possess unique characteristics preventing their replacement (for
instance, a work of art or a trademark).
A smart contract is a computerised transaction protocol (self-executing applications) that can
trigger an action if some pre-specified conditions are met, then execute the terms of a contract. 5 It
is a collection of codes and data inserted in the ledger, and associated with tokens on the blockchain.
The substance of a smart contract is not limited and it can be used for almost any activity or product.
However, some experts have asked 'how smart smart contracts are', particularly because 'the claim
that smart contracts are more efficient and carry no legal costs is negated by the rise of ex-ante costs
in the form of thorough due diligence and the need to consider an exhaustive amount of scenarios
for contracts to be complete. In conditions of low uncertainty, such contracts may be easier to
design and execute. However, when uncertainty is high, the exact costs may be high and the range
of unanticipated events large.'

A wide range of uses mimicking real-world assets

Tokens can be classified as digital assets, in the broader category of non-tangible assets. However,
they can include different functions and characteristics (and have several), and can be defined as an
item of property owned by a person or company. The first use which comes to mind is
cryptocurrency. 6

A wide variety of crypto assets

While all crypto assets use some form of blockchain, not all applications of blockchain involve crypto
assets. Crypto assets can be defined as a type of private asset that depends primarily on blockchain
to secure digital value or contractual rights; they can be transferred, stored or traded electronically.
There is a wide variety of crypto assets, including payment/exchange tokens. 7 A virtual currency is a
crypto asset, but not every crypto asset is a virtual currency.
'Non-fungible tokens' (NFTs) are another type of crypto asset. They use blockchain technology to
certify the authenticity and ownership of a specific and unique digital objet. Anything that can be
digitised can be turned into an NFT, including, for instance, a hyperlink to a digital or physical work
of art.
In the European Union, Article 3 of the Markets in Crypto-Assets Regulation (MiCA), adopted in May
2023, includes the following definitions: 'crypto-asset', 'asset-referenced token', 'electronic money
token' and 'utility token'. 8

Cryptomoney
Cryptocurrencies are the most widely known tokens. Payment involves trust in the money itself and
the payment system that executes the transaction, and both are changing with digital innovation.
Money is fungible, durable, convenient to carry and divide, recognisable and reliable. It serves as a
medium of exchange, a unit of account and a means to store value. Currency is one form of money.
Cryptocurrencies were developed with the promise that the decentralised and secure system would
be quicker, cheaper and more efficient and democratic (financial inclusion). The proponents of
cryptocurrencies presented them as the answer to the shortcomings shown by traditional
intermediaries in the 2008 crisis.

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A cryptocurrency is a privately issued means of payment and value storage system that functions as
'electronic cash protected through cryptographic mechanisms instead of a central repository or
authority'. Cryptocurrencies do not require central intermediaries for clearing and settlement; users
believe the system works because they can see it and track it. Transactions can be token-based
(assets need to be proven genuine) or account-based (need for user identification).
A central feature of cryptocurrencies is that, like
cash, their use or ownership does not intrinsically Decentralised finance (DeFi)
reveal the personal or business identity of those
involved in a transaction. Holders exercise control DeFi is an umbrella term commonly used to describe a
variety of services in crypto asset markets that aim to
through a private 'key' (or address not inherently
provide service transactions analogous to those
linked to identifiable beneficial owners), held in a provided by the traditional financial (TradFi) system
'wallet', but transactions reveal (at most) only a The role of financial institutions and market
public address from which it is encrypted, and infrastructures is replaced to varying degrees by self-
from which it cannot be inferred; hence, they are executing code ('smart contracts'). DeFi uses various
'quasi-anonymous'. A second important feature smart contracts to allow any network participant that
of cryptocurrencies is that, unlike cash, they are meets smart contract criteria to directly fill the roles of
transparent in the sense that details of all automated market makers and liquidity providers,
transactions on a particular coin are publicly among others, to facilitate transactions in
cryptocurrencies. DeFi based on technology requires
available (though not linked to the owner). A third
trust in a combination of internet service providers,
feature of cryptocurrencies that amplifies the core software developers, miners, wallets, exchanges,
difficulties posed by anonymity is their extra- and stablecoin issuers.
territoriality: transactions reveal no information
Source: The financial stability risks of decentralised
on the jurisdictional location of those transacting.
finance, BIS, August 2023.
The word 'currency' within cryptocurrency can be
seen to be misleading, because the extreme price volatility of most cryptocurrencies means that
they do not discharge the store of value and unit of account functions of currencies. In addition,
they bear a transaction cost (in terms of the computing power needed to validate transactions) and
require time to be used (due to the need to record them in the ledger). This helps to explain why
cryptocurrencies have not become a means of payment to purchase goods and services.

Exchanges and trades

Crypto-trading platforms are digital marketplaces allowing buyers and sellers to transact crypto
assets for other crypto assets or for fiat currencies. The most popular crypto-trading platforms are
those for trading cryptocurrencies.
Users send and receive cryptocurrency and crypto assets on-chain using public and private keys,
which are unique strings of alphanumeric characters. Users may store and access them in wallets
(software or hardware) that can either be connected to the internet (hot wallets) or not (cold
wallets). 9 Unhosted wallets are a type of self-custody wallet that lets users keep their crypto asset
balances out of any exchange, or from any third party.
There are broadly three ways in which they may be traded. One is directly peer-to-peer (P2P),
without the involvement of any third party. The second is through decentralised exchanges, whose
purpose is to facilitate such P2P trades, with customers retaining custody of their private keys. The
third is through centralised exchanges, which generally hold their customers' private keys and make
transactions on their behalf, charging a commission or fee for doing so.
When the private keys are hosted by a third-party wallet provider, centralisation is reintroduced and
the risks of losing a wallet are reduced. When wallets keep the private keys for the users, they are
referred to as a 'custodial wallet'. Custodial wallets are provided by centralised intermediaries and
utilised in off-chain transactions (not requiring specific expertise). Transactions can occur off-chain
between parties on the same platform and entail physical debiting and crediting of digital balances.

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 Understanding crypto assets

A crypto exchange is any system (online platforms) where users can buy, sell and trade various
crypto assets. Interacting with cryptocurrency through exchanges is centralised, and individuals
must often use official identification and provide addresses in order to transact. While being more
user-friendly than on-chain transactions, they resemble traditional financial institutions: they
facilitate the buying and selling of unbacked crypto assets and also provide much wider services
than traditional securities exchanges. Crypto assets can also be traded on payment apps, that have
broadened their scope to cryptocurrencies.

Digital money terminology (non-exhaustive)

Central bank digital currencies (CBDCs) are a direct liability of the central bank and, as such, do not carry
any credit risk.
A digital wallet is a software application that stores payment or account details to facilitate traditional
payments that use a bank.
E-money (electronic money, or digital currency) is a digital form of cash stored and exchanged electronically
(by a prepaid card or electronic device). It refers to money (backed by fiat money) that exists in commercial
banks or e-money issuers' computer systems (as a liability on their balance sheets).
Mixer (or tumbler) is a process by which users of a cryptocurrency send theirs to a company that 'mixes' or
'tumbles' the funds with other depositors' and then sends back an equivalent amount of mixed
cryptocurrency.
Stablecoins are a subset of cryptocurrency that is designed to be less volatile than other crypto assets. They
claim to maintain a stable value relative to a specified asset, or a pool or basket of assets.
Virtual currency means a digital representation of value that is not issued or guaranteed by a central bank
or a public authority, but is accepted by natural or legal persons as a means of exchange, and which can be
transferred, stored and traded electronically.
Source: Cryptocurrencies and monetary policy (see also the box on page 4).

Virtual meets reality

When a new technology is developed, positive expectations may arise. The implementation of
blockchain after a decade shows that it is necessary to look into the substance of each crypto asset
to grasp its actual scope and challenges.

Looking into the substance

The use of a new technology does open up potential opportunities, but the mere use of the
technology does not amount to the realisation of all the expected potential outcomes.
Some software engineers have stressed that: 'The real world has fundamental constraints that make
the technology unworkable, [and] whenever it has to interact with the outside world the benefits of
decentralisation disappear and the solutions end up simply recreating slower and worse versions of
processes and structures that already exist ... . There are fundamental limitations to the scalability of
blockchain-based technologies.' Similarly, the assumption that participants would cooperate in
maintaining the system might not remain a plausible assumption when the scope broadens, which
might in turn require adaptations that differ from the initial characteristics. In addition, recording an
asset on a distributed ledger does not change its characteristics or the set of attached risks that
warrant scrutiny by regulators.

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Some features in practice

After more than a decade of blockchain, have crypto assets delivered the outcomes expected of
them? Some experts identify financial inclusion, disintermediation and decentralisation as examples
of positive, expected outcomes that might not have been met.
Crypto assets were expected to function in a decentralised way without intermediaries, in contrast
to traditional intermediaries (particularly in the financial system). Yet, in practice the technology can
lead to centralisation and create intermediaries, or at least a situation where 'a subset of participants
can garner excessive, centralised control over the entire system', because important points of
centralisation are inherent in many blockchains. This results in critical service providers who are key
to the ongoing operation of networks; this is the case in the PoS, where there is an incentive to
concentrate. 10 In the PoW, the necessary resources to participate have the same consequence.
Researchers at the Bank for International Settlements (BIS) have concluded that there is a
decentralisation illusion, where the tendency to centralise cannot be solved by further technology.
Increasing off-chain transactions suggest that some centralised entities are taking the role of
financial market infrastructures. In principle, for crypto assets, traditional financial market
infrastructure tasks, such as clearing and settlement, are carried out by the underlying technology
in a decentralised manner. For example, such transactions will require that some crypto asset service
providers offer clearing services and settlement services. However, in practice most users access
their crypto assets through centralised entities that provide easy-to-use interfaces.
As for disintermediation, the crypto-universe is filled with intermediaries, including hosted wallets
(where investors store their crypto assets), exchanges (where investors exchange sovereign
currencies and crypto assets) or miners (who charge fees to validate crypto transactions – and can
profit from their power to decide which transactions to approve and in what order). Many of these
entities hold information on their users and can accept or block transactions from certain addresses
or can share transaction data with other organisations. These entities act as intermediaries.
Some also see crypto as bringing complexity, rigidity and opacity. The complexity is both
technological and financial, which makes it difficult to understand for a layperson. Complexity can
make products and the related risks harder to understand, anticipate and address, which can lead
to a seemingly minor problem cascading through the system due to unexpected interactions
between components, with the risk of becoming a destabilising element.
In addition, automated functioning with smart contracts brings rigidity, as they implement codes
when conditions are met. This may prevent them from having room for manoeuvre to take into
account unexpected or unanticipated situations and leaving them some time to react. In addition,
automated implementation of a number of similar provisions can create a cumulative effect of
implementation of the same code (potentially creating contagion or runs). 11 In addition, the
difficulty in identifying actors might also complicate identifying to where risks have been moved,
and to whom emergency support needs to be provided.

The example of art-related NFTs and intellectual property rights

NFTs and intellectual property rights show the importance of looking into the substance beyond
the technology, to ascertain the scope and rights attached to the NFT. For instance, NFTs can record
the creation and ownership of an artwork (be it tangible or digital). However, the actual scope is
defined in the related smart contract. Some buyers might think that they are acquiring the
underlying work of art, and all of its accompanying rights, but in reality they are simply buying the
metadata associated with the work, not the work itself.
Transfer of property and licensing of copyright are two separate elements. There is a general
presumption that the copyright stays with the creator of the work, who can transfer or sell the rights
to the copyright to the purchaser of an NFT by contract. The form of the contract does not alter its
scope. The owner only owns the representation in the NFT, unless the smart contract transfers the

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copyright (which generally is not transferred in its entirety). This implies, for instance, that the NFT
owner cannot oppose a representation of the digital or tangible piece of art enshrined in its NFTs,
nor reproduce it for sale, in the absence of a transfer of corresponding copyrights, nor bar
representations of the piece of art.
NFTs are also hit by reality in another manner. An NFT that links to a digital representation of an item
protected by property rights in order to sell it may infringe intellectual property rights, namely
trademarks, or the owner's design or model rights, which bar the sale of imitations. This is
particularly the case when it is accompanied by active commercialisation amounting to
'cybersquatting'.

Challenges
The main challenges of crypto assets relate to the protection of citizens, the preservation of the
(legal) economy and the carbon impact of crypto assets. For cryptocurrencies, this applies to those
that are not digital representations of sovereign currencies (CBDCs).

Challenges regarding citizens' protection

It has been claimed that crypto has the potential to improve financial inclusion. However, the
technology is not living up to this promise of inclusion, as adoption rates remain low, due in part to
scalability issues (i.e. the ability to work efficiently as a payment tool at large volumes). On a global
scale, decentralised finance has the potential to reach populations currently excluded from the
financial system. According to research for the BIS, the inherent limitations of blockchains restrict
the possibilities for improving financial inclusion. In practice, complexity, risk and cost remain major
obstacles to address before the crypto ecosystem could be the solution to financial exclusion. In the
end, crypto is not providing unbanked or underbanked populations with an alternative route to
financial inclusion.
In addition, the privacy provided by crypto might come at the expense of security for its users, apart
from the risk of obfuscating the legal obligations that rest on users and facilitators (in particular,
legal requirements concerning tax and anti-money-laundering). In the EU, ensuring that blockchain
complies with the General Data Protection Regulation may be challenging, but it requires a case-by-
case analysis of the actual features of each blockchain. This, in turn, raises another issue regarding
the territorial scope of the data protection rules relating to crypto.
It is important to protect consumers and investors from malpractice, misuse of power and even
the exploitative activities of participants and intermediaries, as consumers and some investors
(particularly small investors) may not possess sufficient knowledge to combat or be wary of some of
these practices. They may buy unsuitable products, face large losses, or be exposed to fraudulent
activity. As the European Supervisory Authorities stressed in 2022, crypto assets are not suited to
most retail consumers as an investment or as a means of payment or exchange, due to extreme price
movements, product complexity, the risk of fraud and malicious activities, hacks, operational risks
and security issues, and the risk of misleading advertisements, including through social media and
influencers. 12
For instance, a recent BIS study on Crypto shocks and retail losses has established that a majority of
crypto app users in nearly all economies made losses on their holdings over a period longer than six
years. Crypto failures may differ in scope according to the nature and functioning of the crypto
assets. In some cases, the investors exercise an individual proprietary right, in others ownership may
be shared between platform users, while in others they do not have such rights. 13
There is currently a global push for clearer policies on crypto assets. However, some experts stress
that either enforcement of existing rules (on banking, securities, consumer and investor protection
rules) on the basis of 'same substance same rules' or the implementation of new rules specific to
crypto assets will still not make them safe.

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Challenges regarding the legal economy

Crypto assets still comprise a small share of total global financial assets, but it is a larger share than
sub-prime mortgages had before the global financial crisis started. As such, they are considered to
require specific attention with regard to financial stability. This is all the more so as some experts
stress that actors involved with crypto assets have little incentive to protect financial stability
because it is a public good (people cannot be excluded from or asked to pay for it). Linkages
between crypto assets and the traditional financial system could be an important channel of shock
transmission and require specific attention to understand any systemic risks that may emerge from
a growing crypto asset universe.
The May 2023 European Systemic Risk Board study on Crypto-assets and decentralised finance:
Systemic implications and policy options concluded, among other things, that: 'Given the
exponential growth dynamics of crypto-assets seen in the past, the future development of these
markets is uncertain. There are various instances in which crypto-assets could pose a systemic risk,
for example if (i) their interconnectedness with the traditional financial system increases over time,
(ii) their connections to the traditional financial system are not identified before they cause
problems, and (iii) similar technologies are adopted in traditional finance.'
There is acknowledgement that crypto needs comprehensive policies to protect economies and
investors, which is on the agenda of the G20, to answer the question whether crypto could be re-
creating the 2008 financial crisis. In September 2023, the International Monetary Fund (IMF) and the
Financial Stability Board (FSB) issued a roadmap to ensure effective, flexible and coordinated
implementation of the comprehensive policy response for crypto assets.
Little is known about who really owns crypto assets, or about their capital gains and how they are
distributed. All these elements raise tax questions related to the definition of where taxable events
are in this economic activity and to tax design and implementation. This means that studies on
taxation of cryptocurrency are gross estimates. Accommodating cryptocurrencies within tax
systems not designed to handle them is challenging. As stated in the 2023 IMF report on Taxing
Cryptocurrencies: 'Incorporating that possibility ... is more than just a matter of expanding legal
definitions ... . The element of anonymity inherent in crypto assets raises issues of enforcement that
have long been associated with the use of cash. Those in turn raise issues for ... coherence in the
taxation of capital income (viewing crypto assets as a form of property) and – less noted, but perhaps
ultimately more significant – in the taxation of final sales under the VAT and similar taxes.'
On the interaction between crypto assets and anti-money-laundering provisions, the BIS set the
stage as follows in its 2021 insight paper on Supervising cryptoassets for anti-money laundering:
'Although certain cryptoassets have the potential to make payments and transfers more efficient,
some of their features may heighten money laundering/terrorist financing (ML/TF) risks. In
particular, the speed of transactions, global reach, potential for anonymous activity and the
potential for transactions to take place without financial intermediaries make cryptoassets
vulnerable to misuse. In fact, the scale of illicit use of cryptoassets is already significant.' However,
the nature of blockchain, which records every transaction, carries the potential to combat the
phenomenon, provided that customer identification is possible. 14 There are specific anti-money-
laundering provisions on virtual assets (VAs) and VA service providers (VASPs). 15
Crypto assets may also be used to circumvent sanctions, as evidenced by some increases in trading
volumes in crypto assets using specific currencies.

Challenges regarding carbon footprint

The consensus mechanism for PoW crypto assets has a significant carbon footprint, because it
requires vast amounts of computational power to solve the complex mathematical puzzle of mining
the crypto asset, validating transactions and securing the expanding network. There are some
recent estimates of the carbon footprint of crypto assets, which vary and differ from one year to the

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 Understanding crypto assets

next, but which show that crypto assets consume a similar amount of energy each year as some mid-
sized countries.
There are initiatives to address this challenge, via renewable energies for instance, which are not
generally implemented (but only on a voluntary basis) and might have other impacts (for example,
using energies that are not available for other consumption). Another way to reduce computational
power, and hence energy consumption, is through recourse to the PoS consensus mechanism. This
still has implications for the functioning of the crypto assets and some of its key features (such as
decentralisation). As they are now, researchers consider that some crypto assets do not price in the
negative externalities of their energy consumption and private and social costs, which renders them
an unsustainable investment that might not meet the green transition requirements.

MAIN REFERENCES
Allen H., DeFi: Shadow Banking 2.0?, William & Mary Law Review, Vol. 64, pp. 919-968, 2023.
Aramonte S., Huang W. and Schrimpf A., DeFi risks and the decentralisation illusion, BIS, 2023.
Baer K., de Mooij R., Hebous S. and Keen M., Taxing Cryptocurrencies, IMF Working Paper No. 2023/144,
July 2023.
Buckley R., Didenko A. and Trzecinski M., Blockchain and its Applications: A Conceptual Legal Primer,
Journal of International Economic Law, Vol. 26, Issue 2, June 2023.
Chen Y., Gurrola-Pérez P. and Lin K., A review of crypto-trading infrastructure, World Federation of
Exchanges, August 2023.
Hallak I., Non-EU countries' regulations on crypto-assets and their potential implications for the EU, EPRS,
European Parliament, September 2023.
Murray M., Transfers and licensing of copyrights to NFT purchasers, Stanford Journal of Blockchain Law &
Policy, January 2023.
Garrido J., Digital Tokens: A Legal Perspective, IMF Working Paper No. 2023/151, July 2023.
Garcia Ocampo D., Branzoli N. and Cusmano L., Crypto, tokens and DeFi: navigating the regulatory
landscape, BIS, May 2023.
Yaga D., Mell P., Roby N. and Scarfone K., Blockchain Technology Overview, National Institute of
Standards and Technology, NISTIR 8202, October 2018.
Zlati G., Blockchain and criminal law; the fundamentals, ERA Forum, Vol. 24, pp. 295-315, July 2023.

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EPRS | European Parliamentary Research Service

ENDNOTES
1
In fact, 'distributed ledger technology' is often used as a synonym for blockchain. For the sake of simplicity, the term
blockchain will be used, bearing in mind that DLT has a broader scope than blockchain technology.
2
For a detailed presentation, see Yaga D. et al, Blockchain Technology Overview.
3
In a blockchain, the sequence of blocks of data is created chronologically and linked together via a hash value. In other
distributed ledger technologies, the database stored across all the nodes can have a different structure and sequence.
4
See also the classification based on a mechanism's degree of decentralisation, which goes from public blockchains,
through consortium blockchains, to fully private ones (in Garrido J., Digital Tokens: A Legal Perspective, p. 10, Box 1).
5
Smart contracts were defined in 1994 as 'a computerised transaction protocol that executes the terms of a contract',
Szabo N., 'Smart Contracts'.
6
For a presentation of the scope and terminology, see Garcia Ocampo D., Crypto, tokens and DeFi: navigating the
regulatory landscape, BIS, May 2023.
7
Note that the IMF describes unbacked crypto assets as follows: 'These crypto assets are transferable, primarily
designed to be used as a medium of exchange, and although they are often decentralised, there are examples of
unbacked crypto assets that are centrally issued and controlled. Most unbacked crypto assets are currently used for
speculation and not for payment purposes', Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets,
September 2022, p. 11.
8
Regulation (EU) 2023/1114 of the European Parliament and of the Council of 31 May 2023 on markets in crypto-assets.
9
Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets, p. 21: 'Most users and crypto asset exchanges
alike use cold wallets for storing most of their crypto assets and keep only what is needed for transactions in the short
term in a hot wallet. Hot wallets allow for the quicker transfer of crypto assets in peer-to-peer transactions. There is
little real difference between cold and hot wallet technologies. A hot wallet becomes cold upon disconnecting it from
the network.'
10
Aramonte S., Huang W. and Schrimpf A., DeFi risks and the decentralisation illusion, BIS, 2023, p. 8: 'Blockchains based
on proof-of-stake, which are expected to improve scalability, allow validators to stake more of their coins so that they
have a higher chance of 'winning' the next block and receiving compensation. Since the associated operational costs
are mostly fixed, this setup naturally leads to concentration.'
11
Runs happen when people lose confidence that a particular asset will continue to retain its value and function as
expected.
12
This applies to the situation as it is before the implementation of the MICA regulation. See also work on Principles on
Blockchain Technology, Smart Contracts and Consumer Protection, by the European Law Institute.
13
For a presentation, see Kokorin I., The anatomy of crypto failures and investor protection under MiCAR, 2023.
14
See Europol spotlight, December 2021, Cryptocurrencies: tracing the evolution of criminal finances, p. 10: 'Pseudo-
anonymity and decentralisation provide a favourable environment for criminals. It is important to highlight that
cryptocurrencies are not anonymous. Every single transaction is logged in the blockchain, which is a ledger of all
transactions distributed to all users in the network. Most blockchains are publicly available, making transactions
traceable. However, a number of services and techniques can enhance anonymity and hinder law enforcement
investigations.'
15
For more details, see the 6 July 2023 Council of Europe Moneyval report on money laundering and terrorist financing
risks in the world of virtual assets.

DISCLAIMER AND COPYRIGHT

This document is prepared for, and addressed to, the Members and staff of the European Parliament as
background material to assist them in their parliamentary work. The content of the document is the sole
responsibility of its author(s) and any opinions expressed herein should not be taken to represent an official
position of the Parliament.
Reproduction and translation for non-commercial purposes are authorised, provided the source is
acknowledged and the European Parliament is given prior notice and sent a copy.
© European Union, 2023.
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