Crypto assets
What do the terms crypto-asset, blockchain and distributed ledger technology (DLT) mean?
Crypto-assets1 are also known as cryptocurrencies, virtual currencies or virtual assets, for example. Crypto-assets are most commonly used for investment. Crypto-assets usually have in common the technology used to store and transfer them, such as blockchain. Blockchain is one type of distributed ledger technology (DLT). “Crypto” refers to cryptography, i.e. encryption technology. Distributed means that the entries made to a blockchain (or something similar) are not decided by a single, or “centralised” entity. Making entries is based on a consensus mechanism. This means that there must be a sufficient number of approvers for an entry to be made.
There are thousands of different crypto-assets. Crypto-assets are often subject to wild fluctuations in value. Not all crypto-assets may be completely or quickly convertible into cash, i.e. liquid. A crypto-asset might not have a named issuer. There is no kind of compensation fund to protect crypto-asset investments. In addition, due to the distributed ledger technology, specific security risks are associated with crypto-assets.
Blockchains or, more broadly, distributed ledger technologies can also be used in, for example, issuing or trading financial instruments or other financial products. Therefore, even if financial products use technology similar to crypto-assets, these financial products are subject to the same rights and obligations as the same financial products when the technology in question is not used. The term security token may sometimes be used in relation to securities utilising blockchain technology. Therefore, although blockchains or other distributed ledger technologies are, in practice, always associated with crypto-assets, these technologies can also be used for other purposes. In addition, it is possible that, for example, a fund invests in crypto-assets or that a crypto-asset is the underlying asset of a derivative. In that case, it is not crypto-assets that are involved, but financial instruments.
Crypto-assets may also be used to make payments. In practice, the option to pay using crypto-assets in retail shops, for example, is rare. It is possible to use crypto-assets for peer-to-peer payments without a regulated service provider. This is similar to cash payment, with the difference that the information about the transfer of crypto-assets is stored on a blockchain or in another corresponding way. Regardless of whether or not a regulated service provider is used for payment, it should be noted that transfers of crypto-assets are not covered by the same consumer protections as regular transfers of funds.
One of the most famous crypto-assets is Bitcoin. It does not have a designated issuer, i.e. its issuance is decentralised. Bitcoin utilises a consensus mechanism called Proof-of-Work (PoW). So-called mining of Bitcoin is open to anyone. Its value is not guaranteed in any way.
Other phenomena related to crypto-assets
A crypto-asset may also have a named issuer, seller or person who “lists” the crypto-asset on a trading platform or “crypto exchange”. The term initial coin offering (ICO) is commonly used to refer to the presale of crypto-assets. The term initial DEX offering (IDO), for example, is also used. In the latter case, the crypto-asset is sold on a so-called decentralised crypto exchange instead of a centralised crypto exchange. Most crypto exchanges are centralised, which means that a single entity is responsible for the operation of the exchange. A heightened risk of fraud is associated with presales of crypto assets. The price of new crypto-assets is often easy to manipulate. Moreover, since it is practically impossible to determine the value of new crypto-assets, investing is akin to gambling.
Decentralised exchanges (DEXs), are part of a phenomenon known as decentralised finance (DeFi). DeFi activities may be regulated or unregulated. The term DeFi might be used to market a regulated service where a client’s crypto-assets are transferred to a DeFi protocol on behalf of the client. DeFi protocols are associated with heightened security threats, such as hacking.
The term altcoin is often used to refer to all crypto-assets other than Bitcoin. Memecoins are crypto-assets that are often related to an internet meme or other trending phenomenon. They are often associated with wild fluctuations in value. The term stablecoin, on the other hand, usually refers to a crypto-asset where the aim is to keep its value stable by some means or another. An attempt may be made to keep the value stable by, for example, supporting the value with some kind of reserve asset or algorithm. A non-fungible token (NFT) generally refers to a crypto-asset that is unique and cannot be subdivided or with which there is a very limited number of tokens identical to it. A utility token generally refers to a token whose sole purpose is to represent the right of access to some product or service of the issuer of the token in question.
Staking refers to a consensus mechanism based on the Proof-of-Stake (PoS) protocol. Staking can be offered as a service in such a way that the service provider “stakes” customers’ crypto-assets, generally for a fixed period of time. In practice, staking is similar in purpose to mining in that the potential crypto-asset reward from it is used to incentivise the maintenance of the blockchain or other distributed ledger technology.
Crypto-asset wallets
When crypto-asset storage solutions are discussed, the word wallet is most often used. From a customer protection perspective, wallets can be roughly divided into two categories: 1) solutions in which a person transfers to a service provider, at least in part, the private keys needed to manage the wallet, and 2) solutions in which a person keeps the private keys under their control and other entities do not have access to the private keys. If a person transfers control of the private keys to a service provider, the person becomes a customer and the service provider has at least limited liability for the appropriate custody of the customer’s crypto-assets and/or private keys. The customer should always check the service provider’s terms and conditions of use for limitations of liability. If, on the other hand, a solution is selected where the control of the crypto-assets remains entirely with the person themselves, the responsibility for appropriate storage also remains entirely with the person themselves. For example, if a person loses their private keys, it may never be possible to recover them. Without the private keys, the crypto-assets stored in a wallet cannot be accessed.
Wallets are also generally classified as either hot or cold, depending on whether the wallet is connected to the internet (hot wallet) or not (cold wallet). The term crypto-asset account is also sometimes used to refer to a storage solution offered by a service provider.
What are the risks associated with crypto-assets?
Crypto-assets are associated with, among other things, extreme value volatility, aggressive and returns-focused marketing, specific security risks and a heightened risk of being scammed. Customers are not necessarily protected in the event of a service provider’s insolvency. Crypto-asset investments, moreover, are not covered by the Investor Compensation Fund. The customer’s legal remedies in problem situations are weak or non-existent.
Crypto-assets are favoured in cybercrime, such as in crime involving ransomware. Crypto-assets are also used in, for example, drug trafficking, money laundering, terrorist financing, illegal trade, such as on darknet marketplaces, and to circumvent sanctions. There are often vulnerabilities associated with the crypto-asset storage and trading that are exploited by hackers in order to steal crypto-assets. In addition, the risk of market manipulation is associated with new crypto-assets in particular.
To read more about warnings related to crypto-assets, please visit the section Crypto-asset activities of the Financial Supervisory Authority's website, under Warnings for investors and consumers.
What to consider when trading crypto-assets?
Anyone buying, selling, exchanging or mining (including staking) crypto-assets must take into account the Tax Administration’s guidance on taxation of virtual currencies. Similarly, parties who accept crypto-assets as payment or parties who play internet games with crypto-assets should be familiar with the Tax Administration’s guidance.
Read Tax Administration’s guidance on taxation of virtual currencies
1) Defined as a digital representation of a value or right that can be transferred and stored electronically using a distributed ledger or similar technology.