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Demystifying Cryptocurrency

Researching the realities of decentralised finance

Cryptocurrency has rapidly developed from a niche concept into something relatively mainstream - and it offers unique opportunities for Finance researchers. Dr Igor Makarov of the LSE Department of Finance discusses what inspired his world-leading work on cryptocurrency, the realities of decentralised finance, and what lessons can be taken from traditional finance.

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WATCH: Demystifying Cryptocurrency with Igor Makarov, LSE

While the new ecosystem is evolving, different applications are built and the regulatory framework is being developed, research can have a lot of impact

Cryptocurrencies have quite rapidly gone from being a niche product to being almost mainstream - these days there are few people who haven't heard about Bitcoin or Ethereum - and we have also seen the emergence of a new Financial architecture that aims to replace and disrupt the current financial system.

There is much debate about the benefits and risks of this new financial architecture and cryptocurrencies in general. In my research I try to shed light on some of these open questions. While the new ecosystem is evolving, different applications are built and the regulatory framework is being developed, research can have a lot of impact.

this field essentially faces the same frictions that are found in traditional finance

In a recent paper I co-authored with Antoinette Schoar we study the Bitcoin market, which is the oldest and still the largest cryptocurrency market. As part of our analysis we built the most complete database of entities that are tied to Bitcoin wallets, and we use this database to study the evolution of Bitcoin markets. We demonstatre that the reality of the Bitcoin ecosystem is very different from its original ideal of decentralization and leveling the playing field for all. Even after more than 10 years in existence the Bitcoin ecosystem is still dominated by large and concentrated players: the top 10000 investors control more than 30 percent of all Bitcoins and circulation; the top 50 miners often control more than 50 percent of all aggregate mining capacity. This inherent concentration makes Bitcoin susceptible to systemic risk, and it also implies that the gains from further Bitcoin adoption will likely disproportionately fall to a small set of people.

It is interesting to see that this field essentially faces the same frictions that are found in traditional finance. Overcoming these frictions is challenging, and often you do need some regulation - or at least you should not just discard what has been done in the traditional Financial system. The infrastructure or architecture found in the traditional Financial system is not random; in fact it's designed to overcome frictions, make financial markets more efficient, and make them work. In that sense there is a lot that cryptocurrencies can learn from the traditional Financial system

I saw unique opportunites for Finance research

I remember being interested the first time I heard about cryptocurrencies. Because it was a 'Wild West', without regulation, and because it was based on a blockchain technology, I saw unique opportunites for Finance research. Blockchain technology makes data public and records all transactions, so we actually have a chance to look at the behavior of investors and individuals. This type of data can be very difficult to obtain in traditional Finance research.

Of course it's not perfect, because with cryptocurrencies we don't see the real people behind the addresses, but nevertheless we can, in many cases, identify individuals, and by looking at, for example, how tokens move from one address to another, we can deduce how people trade and think about the system, and that allows us to gain a deeper insight into financial markets.

We have already presented our work to the Bank of England, SEC and the New York Stock Exchange among others, as well as many private companies. The cryptocurrency field evolves extremely fast, and Regulators in particular can find themselves in a situation where it's very difficult to keep up with the space - even I, as a researcher, have to learn something new almost every day because of the pace of innovation - so in my research I try to explain how this world works, to map it and make it understandable, and explain the economic forces at play in a way that people can relate to.

Igor Makarov is Associate Professor of Finance at the London School of Economics and Political Science.

Read more about his work at