Traditionally, “backing” of a given financial product is used to decrease market fluctuations and thus increase stability of said product. A common example is the Bretton-Woods period in which the US dollar was backed by a corresponding amount in gold, prior to the halting of dollar-gold convertibility in 1973. In other case, there are also mortgage-backed securities, gold-backed ETFs, and so forth. An interesting post by Nick Szabo illustrates commodity price stabilities during and after the gold standard era.

The graphs effectively shows that a floating fiat currency is correlated to higher commodity exchange rate volatility. Given that commodity prices are often determined by natural supply and demand curves (which are intemporal), the increase in volatility following 1973 could indicate that the volatility actually comes from the US dollar instead.

CheckLockTimeVerify is a Bitcoin add-on feature specified in BIP65. Essentially, it is a process in which a given transaction can be frozen until a certain time in the future. This is similar to the post-dated cheque process in the traditional financial system.

In order for Bitcoin and other cryptocurrency technologies to have a lasting impact on the existing financial ecosystem, at some point a cryptocurrency-backed fund will be approved and listed on traditional exchanges. Custodial risk is cited to be an important issue for such a fund (here is the SEC application, if anyone dares to read through it).

Source: Reuters

If such custodial risk can be mitigated by “freezing” the funds using a CLTV transaction, the fund administrators may be able to spend less time and resources on holding their funds, and also publicly demonstrate an auditable proof of holdings. This would be akin to holding a gold reserve, but which reserve and non-spendability status can be cryptographically verified until a specified date in the future. This can be useful to avoid a potential fractional reserve and insolvency situation, whether intentional or not.

Legally speaking, using CLTV may also remove custodial responsibility for a specified amount of time, as the transaction can be thought of no longer being in ownership until the unlock date. An analogous situation would be sending a package in a lengthy trip around the world to oneself. During the time the package is sent, it is not longer in the possession of the sender/receiver. A title will be issued, which is used to claim the package, but it likely will not constitute possession of the package itself.

However, CLTV should not be thought of as an adequate defense against cybersecurity risk. Since even if the private key is compromised during the freezing period, a hacker could simply automate a transaction being sent as soon as the funds are unlocked. It any case, CLTV should only show that the owners of a fund is not capable of spending its funds, which is already a step ahead of centralized holders of backing reserves currently.

Disclaimer: This article is not intended to provide legal or financial advice. Forward looking statements are not guarantees of any future events. Any opinions expressed in this piece are the author’s own and do not necessarily reflect the view of the SkycityCI team.