What is Cryptocurrency and what impact may it have on the global markets?
Updated: Dec 14, 2021
What is Cryptocurrency?
Cryptocurrency was invented in 2009 as a digital, virtual current that is secure and decentralised through cryptography, making it almost impossible to counterfeit or double spend unlike with traditional currency. These cryptocurrencies run on decentralised networks that use the blockchain technology, this works through a distributed ledger that is completed through a disparate network of participating computers who mine these cryptocurrencies. The main appeal of such a currency is that they are not issued by governmental bodies or central banks, making them appealing for individuals who want to protect their investment from manipulation or interference.
Physical cash is still used across the world still with some developed nations like China being the biggest exception, almost purely using mobile payments. Most consumers in developed nations are following this with ApplePay and other alternatives becoming popular in the younger generations. Consumers in less developed nations heavily rely on physical cash because there is no banking infrastructure to facilitate a nationwide adoption of bank accounts but this seems to be rapidly changing in exchange for mobile payments with cryptocurrency seeing a rise. Furthermore, much of the reserves that central banks issue exists only in electronic form with more money existing digitally than physically by a large margin. This means the idea of cryptocurrency is not entirely alien to society.
Cryptocurrencies remain very volatile with some going up and down 30% in a single day with this being a regular occurrence that people don’t bat their eyes to anymore. This is appealing because it is possible to make large returns in a very short period of time. The S&P 500 averages only 9.12% annually where as some cryptocurrencies can gain over 500% or lose their value entirely. The risk tolerance of such an investor must be high with sometimes a medium time horizon. An example is Bitcoin which rose in 2017 from $1,000 to $20,000 and then dropped to $3,000 in the space of 2 years. In 2020 with the pandemic and inflation, it reached $60,000 and now is hovering around $50,000 in 2021.
Cryptocurrencies have become extremely popular due to the ideals of decentralization they convey, along with potentially outsized gains, but their volatility remains high and these assets carry a greater risk of losses than many traditional assets. For instance, in 2017, Bitcoin prices rose from about $1,000 to a high of more than $19,000 before dropping to around $3,000.1 Then, Bitcoin again rose through the end of 2020, reaching new highs of around $60,000 before dropping again to $30,000 in the summer of 2021.
Cryptocurrency from a global perspective
Cryptocurrencies have been seen in their earlier years in the United States and Europe as a novelty or a fad, however, they have proven their place in the world with countries who have mismanaged domestic currencies as well as young investors globally. One example is Venezuela with their hyperinflation and increasing poverty leading to millions of citizens using their computers at home to mine, distribute and exchange cryptocurrency instead of their national currency as it is seen as more secure and in the hands of the people, not the government. However, the unregulated nature of cryptocurrencies has a downside with a greater potential for tax evasion, illegal purchases, sales abroad and scams in addition to money laundering.
Governments across the world have seen cryptocurrency as sometimes a threat to a banking system with some nations banning it all together. Some large organisations have been supportive and have adopted the new technology whilst some of the biggest banks and organisations remain cautious due to the volatility and their potential impact on the world markets. Here are the official stances of cryptocurrency across some nations:
United States: U.S. Federal Reserve Chairman Jerome Powell believes that “the technical issues remain, and governance and risk management will be crucial before cryptocurrencies become part of mainstream society.”
Bank of Japan: The Bank of Japan doesn’t see a market for cryptocurrencies and remains traditional.
European Central Bank: European Central Bank Vice President Constancio called Bitcoin a “tulip” in reference to the 17th-century bubble in the Netherlands, and many other governors have expressed similar scepticism.
People’s Bank of China: The People’s Bank of China believes that conditions are “ripe” to embrace cryptocurrencies with the central bank desiring full control over the market, and authorities are cracking down on the cryptocurrency ecosystem in the country that are being misused.
Bank of England: Bank of England Governor Carney called cryptocurrencies “part of a “revolution in finance”, making the central bank one of the few governmental promoters of the technology.
One other argument is that a cryptocurrency crash could have a devastating impact on the wider markets like with how mortgage-backed securities caused the 2008 financial crisis across the world. With cryptocurrencies large volatility, these concerns are understandable. The counter argument to this is that the market cap of cryptocurrencies in 2021 hovers around 3 trillion dollars which is less than most large companies like Apple, Samsung and Google, subsequently, this doesn’t pose a substantial risk like with the 2008 market crash or the dotcom bubble. This may become a real risk as cryptocurrencies expand into the future however.
Little to no major central banks have seriously proposed issuing their own cryptocurrencies. So far, only a couple central banks have issued their own digital currencies: Ecuador and Tunisia Sweden, where the use of cash is evaporating faster than almost any other sizeable economy, is contemplating whether to issue an e-krona but this is just speculation.
How Cryptocurrency can add value to the economy
Cryptocurrencies have already allowed many investors and companies to develop and flourish, while many also rely on trading as their source of income which has produced an entirely new market. The economy is slowly shifting to adapt to these needs and cryptocurrencies have a great potential in satisfying them. More than 2.3 billion people do not have access to any sort of basic banking services, limiting their social mobility and protection from a financial crisis. These people are usually already financially disadvantaged, resorting to black-market and dangerous lending practices which put their lives at risk. The terms of conditions and interest rates are unfair, leading to instability. This is where cryptocurrencies come into use with their ease of use and high volatility. Some people have started banks that use cryptocurrency in order to offer higher interest rates on saving accounts with some reaching as high as 5%, with most regular banks offering less than 1% due to inflation, this has the possibility have a substantial impact on the wider economy if more and more people switch. There are numerous free to sign up for apps that facilitate the use of cryptocurrencies and bring them closer to the wider audience, allowing for trading to occur across borders. This will allow everyone to be more financially connected and empowered.
Because cryptocurrencies and blockchain don’t need an actual highstreet building to exist, the costs associated with their transactions are minimal. There is no need for employee wages, utility bills or rent to be paid, so these savings naturally pass onto the consumer in the form of lower transaction fees in order to attract more and more customers, creating a more competitive market. This in turn encourages more and more people to trust these new financial tools and start transactioning, allowing for the global economy to be more closely form over the coming decades.
Finally, cryptocurrencies use an automated system which is easily tracked by anyone who wishes to see where the money is flowing, meaning no manipulation can take place as corrupted and fraud will be easily detected. This allows underdeveloped countries, who have a greater chance of entering the financial transactions game and boost their own economy and social prospects, to utilise these features and adopt cryptocurrency into their economy. What’s more, citizens will be able to keep track of where governmental funds will be directed and will thus have a say within their own political climate as it may expose overspending or mismanagement.
The impacts on the global markets are extensive with over 55 monetary authorities, representing the bulk of the world GDP, are researching and potentially racing towards a digital version of their currency which will allow for independence from the US dollar, a currency which is the backbone of the world. The Bahamas has a digital currency called the sand dollar which has seen stability over the last year. El Salvador, a historically poor and unstable nation, has recognised bitcoin as legal tender with some countries expected to follow.
The Treasury and Bank of England have launched a taskforce to investigate a possible UK Central Bank Digital Currency – in contrast to the decentralised nature of Bitcoin – this could shift power away from privately owned banks to the state. Dubbed ‘Britcoin’, the currency would be an alternative form of GBP, but with the British financial services forming such a crucial part of our economy, it is unlikely any big changes would be made without wider consultation with and support from other institutions. In addition, we know and trust traditional currencies and any real change in how we operate day to day would likely be a long game.
In recent years there has been a shift towards ensuring that regulation offers crypto investors the same comfort and protection as investors in other financial assets. In particular, cryptocurrency exchanges (the way most cryptocurrency holders buy, store and trade) must now be registered with the FCA, conduct customer due diligence and report suspicious transactions (among other things).
Cryptocurrencies have numerous benefits when it comes to effortless transactions and inflation control, however, numerous investors and consumers are simply adding these currencies as assets to their diversified portfolios. Right now, it doesn’t look like cryptocurrency is going to overwhelm the global markets any time soon but instead are a nice addition to the financial world. These cryptocurrencies hedge against risk in some situations, similar to now less held precious metals like gold or silver.