Over the last year, there has been too much talk on the media about Facebook’s plan to release its own digital currency Libra. Soon, rumours started spreading that this will mean the end of the financial model and that digital currencies will eventually replace the money. However, the existence of the digital currency is not breaking news.
Ten years have passed since Bitcoin, the first electronic currency was firstly introduced by its founder under the pseudonym Satoshi Nakamoto; three years later, Ripple followed. Since then, the world has been witnessing a transitional period in the financial market with the introduction of the cryptocurrencies; an alternative digital form of money used in parallel with the traditional money.
At a quick glance, hundreds of currencies are now in circulation, while new constantly emerge. The International Monetary Fund estimates that ‘’ there were more than 1,500 cryptocurrencies, according to coinmarketcap.com’’. In fact, their value has skyrocketed over the last years, reaching 1,200% by 2017 (Bovaird, 2017; quoted in Houben and Snyers, 2018: 29). One of the most popular and best-performing cryptocurrencies is reportedly the Bitcoin (BTC) with the highest value, followed by Ethereum (ETH) and Ripple (XRP).
Due to limited use of digital money, policymakers and financial institutions did not react – until now – to the presence of cryptocurrencies. However, the entry of the social media platform on the crypto market was a big trigger for the reaction of the US authorities. Due to its big stature, the introduction of the new digital coin which would potentially be used by millions of Facebook users would be a game-changer. The above suspicions were further fuelled by the continuous growth of the largest cryptocurrencies, which exceeded the €330 billions of total market capitalisation in early 2018 (Houben and Snyers, 2018).
So, the big question that arises is whether the cryptocurrencies undermine the financial model? Or, to the other end, should it be considered as the natural successor of the money-based economy into the future? This exact question attempts to answer the current analysis by setting out the benefits as well as the risks associated with the crypto market. In this context, the following section outlines the key features of the digital currency and the technology used behind it.
How is a cryptocurrency used and what new has to offer?
The term cryptocurrency comprises two words; the first component is ‘’crypto’’, which means hidden or secret referring to the encrypted technology used as a layer of protection during a transaction; the second component is ‘’currency’’ which pinpoints the practical use of cryptocurrency as a unit of value for the exchange of goods and services.
Although cryptocurrencies can be used as a payment method, the way a transaction is performed differs from the business as usual standards. Based on the blockchain technology, which uses computing and cryptography, each member verifies and validates the transaction with the use of two keys – one private and one public. Once a consensus is reached, the completed transaction is saved permanently as a block to the ledger and can be viewed from anyone.
In fact, the unique selling point of the virtual money lies on its independence from any intermediaries. In the traditional economy, fiat money is monitored by central banks. Here, the bank’s role as the ledger is to ‘’adjust the position of their account holders in their internal ledgers, while the central bank validates transactions among financial institutions in a central ledger’’ (Bouveret and Haksar, 2018). Therefore, the ledger safeguards the transaction and ensures that the money is not spent twice.
Unlike traditional currency, there is no need for intermediaries in the crypto market. Instead, there are anonymously distributed ledgers – known as miners – that verify the authenticity of a transaction. As such transactions cannot be manipulated, this adds extra points to the credibility and transparency of the digital transactions. What’s more, by overstepping the intermediaries, the cost for overseas transactions drops down significantly.
Different approaches from countries around the world
There are different approaches of what cryptocurrency represents: “a digital currency in Argentina, Thailand, and Australia; a virtual commodity in Canada, China, Taiwan; a crypto-token in Germany; a payment token in Switzerland; a cyber currency in Italy and Lebanon; an electronic currency in Colombia and Lebanon; a virtual asset in Honduras and Mexico’’ (The Law Library of Congress, 2018). For international organisations, the cryptocurrency is equal to virtual currency (EU, the International Monetary Fund), while for the World Bank, a digital currency. From the investor’s perspective, the cryptocurrencies are an ideal option for long-term investment. This is why the Bank of England classifies them as crypto assets instead.
Following the explosive growth of cryptocurrencies, many countries have taken further steps to protect their economies by releasing new laws to regulate and protect their financial market. A good example is the inclusion of cryptocurrencies as a form of investments on the tax system. Depending on the views of each country on this topic, there is a deviation on the legislation followed, which from more to less tolerant towards the digital currency. In one hand, there is a group of states that classify any investments or transactions made with cryptocurrencies as money laundering (Australia and Canada); or worse, as illegal and therefore banned from the domestic market (Algeria, Bolivia, Morocco, Nepal and Vietnam).
On the other hand, some countries appear more open to this new model. As a general concept, cryptocurrencies are treated as funds, which are subject to the national regulations (Spain, Belarus and Luxemburg). A more reserved view simply allows the use of digital currencies, due to their marginal impact on the domestic economy (UK, Belgium and South Africa). For those with more liberal views, such as China and Venezuela, the realisation of the technological potential of cryptocurrencies has initiated the talks for issuing a national cryptocurrency. An even bolder approach is the acceptance of virtual money as a form of legal payment in the local economy including the Swiss Cantons of Zug, the municipality within Ticino Mexico and the Isle of Man.
Is it all sunshine and rainbows?
Despite the continued growth of the crypto market, the performance of the digital currencies has not been very consistent. Over the last four to five years, a soaring of 65% on their value was followed by 25% sudden drops. Characteristically, the total capitalisation value of all cryptocurrencies reached its peak at $728 billion, only to plunge into $360 billion three weeks later (Houben and Snyers, 2018).
Another interesting remark is that cryptocurrencies are considered a risky investment because of their decentralised system and limitation to online mainly transactions. Unfortunately, cryptocurrency transactions are irreversible, as there is no intermediary involved to back the assets. Even worse, there is no form of protection, in case the cryptosystem fails. Hypothetically, if a user loses the password, it is impossible to recover it.
On a further scale, the anonymity on the crypto market has been associated with criminal activity and the dark web. In the absence of a legal regulator, the validation of a transaction from anonymous users can be a flaw to the system. Reaching the point of pseudo-anonymity, the crypto transactions do not allow adequate monitoring of shady transactions made from criminal organisations that aim to access clean cash. Apart from criminal activity anonymity can become a burden for tax authorities when trying to detect tax evasion. This is why many countries have decided to ban digital currencies.
Are cryptocurrencies our future?
In conclusion, what new opportunities may cryptocurrencies present to the economy? Despite the criminal risks and the lack of practical implementation, there is a huge potential for the blockchain technology to revolutionise the future business and banking model; all thanks to the blockchain technology, which uses encryption techniques to monitor monetary units and trading behaviours.
Of the major benefits, transparency and easy access to information can build a competitive future for the financial services. Although this new technology might be more secure than the traditional transactions, hackers can still hack systems to extract sensitive personal information and use the cryptographic keys for making digital transactions, which is similar to hacking the PIN of a bank card.
In this context, big companies have already expressed interest to further explore the crypto market. Recently, a second NBA team has also announced the acceptance of digital currencies for the sale of tickets and merchandise (Barnathan, 2019). According to Sidorenko, 80% of banks are expected to start blockchain projects, while an increasing number of countries are planning to use the blockchain technology beyond finance: the voting system with the secure identity verification; the management of health records with the prescription of medicine; the vehicle registration; property market (Medcraft, 2019).
In spite of the promising future, the evidence shows that there are still many barriers to overcome before this new technology wins regulatory backing and public trust. The above consideration is evident from Facebook’s case when announced the plans to release its own digital coin called Libra. Invoking security risks for the financial system, the US authorities criticised heavily this decision, which proves that the world is not ready for such a change. The impact was immediate to the market value of Bitcoin, which fell around 8% according to BBC’s estimates, bringing to its lowest level since June (BBC, 2019). Political pressure has also urged investors to back down despite their commitment to the project by injecting $10 million.
There is still a conservative – not to say hostile – environment towards the crypto market. As more firms express an interest to expand their activities on cryptocurrencies, the more reactions arise. On this group belong the traditional ledgers, who fear that they will lose control of the financial market. As a counteroffer to the above reservations, a cross-collaboration between banks and blockchain players would be a cornerstone for securing the success of a new business model. More banks, insurers and fintech companies will try to integrate the new technology on their systems for reasons of cost-efficiency and simplicity; to cut down the cost of cross-border payments. A good example is the Commonwealth Bank of Australia which has already started exploring the potential of cryptocurrencies; in 2015, the CBA tested the use of Ripple on its operations. Another possible scenario would be the banks to issue their own currency such as Citigroup with the creation of Citicoin as a laboratory experiment.
One is certain, that despite the reactions or negative feedback, the digital money will play a vital role in the future if regulation and anti-crime measures will be implemented correctly to ensure proper use. Creating an unwelcoming environment could delay severely the integration of the cryptocurrencies into the financial market. Of course, such a delay could give the opportunity for another country to take the lead and develop its own cryptocurrency.
Reaping off the benefits of a transparent and lower-cost system will also depend on the regulatory framework that will be imposed by the governments. Otherwise, uncertainty will continue discouraging businesses from investing in the blockchain technology. For this reason, it is essential that policymakers should build a new business model and set new industry standards that will help blockchain innovations to flourish. Towards this direction, the European Union has developed the most comprehensive regulatory framework. Although digital money is tax-exempt, cryptocurrency entities are obliged to report any illegal activities, individuals or companies that invest in cryptocurrencies.
Photo: Alpari Org, Cryptocurrency Coins (2019). Source: (flickr.com) | (CC BY 2.0)
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