You might not understand how cryptocurrencies work. In fact, how many people do? But chances are, you would probably have heard of Bitcoin. You might have even heard of Ethereum and Ripple. These are just three of more than 1,000 cryptocurrencies that have emerged over the past few years.
Cryptocurrencies are digital currencies that utilise the blockchain technology, which is best described as a digital ledger that contains the currency’s complete transactional history. It’s supposed to be so secure that it’s impossible to manipulate.
The unique thing about cryptocurrencies is that they do not rely on central authorities to govern transactions. There’s no central bank for Bitcoin or any of the other cryptocurrencies. That doesn’t mean regulators in various countries aren’t trying to impose some controls though.
Some are responding with panic and issuing serious clampdowns. Both India and Vietnam, for example, have banned cryptocurrency as a means of payment. Meanwhile, China and South Korea have banned Initial Coin Offerings (ICOs) of new cryptocurrencies. Japan hasn’t banned cryptocurrencies but has introduced a licensing regime for cryptocurrency exchanges.
On the corporate front, there have been some developments that have been detrimental to cryptocurrencies. Facebook, for example, is blocking ads for Bitcoins and ICOs to avoid fraud. Both Mastercard and Visa have classified Bitcoin transactions as “cash advances” rather than purchases, and are thus charging higher interest rates for them.
There’s serious doubt that Bitcoin and its ilk can even be considered currency. The US Commodity Futures Trading Commission has decreed cryptocurrency to be a commodity, not a currency. The US Internal Revenue Service treats cryptocurrency as property rather than currency and thus requires profits made on them to be declared.
Currency or commodity?
There’s a very good reason why Bitcoin should be considered more as a commodity or property than currency. Its value fluctuates wildly due to speculation. People don’t really buy Bitcoins to be used as payment for goods and services but rather to keep them like a stock whose value they hope will go up.
The cryptocurrency mania reached fever pitch late last year when Bitcoin rose to a high of nearly US$20,000 per Bitcoin in December. That’s nearly RM78,000! The value of Bitcoin has climbed down considerably since then. At the time of writing, it’s valued at about US$10,900 dollars or RM42,300. That’s a huge difference in just a matter of months.
Ethereum and Ripple didn’t fare so well either when it comes to stability. Both also rose to record highs late last year before dropping by about 40 per cent. Stable currencies don’t fluctuate like that.
Although the blockchain technology behind cryptocurrency is solid, the cryptocurrency exchanges that have emerged are not. These exchanges allow people to trade their cryptocurrencies for other currencies or legal tender and are popular because speculators don’t want to always hold on to their cryptocurrencies. When the value rises, they want to cash out.
But some of these exchanges were not so secure and there have been several high-profile hacks. The breaches at Mt. Gox and NiceHash, two major exchanges, had resulted in a loss of over US$500. A more recent hack on Coincheck, another cryptocurrency exchange, cost the company nearly US$530 million.
Although there’s a lot of fascination among the general public about cryptocurrencies like Bitcoin, there are some high profile detractors. Warren Buffet, for example, said in January: “I can say almost with certainty that cryptocurrencies will come to a bad end.” Buffet’s business partner Charlie Munger is just as critical of cryptocurrencies calling their soaring prices last year “total insanity”.
In some countries where government-issued currency is close to useless, cryptocurrencies could actually play a useful role. They are popular, for example, in Zimbabwe and Venezuela because the local population there has no confidence in government-issued money. As volatile as Bitcoin may be, it’s still more stable than the local currencies in those places.
Future of money
However, for most countries the established financial system works much better. Government issued currency is more stable and accepted everywhere, which is not the case with cryptocurrencies. But that doesn’t mean there’s no future for cryptocurrencies.
They might just not be in the form that we see today. Central banks of governments around the world may decide to create their own respective cryptocurrencies with their own set of controls in place to regulate them.
Most experts agree that the future of money is digital. A solid technology is needed to ensure that the digital transactions are secure. The blockchain technology that powers cryptocurrencies could very well become the standard technology adopted by central banks around the world for creating their respective digital currencies.
This kind of future may not be so far away. The Bank of England, for example, is already looking at creating its own cryptocurrency and has even come up with an experimental cryptocurrency framework called RSCoin.
Under this system, the Bank of England would continue to issue money but instead of physical notes, it would issue digital money. Like Bitcoin, RSCoin would use the blockchain technology with a public ledger and a cryptographic system to distribute money.
The big difference is that RSCoin would not be so easily speculated on because the Bank of England could control its value by regulating how many RSCoins would be in circulation. It’s basically just replacing paper money.
Wait and see
So is this the future of cryptocurrencies — that its underlying technology will be co-opted by central banks to issue national cryptocurrencies? Perhaps but who knows. Cryptocurrencies might evolve in ways that we can’t anticipate.
Cryptocurrencies and the blockchain technology that powers it are reminiscent of the early days of the Internet with its dotcom bubble. Eventually that bubble did burst and there were many flame-outs. But amongst the dotcom rubble were some real big winners like Google and Facebook which are today indispensable aspects of our daily lives.
Will the likes of Bitcoin become like Google and Facebook or will they become more like Yahoo and Pets.com? It’s impossible to tell but one thing is for sure, cryptocurrencies and the blockchain technology are not fads. They will be an important part of our future. We just don’t know in what form yet.