Imagine, if you will, purchasing a dollar bill that does not exist. Your wallet contains the evidence you need to prove that this dollar bill exists in a dimension that is not yours. The non-existent bill has no gold bullion or state intervention to guarantee that it is worth any amount of money at all. Indeed, the government might suddenly stop you in the street to tell you that it has declared your dollar illegal. You exchange this cryptic evidence with a barista to buy yourself coffee, and now the cafe holds the evidence of your fabled dollar bill. The cafe might have made a profitable transaction, and then again it might not have: there is no telling your luck in trading with non-existent currency. The moment the bill was exchanged for coffee, a thousand accountants all over the world also make note of the transaction: it would be nigh impossible now for you to destroy the paper trail of your caffeine habits.
This is also how cryptocurrency works. Confused?
Cryptocurrency is a digital form of money: instead of changing hands, crypto completes transactions by travelling via computer networks. No state or commercial institution mediates crypto transactions, making the currency the basis of a decentralised ecosystem. Real dollar bills are of course part of an extremely centralised system: governments provide money with their value, legitimise its transactional utility and defend its power to ensure its ecosystem is sustainable. Like an army of obsessive accountants, many different points in the computer network that crypto travels through and lives in make note of its passing or arrival. This makes it next to impossible to ‘cook’ crypto books, making for far more accurate and secure bookkeeping than a bank could hope to emulate.
Evaluating whether cryptocurrency is for you
What purpose does cryptocurrency serve?
Cryptocurrency is perhaps best understood as an attempt to create a new framework within which the new currency could operate. Crypto works through and is supported by blockchain technology. In the simplest of terms, blockchain technology consists of connected ‘blocks’ of information maintained over a large network of online ledgers. Each transaction/s made using crypto is independently verified by each ledger ‘validator’ when it is recorded. Cryptocurrency is one practical use for this ‘record keeping’ technology which helps money break away from centralised institutions like banks and other monetary institutions that monitor money in the real world. This is why cryptocurrency is often described as an effort to decentralise the financial system. The chain of online ledgers that keep track of transactions also eliminates the possibility of a single mistaken entry causing a larger issue.
Cryptocurrency as legal tender
It is important to establish the legality of holding or trading with cryptocurrency in your country or state before deciding to adopt cryptocurrency into your personal finance ecosystem. Physical currency or their accepted alternatives are backed by the relevant monetary authority within the currency’s territory. Cryptocurrency on the other hand is not backed by any such authority, be it public or private. Only a select few countries even accept cryptocurrency as legal tender.
A court ruling made in the US this July stated that cryptocurrency would be considered a security when it is purchased by institutional buyers, but not when bought by retail buyers on exchange platforms. Many consider this a positive for the future of cryptocurrency in terms of securing its legal status. Cryptocurrency is legal in the European Union while its derivatives and other crypto-based products are considered financial instruments. In Japan however, cryptocurrency is regulated as ‘property’, or an asset class. On the other hand, crypto is completely banned in China, while India is in the process of formulating a national framework for cryptocurrency.
Cryptocurrency as an investment
Perhaps the most popular use of cryptocurrency is in its capacity to be used as a vehicle for investment. However, cryptocurrency has very little to recommend it as a form of investment. The value of cryptocurrency can also be very volatile as it is not backed by any physical asset.
The fluctuation in the price of cryptocurrency is based solely on speculation, which are affected by macroeconomic variables such as inflation, economic recession and even non-economic variables such as company messaging and pop culture trends. There is also no real way of estimating the returns on your investment. Regulatory authorities and legislation are still evolving to meet the needs of cryptocurrency, which means that the space is still alive with scams, hacks and other bugs that are the bane of computer networking.
Advantages of cryptocurrency
One argument popularly made by proponents for cryptocurrency is its potential to decentralise the financial system. This however comes with its own consequences, as the lack of regulation is directly responsible for the volatility and the prevalence of fraud in the crypto space. Cryptocurrency also makes transferring money faster and easier, all over the world. This is because no mediating parties are needed to facilitate the transfer or currency conversion. Cryptocurrency also has the potential to act as an intermediate currency for international transfers. The speculative market around cryptocurrency has also generated large amounts of profit for those who have profited from it, which has changed many lives for the better.
Disadvantages of cryptocurrency
While cryptocurrency theoretically ‘decentralises’ finance, it has also so far resulted in the centralisation of a large amount of wealth. It has been calculated for example that just 100 blockchain addresses hold close to 12% of the total value of bitcoin in circulation. The security promised in cryptocurrency is also only relevant to blockchain technology. Crypto-key storages can still be hacked or stolen. Many such hacks have taken place over the years since crypto has been in circulation, resulting in losses amounting to millions of dollars.
One other overlooked aspect of cryptocurrency is the overall environmental impact of mining cryptocurrency: mining some of the more popular currencies can require as much energy as an entire country does.
Is cryptocurrency for you?
Perhaps.
Cryptocurrency may be the best fit for you if you are seeking to take advantage of the particular benefits offered by crypto, such as streamlined currency transferring for smoother business across the world. As an investment vehicle however, it still leaves a lot to be desired.
(Theruni Liyanage)