It’s hard to have missed the wave of hype surrounding cryptocurrencies, and resultant controversies over what to do with these assets — how to use them, how to store them, how to classify them. Digital and decentralized currencies began 2017 with a rally that took their price to stratospheric highs. The most popular of all cryptocurrencies, the Bitcoin, has made the most headline, understandably. The price of the blockchain-based “coin” surpassed that of an ounce of gold for the first time in March this year, and the currency is currently trading near its all-time record, often flirting with the $3,000 dollar-mark. Rival currencies, notably Ethereum have soared higher, even managing to challenge Bitcoin’s market dominance. As the combined market capitalization of these coins reached $100 billion early last month questions on the future of these currencies are unescapable.
But every boom raises the specter of bust. When an asset gains value at such a neck-breaking speed and so many people are profit from it, talk of bubbles or Ponzi schemes is inevitable. Reasons for skepticism range from the plethora of different digital “coins” in circulation — now close to 800 of them — to the volatility of these assets, shown by a drastic fall in the price of many cryptocurrencies by the middle of June, leading many to question their ability of serving as a reserve of value. That’s natural. But there is good reason to believe that these currencies do have a future — and the potential to revolutionize how we make financial transactions.
Just look at markets which starting to take these currencies more seriously. Many governments, especially in Asia, have created or are considering the introduction of necessary regulation to encourage people use digital currencies. The Japanese government announced in early April that bitcoin had been approved as a legal payment method in the country. In India, the Inter-Disciplinary Committee within the Ministry of Finance was actively investigating the legal status of Bitcoin and considering the possibility of regulating the market. In Russia, President Putin committed to recognize cryptocurrencies as legal means of exchange by 2018. Other countries like South Korea, Australia, the Philippines and Singapore are following a similar approach, but others have gone so far as to consider the establishment of digital-only currencies in addition to traditional denominations, with China’s central bank reportedly running trials, while Danish authorities have entertained the possibility of a digital-only e-krone.
A rise in government interest in cryptocurrency is due in no small part to rising public interest in a deflationary means of exchange and the perceived utility of cryptocurrencies. Because these virtual currencies are tracked and maintained by a network of computers, no government or company is in charge, making them less susceptible to meddling by officials. Political risk plays an important part here: it is a major factor underpinning the decision of many to seek cryptocurrencies as a safe haven. This was true during the Modi’s demonetization effort in India, and it remains true in countries like crisis-torn Venezuela. Zimbabweans, for example, virtual currencies as a saving mechanism, since past experiences with hyperinflation have made them less keen to trust central bankers.
Previously scarce real life uses for these currencies — apart from moving money around — are also on the up. A growing number of businesses is showing willingness to accept cryptocurrencies, from companies like Microsoftto travel operators like Expedia. Moreover, startups, such as Singapore’s TenX, are looking for ways to enable users to use their virtual funds directly using debit cards converting cryptocurrencies straight into fiat ones.
Worries persist around cryptocurrencies because of their wild volatility, as it is not unusual for cryptocurrencies to go through 10 percent-plus fluctuations in a matter of 24-hours. However, for digital tokens still in their infancy this normal for four reasons. Markets are still trying to gauge the right price for each token, as lack of history makes technical analysis more difficult. Secondly, every day new frontiers are open, with more investors coming in and new markets becoming available, so that the scope and scale of this market is not yet clear. Thirdly, there is no central bank to intervene, and, like any other asset, their value is contingent on what central banks are doing. Finally, it’s impossible to avoid some degree of irrational behavior as users as faced with a technology they don’t yet fully comprehend.
In the longer term, however, these are fluctuations garnishing a strong growth trend. Busts will eventually lead some to abandon this market. And this is actually a great thing. This market, like the financial technology sector more generally, has the capacity to stir innovation and reinvent itself, coming much stronger from previous crashes are aiming for ‘ever higher lows’ while a new economic infrastructure develops. As former Barclays CEO Anthony Jenkins noted, “One of the beautiful things about bitcoin is you get to see free-market economics at work every day, and bubbles and creative destruction are part of that process.” The end of cryptocurrencies is not close at hand. Despite, claims that the cryptocurrency “bubble” was about to burst anytime soon, there are important voices defending that this market is far from peaking. Michael Novogratz — a Wall Street star who has invested around 10 percent of his multi-billion net worth in a portfolio of cryptocurrencies including Bitcoin, Ethereum and Litecoin — says that the cryptocurrency market could reach $5 trillion by 2022. The number of potential buyers is thousands of times larger than the pool of present cryptocurrency holders, giving them a lot of room to grow.
But would all this been in vain if cryptocurrencies fail? Absolutely not. The hype around cryptocurrencies notwithstanding, the very technology behind most of them — the blockchain — is revolutionizing financial transactions, online contracts and cybersecurity. Defining it in simple terms, the blockchain is a shared public ledger, which holds a record of every single transaction made by users of a given system. What makes it so valuable is the inherent transparency of this record, given that the content and integrity of the ledger is ensured by the need for validation of any change by all peers who share maintenance of the ledger. In other works, one cannot simply fiddle with the ledger without the knowledge of the all other peers, making distributed ledgers an effective risk management tool. All blockchain transactions are easily accessible, traceable and legitimate, making auditing in many ways redundant.
The blockchain is interdisciplinary, and its applications go far beyond serving as a public record of cryptocurrency transactions. Some firms have already start to invest in serious blockchain research. For example, Borsa Italiana, a subsidiary of the London Stock Exchange has developed a blockchain solution to help SMEs digitize capital structure and securities ownership, in collaboration with IBM. More than 50 banks including Barclays Bank Plc and JPMorgan Chase & Co. have joined the R3 consortium, aimed at finding ways to use blockchain as a decentralized ledger to track money transfers and other transactions for their services. There are some limitations to the deployment of blockchain-based technologies, including the need of a great processing capacity and physical restrictions to the rate at which records can be added to a distributed ledger. Nonetheless, the transparency and efficient risk management solution provided by blockchain will continue to foster initiatives to develop solutions based on this technology.
All things considered, we should stop writing obituaries for cryptocurrencies and appreciate the fundamental advances behind it. They are a valid and necessary financial experience as many others, and it could potentially take us to a point where money becomes much cheaper and safer. Fiat currencies and central bankers have often failed us, but we don’t talk about going back to carrying precious metals around or reinstating the gold standard. Cryptocurrencies are not the new Tulip-mania, or gold mining stocks. Speculation is present to the extent that the lack of clear contours as to the future of these currencies gives margin for bold investor to try making quick profits. Nevertheless, these are not the only players in town. Booms and busts are a normal part of any economic cycle and creative destruction can be useful to perfect cryptocurrencies to attract more adherents. In the most adverse future, cryptocurrencies are still operating in a fairly contained system that won’t risk financial stability, and even should the worst happen, there is an underlying technology with vast potential benefits.
It’s worth a try.