Over the past couple of years, cryptocurrencies have grown remarkably popular. In 2017, Bitcoin prices increased by 1,318 percent as opposed to only 15 to 30 percent for most major equity indexes globally. Also during the year, the four best performing less popular digital currencies all returned over 10,000 percent. Initial coin offerings(ICOs), also garnered more than $3.7 billion in 2017 with a set of new digital assets hitting the market.
What Are Cryptocurrencies?
A cryptocurrency is a digital, decentralized currency created to serve as a means of exchange. The prefix, ‘crypto’ comes from the fact that cryptocurrencies verify and secure transactions as well as create new currency units using cryptography. Cryptography makes it very easy to program something that is very easy to solve with a key and very hard to decipher without a key, which means coins can be tough to create, but transactions can be simple to verify.
In the real sense, cryptocurrencies are entries in a permanent and anonymous database, referred to as a blockchain, that no one can modify (except under desperate conditions when direct edits are performed). The blockchain is a public ledger that is verified by many various nodes, which makes double spending coins extremely difficult or impossible. The blockchain technology also makes it easy to trace any particular transaction between anonymous specific wallets or accounts.
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Global Appeal of Cryptocurrencies
Cryptocurrencies provide an easy-to-use, digital option to traditional fiat currencies. Users from European Union or the United States may view digital currencies as a novelty, but there are several countries with mismanaged fiat currencies. For instance, Venezuela’s dictatorial regime has become notorious for its high inflation, which has led to dwindling living conditions for millions of residents without access to external currencies.
The extremely volatile nature of Bitcoin and other digital currencies may look risky to U.S. users, but Venezuelans may find the fluctuations tolerable when their national currency has been in an explicit decline over many years with no signs of improving. Simply put, many consumers globally may see cryptocurrencies as a way out of inflation since the number of digital coins in circulation is mathematically capped over time.
Other countries have stringent capital controls in place to regulate the flow of money and impose high taxes. Digital currencies can be used to evade these capital controls and taxes—legal or not—which has resulted in increased demand on the part of businesses and consumers. Because of this, many countries have begun cracking down on the unlawful uses of cryptocurrencies for tax evasion or illicit purchases or sales overseas.
How Governments Are Responding
The official acknowledgment of cryptocurrencies has been tepid at best across financial institutions and central banks. While some organizations have been supportive of the digital currency, many central banks remain wary given the market’s excessive volatility and the high-profile security problems it encountered in the recent past.
The issues as mentioned earlier with tax evasion and capital controls have also resulted in some significant concerns about the world market cryptocurrency.
United States Federal Reserve: Jerome Powell, Chairman of the United States Federal Reserve believes that technical problems remain, and risk management governance will be essential before digital currencies become generally accepted as a medium of exchange.
European Central Bank: Vitor Constancio, Vice President of the European Central Bank tagged Bitcoin a “tulip” in a citation to the 17-century bubble in the Netherlands, and a number of other governors have expressed similar doubt.
People’s Bank of China: The People’s Bank of China thinks that conditions are “ripe” to adopt digital currencies, but the central bank wants complete control, and officials are cracking down on the cryptocurrency exchange platforms and crypto-related activities in the country.
Bank of Japan: The Bank of Japan believes there is no market for digital currencies in the country.
Bank of England: Mark Carney, Governor of the Bank of England, referred to cryptocurrencies as part of a “revolution” in the financial sector, making the central bank one of the few governmental defenders of the technology.
The Venezuelan government, experiencing capital limitations of its own, recently launched its own cryptocurrency, called the Petra, which is allegedly backed by barrels of crude oil. While official sources reported that the country amassed billions of dollars, many experts are suspicious of these figures, and the United States has banned U.S. citizens from buying the currency.
Impact on Global Investments
Cryptocurrencies have a lot of advantages when it comes to inflation control and smooth transactions, but many investors are including these currencies in their diversified portfolios as assets. Notably, the non-correlated property of the market makes cryptocurrencies a possible hedge against risk, just like gold and other precious metals. A lot of cryptocurrency exchange-traded products (ETFs and ETNs) have been launched for this particular reason.
However, some experts fear that a crash in a particular coin in the global cryptocurrency market could have a disadvantageous influence in the broader market, just like how mortgage-backed securities sparked an extended global financial crisis. It’s important to bear in mind, however, that the total market capitalization of all digital currencies is less than that of most public companies, like Microsoft Corp., which indicates that it may not have a significant influence on global markets.
Overall, many investors see cryptocurrencies as either a medium for speculative trading or a hedge against inflation, but as of early 2018, the size of the market doesn’t pose a systemic risk.
For options on how to invest in cryptocurrencies, check our cryptocurrency exchange guide.