The emergence of cryptocurrencies has dominated the financial news for the last few years. But is this a fad, or are cryptocurrencies here to stay? Are cryptocurrencies radical, or are they old financial products in new wrappings? Indeed, regulators worldwide are scrambling to understand and control these new, rapidly growing instruments.
How big is the Crypto market?
There are now around 6,000 cryptocurrencies worldwide with a global cryptocurrency “market valuation” of USD 2 trillion. This is 2/3rd of the size of the Indian economy! The most popular cryptocurrency is Bitcoin, and it makes up more than half the total crypto market valuation. Other popular cryptocurrencies are Ethereum, Tether, and Binance Coin.
What is so special?
The answer to what is unique about cryptocurrencies depends on who you ask! Essentially a cryptocurrency has three features:
- It is a digital financial instrument. Unlike money or gold, which you can touch or a share of a company where you have part ownership of a business and a share of its dividends, a cryptocurrency is just a digital record that you “own.”
- Ownership of the instrument is recorded and written in a digital ledger (like an online book), and this ledger is stored on millions of computers worldwide. Thus, compared to a banknote that only the government prints and central banks can authenticate, a cryptocurrency is authenticated, and no one central authority records its transfer.
- Because of its decentralized storage, there are few intermediaries. We need banks to keep our salaries. In cryptocurrencies there are usually no intermediaries and regulations permitting; we can directly operate the cryptocurrency accounts.
The similarity between cryptocurrencies and banknotes or the currency you deposit in a bank is that the value of the cryptocurrency ultimately depends on what most other people think it should be! This is the most crucial aspect that often gets ignored.
At the end of the day, the US dollar has a particular value based on demand and supply. People may buy or sell the US dollar based on what they think the US economy is doing or expectations on interest rates and inflation, and trade flows, but finally, its value is determined by how many want to buy the US dollar and how many want to sell the US dollar.
Similarly, the value of Bitcoin depends on demand and supply. When Eon Musk sold Bitcoin or said Tesla would not accept it for some time, demand fell, and the value of Bitcoin fell. When demand picks up, the value of Bitcoin goes up.
The “New” and the “Old”
Thus there is nothing new in the value and fluctuations of cryptocurrencies. They will be affected by fads and other financial and economic factors, depending on demand and supply.
The real difference is the distributed record-keeping and anonymity of ownership. This has advantages and disadvantages. The advantages are that governments cannot artificially affect the value of the cryptocurrency. Look at what is happening in Turkey, with the Turkish Lira plummeting in value due to government policies. Governments cannot directly affect cryptocurrency values.
The disadvantage is that the anonymity of cryptocurrencies means that illegal trades can occur without anyone knowing. This is what concerns governments and central banks and why they want to regulate cryptocurrencies or even ban them.
Nassim Taleb, the philosopher-trader, says, “Bitcoin is the beginning of something great: A currency without a government, something necessary and imperative.”
On the other hand, Abhijit Naskar, a famous neuroscientist and humanist, writes, “What [people forget about crypto currencies] is that it also means the user alone bears liability. Not every fancy innovation is gonna benefit society, and innovation without accountability is only a delusion”.
Governments provide many advantages to their citizens – safety, security, infrastructure, logistics etc., and traders such as Taleb may be looking too narrowly at the benefits of cryptocurrencies.
Perhaps with regulations in place, cryptocurrencies will become just like any other financial instrument, to be used and invested in with care.