Cryptocurrency- The Latest Financial Avatar
A currency that surges and slumps based on China’s crackdown on crypto usage and mining, Elon Musk’s tweets and social media speculative battles, cryptocurrency is being popularised as the ‘future of money.’ While Warren Buffet described them as of zero value and termed Bitcoin as a “rat poison squared”, El Salvador became the first country in the world to officially classify Bitcoin as legal currency.
Before understanding the basis for such highly diversified opinions on cryptocurrency, it is essential to answer the question that haunts every young booming investor-how does cryptocurrency actually work? Cryptocurrency, fundamentally a digital currency, acts like a token and works on a publicly distributed ledger called blockchain technology. It can be used to purchase goods and services or to invest. This medium of exchange is encrypted and decentralized owing to a peer to peer currency system. Unlike how RBI regulates Indian rupees, this currency is beyond the management and maintenance of any central authority. Instead, these tasks are broadly distributed among cryptocurrency’s users via the internet. The transactions are verified and regulated in a form of programme called the blockchain. This is a simple database system where as soon as a user requests a transaction, the network of computers verifies the information and records it as a ‘block’ on a ‘chain’ of previously made exchanges. This completes the transaction, further making it permanent and irreversible. Simply, “Imagine a book where you write down everything you spend money on each day. Each page is similar to a block, and the entire book, a group of pages, is a blockchain” says Buchi Okoro, CEO and co-founder of African cryptocurrency exchange Quidax. The two different validation techniques that are used in the technology are ‘Proof of Work’ in which an algorithm provides a mathematical problem that computers race to solve, and ‘Proof of Stake’ in which verification depends on the amount of cryptocurrency a person is willing to temporarily lock up as a collateral in chance of participation. In this, each individual user’s verified transaction must be checked and approved by the majority of ledger holders, providing a sense of security to this payment system.
At present, there has been a tidal wave of new digital currencies with more than 4000 cryptocurrencies in existence. However, Bitcoin (BTC) has grabbed the highest attention amongst the users. Regarded as the ‘original cryptocurrency,’ Bitcoin was founded in 2009 by a programmer (or, possibly, a group of programmers) under the pseudonym Satoshi Nakamoto. Satoshi's whitepaper outlining bitcoin described the concept of blockchain technology for the first time. However, attempts at creating a cryptocurrency have been made 20 years before the bitcoin creation. Interestingly, there were increasing cases of night-time threats in petrol stations in the Netherlands which stimulated a group of developers to try to link money with newly designed smart cards. This was the earliest example of digital currency. American cryptographer David Chaum experimented with electronic cash as well, and conceptualised a token currency for transactions known as ‘blinded cash.’ He, then, founded DigiCash based on this model, which went bankrupt in 1998 but his encryption tools and formulas are significant developments for the cryptocurrency space. In this pre-Bitcoin era, B-Money, Bit Gold, Hashcash were some of the major developments, but they couldn’t achieve any substantive success. In 2009, the Bitcoin software entered the public arena and the process of mining, by which new Bitcoins are created and transactions are recorded and verified on the blockchain, began. In 2010, a Florida man named Laszlo Hanyecz exchanged 10,000 BTC at Papa John's pizza for two pizzas, the first ever official trade in bitcoins which assigned a monetary value to these coins. The first official stock exchange called ‘Bitcoin Market’ was launched the same year. It witnessed the first rise in its price from US$0 to US$ 0.0008 (In today’s rupees, the price was 5 paise) and then, to US$ 0.83. With the skyrocketing popularity of these decentralised and encrypted coins, there came alternative cryptocurrencies in the market, also referred as altcoin such as Namecoin, Litcoin.
The thriving success was marked with the introduction of the new measurement system called milliBitcoins (mBTC), microBitcoins (uBTC) and Satoshis. By December 2013, it touched a high of $1,164. However, the currency being highly volatile, crashed for the first time to a low of $760 in 2014 and further to $315 in the subsequent year. There was a total loss of 241%, raising the apprehensions over the stability of this greatly fluctuating currency. More so, it also became a lucrative target for criminals. In 2o14, the world’s largest Bitcoin exchange in Tokyo, Mt.Gox went offline, and the owners of 850,000 BTC never saw them again. Investigations are still trying to get to the bottom of exactly what happened but it exposed the theft of currency valued at $450 million dollars at that time. At today’s prices, those missing coins would be worth $4.4 billion.
Despite these backdrops, the growth revived quickly, raising the price to $959 by the end of 2016. In absence of any regulatory body, news headlines and market speculations largely drive these prices. JPMorgan’s CEO Jamie Dimon called the cryptocurrency a “fraud” and said bitcoin mania is reminiscent of the tulip bulb craze in the 17th century. He later took the statement back pushing the price to an all-time high of $20,000 in March 2017. Alongside, other cryptocurrencies like Ether also grew, especially through ICOs. The Initial Coin Offerings (ICOs) are fundraising platforms which offer investors the chance to trade mostly stocks or shares in start-up ventures using these crypto tokens. They are one of the major causes for the boom of the cryptocurrencies between 2017-18. The frenzy for investment in cryptocurrency became widespread especially in developed nations. From the next door neighbour to the biggest hedge fund managers, everyone joined the bandwagon. In the US, the Securities and Exchange Commission (SEC) warned investors that, due to the lack of oversight, ICOs could easily be scams or ponzi schemes disguised as legitimate investments. ICOs, owing to its anonymity, were reckoned as vulnerable to money laundering and terrorist financing, impelling the Chinese government to further ban them outright. Several analysts believed the upward growth of cryptocurrency as a ‘bubble’ soon to burst. In 2018, the bubble did burst with the crash of the price of Bitcoin to $3200, facing a 625% loss. Amidst rumors that South Korea could be preparing to ban trading in cryptocurrency, the price of Bitcoin first depreciated by 12 percent: Later In 2018, Coincheck, Japan's largest cryptocurrency OTC market, was hacked. This is the largest loss ever by an accident of theft and cost US$ 530 million. This caused Coincheck to indefinitely suspend trading. Hacks have a chilling effect on crypto, filling consumers with concerns that their money can go missing. Facebook, Google, and Twitter banned advertisements for initial coin offerings (ICO) and token sales. There were several speculations that the rise of bitcoin is a product of a pump and dump scheme and thus, is bound to burst. The U.S. Justice Department looked into one such theory about the digital coin Tether, pegged with the US dollar. The theory believes that Tether was used to manipulate the Bitcoin market and cause a run up in price. Another hit for bitcoin was the refusal of the SEC for a bitcoin exchange traded fund which would have allowed users to dabble with blockchain without owning the actual assets, making Bitcoin available on the actual financial markets. The refusal set precedence for the norm of absence of institutional faith in the system, causing the downfall of prices. In addition to the outside pessimism, the democratic nature of the system made the currency more volatile. In case of lack of consensus amongst the users, all hell breaks loose. Disagreements over the fundamentals of the bitcoin system compelled a few users to fork a new blockchain, initiating a civil war between two new bitcoin cash sects. With this, participants had to choose between them leading the entire cryptocurrency market to drop. Gradually, hopes were reassured as prices began to hike and a relatively ‘mature’ market developed. The COVID19 pandemic brought a fall in prices which was swiftly refuelled.
In 2021, the cryptocurrency market is majorly handled by Elon Musk’s twitter account. After Tesla announced its investment worth US$ 1.5 billion in Bitcoin, there was a stark rise in price. Musk later tweeted that Tesla will be accepting payments for their cars in Bitcoin. This made the prices jump to an all-time high of $64,829.14 on April 14. Soon after this, Elon dropped the idea due to the high energy consumption of Bitcoin in the mining process. The breakup meme resulted in Bitcoin crashing by nearly 50 percent. He again went to toy with crypto and took to Twitter to indicate his support to help miners make their processes greener. Following the tweets, Bitcoin jumped 19% to trade at $39,944. The impact of these tweets aren’t a unilateral force for these price fluctuations, rather a catalyst to spur certain speculations in the market. The more beloved crypto of this billionaire is in fact a parody currency, Dogecoin, which has witnessed an upsurge in prices on several occasions with his tweets. The meme-fuelled crypto community guided by the self-proclaimed ‘Dogefather’ has attracted investors and scammers equally. In May 2021, cryptocurrency scammers earned US$2 million over the past six months by faking as Elon Musk.
Cryptocurrency is subjected to government regulations that vary with countries. Some countries which have outright or de facto bans on cryptocurrency drastically curtail its viability. For example, China has directed financial institutions not to support cryptocurrencies such as Bitcoin. It has also ordered a halt to mining, and an estimated 90 percent of miners there have closed as of mid-2021. In addition, because the Internal Revenue Service in the US has labelled Bitcoin an asset and not a currency, every transaction with Bitcoin has the potential to create a taxable capital gain meaning that spending Bitcoins at a price higher than its cost requires tax payment.
The system has also gained increased legitimacy among users, investors and tech developers in developing nations like India. Earlier in 2018, the Indian government put it off by introducing a blanket ban on banks to prevent them from facilitating crypto transactions. In May 2020, the Supreme Court quashed the ban. India has seen a nearly 612% growth in the number of cryptocurrency users. The largest Indian crypto platform, CoinSwitch Kuber, has boarded almost 6 million active users since its inception in June 2020. There lies a remarkable potential in cryptocurrency to have a global payment system beyond geographical barriers, and restrictions created by a lack of credit history or bank account. In recent times, several tech developers have devoted their efforts to cryptocurrency mining, while others have focused on more entrepreneurial pursuits such as developing exchanges, wallet services and alternative cryptocurrencies. The advantages of reduced transaction fees due to elimination of a middleman, and higher security with the use of public and private keys has made the medium user friendly for consumers and corporations.
The major leverage it has over the fiat currency is that it shifts the power and responsibility to the currency holders’ hands. This might portray a romantic picture for its future but in reality, the volatile and unstable nature 0f cryptocurrency and consequent government regulations are the challenges that cannot be overlooked. Mining requires a substantial amount of energy adding to the carbon emission. Researchers from MIT and the Technical University of Munich concluded that Bitcoin mining alone accounted for 0.2 percent of global electricity consumption. Besides these environmental concerns, the supply of certain currencies is fixed and thus, cannot be devalued. The reason why countries have opted out of the gold standard is that they expose the economy to potentially destructive deflationary spirals. With fiat currency, central banks often increase the money supply during financial crises in the market to induce inflation and prevent the economy from seizing up. However, cryptocurrencies would act just like the gold standard. The wavering nature of cryptocurrency further makes it unusable for consumers. As the price of the currency sways, all the goods and services will have a different price every day. Due to the instability in the purchasing power of the virtual currency along with the lack of security in digital wallets, and the associated crimes, it is unlikely for most countries to officially adopt cryptocurrencies in the near future.
By Abhilasha Rawat