Virtual currencies are increasingly being viewed as a viable asset class and practical form of payment
By Howard James
Love them or loath them, cryptocurrencies are here to stay.
When they entered the market almost a decade ago, they were met with both jubilation and cynicism. These polaric viewpoints remain today.
At the heart of the debate is secrecy. Using blockchain, which is void of a centralised custodian and where P2P transactions are executed in a secure and encrypted environment, regulators and consumers are understandably worried about how safe their money is, and what is really going on within the technology’s infamous black box.
Optimism continues to be dampened by negative comments from foremost industry leaders. JP Morgan CEO Jamie Dimon famously labelled Bitcoin a “scam” and a “fraud” — despite his bank later taking interest in developing its own cryptocurrency offering. And Agustin Carstens, General Manager of the Bank for International Settlements, called bitcoin “A combination of a bubble, a Ponzi scheme and an environmental disaster.” Uncharacteristic combative talk from executives who are globally respected for their balanced views on all things financial.
Risk and regulation
An added challenge stems from there being no standard viewpoint from regulators. In the EU, for instance, a block supposedly united by overarching regulation that supersedes national laws, countries have their own take on cryptocurrencies, supported by vague references to them at the pan-European level. Luxembourg proudly launched the world’s first national Bitcoin exchange in 2016. In contrast, Hungary overtly warns consumers of the severe financial losses that can stem from investing in cryptocurrencies.
Authorities in Asia are equally divided. Japan recognises bitcoin as a form of legal tender; China prohibits internet users accessing cryptocurrency platforms and exchanges; and Bangladesh imposes up to 12-year prison sentences for anyone caught trading cryptocurrencies.
Behind much of this angst is the belief that cryptocurrencies — otherwise referred to as virtual currencies, or VCs — are widely used to facilitate money laundering and other financial crimes. Yet research by the Royal United Services Institute for Defence and Security Studies argues otherwise.
“VCs have several characteristics that can limit their usefulness in financial crime,” claims the institute. “They are still a small part of the global financial system and they require a technological adeptness that some criminal organisations are just acquiring. More importantly, despite a common misperception, VCs are not uniformly anonymous.”
The institute’s last observation is noteworthy. Not only are cryptocurrencies more transparent than most people realise, no two are the same. While Bitcoin is leading the space, there are more than 700 cryptocurrencies, according to the UN’s Economic and Social Commission for Asia and the Pacific. This signifies the vast diversity of the market.
Their lack of transparency is also somewhat of a myth. While currencies such as Monero and Zcash are completely anonymous, others make their data public and subject to analysis.
For instance, Bitcoin, Litecoin and Etherereum can be analysed for KYC and AML purposes by solutions provided by vendors Coinfirm, Chainalysis and Elliptic.
Volatility is an issue. Bitcoin’s rise and fall during 2017, where it surged more than 2,100% and later lost two-thirds of this value, according to Bloomberg data, exemplifies how volatile cryptocurrencies can indeed be.
Energy consumption is also a big problem. At the time of writing, verifying a single bitcoin transaction consumes 1,023 kWh of electricity, states Digiconomist.com — that’s 100,000 times greater than the 0.01kWh per transaction needed by Visa, according to the payments giant’s Annual Report 2017.
Nonetheless, the emergence of various indices and KYC/AML tools is gradually stabilising the market, and moving it from being an environment dominated by speculators to one balanced with investors seeking long-term objectives. To further cool the market, however, regulators must have buy-in. The cryptocurrency community must work with authorities to educate them on the underlying technology and share opportunities and challenges. They must also lobby for greater alignment between jurisdictions globally.
As for energy usage, the FinTech community has a long way to go to make the mining process more efficient. In doing so, it will validate cryptocurrencies as a viable payment tool and sound investment class — attributes some argue they already are today.
Increased transparency into who owns and trades cryptocurrencies, combined with less volatile valuations, make them today a viable investment class for some banks, asset managers and retail investors.