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Jan 19, 2018

Cryptocurrencies: A new currency, a new gold, or a speculative mania?

Banking/Personal Finance, Financial Literacy, General Information

stocks showing bitcoin going upPeople value and define cryptocurrencies like Bitcoin in different ways. Despite the recent popularity, cryptocurrencies have no intrinsic value and currently remain an experimental concept that is not regulated or backed by any central bank worldwide.

In less than a year, the popularity and price of Bitcoin and other cryptocurrencies has blown up, forcing large institutions and governments to consider their validity and uses in the finance, business and media spotlight. Critics point to all the signs of a bubble while many continue to see it as a financial revolution.

Regardless of your opinion on digital currencies, it is important to differentiate between the cryptocurrencies and the technology behind them, such as blockchain. Blockchain technology is a chronological chain of records that are linked together and protected by cryptography and then shared with everyone on that blockchain—essentially a public ledger or spreadsheet. This technology can potentially have many viable applications outside of cryptocurrencies, including transaction verification, securities clearing and settlement, and supply chain management.

Then how do you define a cryptocurrency you may ask? Cryptocurrencies are virtual “coins” with no physical form that use blockchain technology to operate on a peer-to-peer basis without a central authority, such as the Federal Reserve. The coins are digital, and once created, or “mined,” rely on a network of computers to ensure that the buyer has the coins for the transaction at hand, then confirm and encrypt the transaction into the blockchain. This process creates an open and decentralized ledger. The network of computers that have access to this ledger makes it extremely difficult to hack into that particular blockchain, and hence, can help reduce fraudulent electronic theft within that system.

For example, the Bitcoin blockchain is a record of all the Bitcoin transactions that have ever taken place. Each account balance at any point in time and each transaction between two accounts are stored on the blockchain. There are thousands of copies of the file on computers around the world. As long as a copy of the blockchain exists, the “Bitcoin system” can continue to operate. The blockchain allows Bitcoin to be decentralized. Since there is no one server or computer that holds a master copy of the chain, a hacker, government or other organizations would have to alter the data in multiple locations. However, this does not entirely insulate the process from theft, as some third parties, such as exchanges and digital wallets, that interface with blockchain technology have been hacked recently, resulting in millions of dollars stolen out of individual wallets with zero recourse for the users.

What is so special about this technology? For one, cryptocurrencies allow users to make peer-to-peer transactions by using algorithms without the use of a trusted third party to verify transactions. For example, the design for Bitcoin is public; no one person/group owns or control the cryptocurrency, and anyone can participate.

One big question on everyone’s mind: will the price of cryptocurrencies keep increasing? Nobody really knows, but we do know that the price of cryptocurrencies is impacted by supply and demand, and therefore, driven by various components. Here are some factors that may impact the price of cryptocurrencies:

Adoption, Accessibility and Liquidity – the ability to transfer in and out of other currencies and the acceptability by more merchants and service providers will increase transactions from individuals, businesses and governments. This requires widespread acceptability and could take years, if it happens at all.

Uses – the ability to purchase goods and services (currently very limited), send money across borders at very low costs, track any and all transactions within a given system. The anonymity of the transactions and the lack of direct governmental oversight can create new hacking, money laundering, terrorism, and other criminal risks.

Speculation – current price trends indicate speculation and have likely contributed to demand, but could potentially reverse at any time. Price speculation is very risky, particularly for a sensitive and volatile digital asset with no intrinsic value.

Limited Supply – cryptocurrencies have a limited supply of coins established at its creation and some argue that it can act as a store of value for this reason. However, the limited history and risk of replacement by updated technology/coins currently could prevent it from acting as a long-term store of value.

Risks – individuals must hold their cryptocurrencies via exchanges or “digital wallets” and are at risk of being hacked. Several exchanges have recently been hacked and users have lost up to 75% with limited recourse. These events create market scares and can influence the price significantly.

There remain major regulatory concerns around cryptocurrencies, which will remain a primary focus for central banks and governments in the years to come. Amid the concerns is anti-money laundering (AML) issues due to the anonymous nature of cryptocurrencies. While the price of cryptocurrencies remain widely uncertain and should be considered as a risky and volatile asset, the blockchain technology behind them will likely change, and potentially revolutionize, operations across many industries.

The content provided in this blog consists of the opinions and ideas of the author alone and should be used for informational purposes only. Mission Federal Credit Union disclaims any liability for decisions you make based on the information provided. References to any specific commercial products, processes, or services, or the use of any trade, firm, or corporation name in this article by Mission Federal Credit Union is for the information and convenience of its readers and does not constitute endorsement, control or warranty by Mission Federal Credit Union.

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