Understanding Cryptocurrencies
A cryptocurrency is a digital or virtual currency designed to serve as a medium of exchange. The prefix “crypto” comes from the fact that cryptocurrencies use encryption to secure and verify transactions and to create new units of currency (coins). Encryption makes it easy to encode something that can be decoded with a key and hard to decode without a key, which means that currencies can be difficult to create but transactions can be easily verified.
Global Appeal
Cryptocurrencies offer an easy-to-use digital alternative to traditional currencies. Consumers in the United States or the European Union may see cryptocurrencies as a novelty, but many countries suffer from low-quality local currencies. For example, the authoritarian regime in Venezuela has become infamous for its soaring inflation, leading to deteriorating living conditions for millions of citizens who lack access to foreign currencies.
Cryptocurrencies provide a means of protection against inflation for many global consumers, as the number of circulating cryptocurrencies is mathematically limited over time.
There are other countries with strict capital controls to manage the flow of money and/or impose high taxes. Cryptocurrencies can be used to circumvent these controls and taxes – whether legal or illegal – leading to increased demand from consumers and businesses. For this reason, many countries have begun to combat the illegal uses of cryptocurrencies for tax evasion or illegal buying and selling abroad.
Government Response
The official response to cryptocurrencies has been lackluster at most central banks and financial institutions. While there are some organizations that have been supportive, many central banks remain cautious due to extreme market volatility. Issues of tax evasion and capital controls have also raised some common concerns.
U.S. Federal Reserve: U.S. Federal Reserve Chairman Jerome Powell believes there are lingering technical issues, and governance and risk management will be critical before cryptocurrencies become part of the mainstream economy.
European Central Bank: Former European Central Bank Vice President Vítor Constâncio described Bitcoin as a “lily flower” referring to the 17th century bubble in the Netherlands, and many governors have expressed similar skepticism.
People’s Bank of China: The People’s Bank of China believes the conditions are “mature” for adopting cryptocurrencies, but the central bank wants complete control, and it has fought against the cryptocurrency system in the country.
Bank of Japan: The Bank of Japan does not see a market for cryptocurrencies.
Bank of England: Former Bank of England Governor Mark Carney described cryptocurrencies as part of a “revolution” in finance, making the central bank one of the few government supporters of the technology.
The Venezuelan government, facing its own capital controls, launched its cryptocurrency, called “Petro,” in 2018 – which is purportedly backed by barrels of crude oil. While official sources claim that the country has raised billions of dollars, many analysts dispute these figures, and the United States has banned its citizens from purchasing the cryptocurrency.
It is worth noting that the Petro currency continues to struggle to become a functioning currency.
The Impact of Cryptocurrencies on Global Investments
Cryptocurrencies offer several benefits related to seamless transactions and inflation hedging, but many investors add these currencies as assets in their diversified portfolios. In particular, the non-correlated nature of the market makes cryptocurrencies a means of protecting against risk, similar to precious metals like gold. Many cryptocurrency trading products (ETFs and ETNs) have emerged for this reason.
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On another note, some experts fear that the collapse of cryptocurrencies could negatively impact the global market more broadly, akin to how mortgage-backed securities triggered a larger global financial crisis. It’s worth noting that the total market capitalization of all cryptocurrencies, which ranges between one and two trillion dollars so far, is still lower than the value of some large public companies, such as Meta (formerly Facebook) or Amazon. However, cryptocurrencies are considered a new and dynamic asset class that can head in any direction. Ultimately, many investors view cryptocurrencies either as a means of speculation or as a hedge against inflation, but the market size does not represent a systemic risk as of 2021.
Sources:
Coindesk. “Bitcoin (BTC).” Accessed Oct. 29, 2021.
Meta. “Introducing Meta: A Social Technology Company.” Accessed Oct. 29, 2021.
Source: https://www.thebalancemoney.com/how-cryptocurrencies-affect-the-global-market-4161278
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