Hailed as the new gold rush and the greatest technological breakthrough since the internet, what exactly is cryptocurrency? Defined variously as an ‘emerging asset class’, ‘digital currency’ and ‘trading platform’, confusion abounds about which umbrella – if any – it falls under.
Originally intended as an anti-establishment alternative to centralised currency (i.e. a currency that a government has declared to be legal tender), cryptocurrency is now being considered by the very financial institutions it was designed to disrupt. The Bank of International Settlements (BIS) (external link) advised in September that central banks must consider whether or not to issue their own digital currencies in the near future.
Cryptocurrency differs to traditional money in that it uses online systems to record its every trade and operates independently of a central bank. The medium of exchange is both created and stored digitally, using encryption techniques to verify transactions and control the creation of new ‘money’.
Who are the big hitters?
Bitcoin is by far the best-known example and its value has exploded since its creation in 2008. From a hundredth of a dollar to over $4,400* within a decade, how is it that a currency that exists more in concept than in reality has amassed such a following?
User trust, utility and regulatory acceptance underpin Bitcoin’s spectacular rise. But other pretenders to the crypto-throne have emerged to challenge its dominance. Today, cryptocurrencies are created almost daily, and at last count there were more than 900. Ethereum skyrocketed 5,000% (external link) in the first half of 2017, as did Ripple, a venture-backed startup that aims to exchange value for free.
According to Bobby Ong, co-founder of CoinGeck, ‘some of the big [non-coin] players are wallet operators and exchanges like Coinbase, which recently raised $100m in Series D funding with a valuation of $1.6bn. Other major players in the industry include mining operators like Genesis Mining’. Clearly the value isn’t only in coins but in the applications that surround them.
What are the benefits?
The boom in prices means cryptocurrencies have become both currencies and assets. Increasingly, individuals and organisations are assigning value to them, and most experts agree there is scope for growth far into the future.
‘Cryptocurrencies allow value to be transferred between users without an intermediary, thus making transactions faster and in many cases cheaper,’ says Ong. ‘Also, because the market is open 24/7, transactions can happen in real-time without having to happen during office hours.’
Digital currencies cannot be counterfeited, nor are they subject to the same transaction fees as regular currency. Controlled by a global network of computers, they’re not bound by exchange rates, and anyone with an internet connection – including the unbanked – can access them.
In contrast to rival electronic cash systems, cryptocurrencies can only be managed by the user and the user only. Ong cites cryptography as the defining characteristic of cryptocurrency, which relates to the method of storing and transmitting data in such a way that only those for whom it is intended can read it.
Whereas companies like PayPal have the power to freeze assets, with cryptocurrencies the user owns both the private and public key. The public key acts like an address that other people use to send a cryptocurrency to your account, while the private key acts like a secure password. Unless you reveal your cryptocurrency’s private key, only you can transfer your cryptocurrency to someone else.
Are there risks?
‘There are many risks associated with cryptocurrency, chief among them security,’ says Ong. ‘Hacking incidences are pervasive and users need to learn how to secure and store their cryptocurrencies safely.’
The second major risk, says Ong, is price volatility. ‘It is not uncommon for a cryptocurrency to lose 50-70% of its value in a short period of time. Users should only put in money they are willing to lose.’ Ethereum (external link) prices slumped 30% over a seven-day period in July after a flash crash on one exchange, and 20% the previous month after unsubstantiated rumours about its founder’s death.
What is the future?
Popular as they are, cryptocurrencies remain an obscurity for most people. In a PwC (external link) study, only a tiny cross-section of respondents were familiar with the concept. Although cryptocurrencies share an appeal among tech-savvy millennials, who will no doubt push for ever-more imaginative applications, whether they’ll migrate to the mainstream remains uncertain.
Nevertheless, most experts are bullish about the future. As yet unknown currencies will likely make it big, with Fortune’s Brainstorm Tech conference predicting another dominant coin in the next year or two. Likewise, we’ll see major crashes and regulatory overhaul as the months and years unfold.
*Bitcoin over recent weeks continues to spike in price. The volatility of the currency makes some aspects of this article out of date, but the leanings and commentary remains insightful.