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Despite criticisms of being an investment fad or bubble, cryptocurrencies have remained relatively strong over a lengthy period of time. Whilst much of the hype over currencies such as bitcoin and ethereum has focussed on hyperbolic price gains, the underlying case for cryptocurrency must surely lie in its fundamentals as an asset. So where do cryptocurrencies, especially the more larger ones, get their value.
The main use of cryptocurrency is that of a medium of exchange. Domestic and global economies maintain transactional efficiency through the issue and use of currencies, most of which is now in a digital format. This means that merchants don't have to barter goods or carry barrels of gold coins in order to facilitate trade. But this does mean that centralised systems (e.g. bank networks, government treasuries, etc) are required to ensure that payments are made in a secure and trustworthy manner (i.e. valid currency, trace of transactions).
Cryptocurrency can also fill this role, but has needed to overcome the trust issues that stem from a system that doesn't require banks and governments to keep on top of how much money has been issued and how much is in everyone's account. This is where the real value of cryptocurrencies, such as Bitcoin, lies. Instead of banks and governments holding ledgers of accounts and transactions, cryptos place the ledger at the heart of its creation. No-one is required to maintain ledgers because everyone has the ledger.
For Bitcoin, for example, there is only one ledger: One ledger that has recorded every coin that has been created and that has also tracked every single transaction in Bitcoin that has ever taken place. The ledger, also known as the Bitcoin blockchain, has a new ledger page (block) added about every 10 minutes, recording and finalising all the transactions that have taken place in the past 10 minutes. This process (otherwise known as mining) requires a hoard of Bitcoin miners to validate each block by way of consensus, and allows the currency to be completely decentralised (no banks/governments involved).
The popularity of cryptocurrencies as a way of paying for goods is still growing, and still requires wider adoption for its value to be secured. At the moment, it would seem that much of its use in transactions (as a means of payment) has been for those wanting to avoid the eye of government. This may be in order to bypass cross border restrictions or for more nefarious purposes (e.g. cyber hacking ransoms). Bitcoin and other such currencies will need to convince those that have no issue in bank or government agency oversight to make the switch from traditional money if they are to continue to be of real value.
The above point highlights one of the real risks to the value of cryptocurrency - government restrictions. There has been some government action against cryptos over the past decade, but if the risk of 'black market' activity facilitation becomes too high, governments might simply look to ban its use (which would reduce its true value considerably). Other major risks facing cryptocurrencies include:
- Environmental issues - the process of secure mining requires a lot of computing power, which requires a lot of energy (Bitcoin - expected to be more than the entire energy consumption of Australia by 20241). This is not necessarily speeding up the transition to renewable energy, which means that cryptos are producing more greenhouse gases than many developed nations. This is an issue, albeit reasonably solvable, but that has already caught the ire of Chinese authorities that have banned mining activities in the country
- Security - This may come from hacks to the ledger or to accounts (especially with the rise of quantum computing). There is also a real risk of losing access to your account forever by simply forgetting your password!
- Price volatility - Prices for goods in one's own country don't change all that frequently. When buying goods overseas, price changes due to currency movements will be more volatile, but not overly significant in short timeframes. Goods priced in cryptocurrencies, however, need to take into account the large volatility in rates that might occur, which might dissuade its use.
There are some predictions that first generation cryptocurrencies will eventually make way for newer ones that remove much of the above teething problems. This might be a cryptocurrency that demands renewable energy investment and generation by miners, or one that will open up account details to authorities when required (or otherwise heavily discourage its use for illegal activities). It would also not be surprising to see banks or payment companies (e.g. Visa, Paypal) lead the way with next generation of cryptocurrencies.
1. https://reneweconomy.com.au/bitcoin-mining-to-consume-more-electricity-than-whole-of-australia-by-2024/
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