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Cryptocurrencies: Speculative instrument or game-changer?

Aug 31 2017 09:31
Mariam Isa

Cryptocurrencies have taken the world by storm this year, grabbing the headlines in mainstream media. But you would be hard-pressed to find a single financial adviser who recommends investing in them. 

Even the savvy people who have bought the digital creations themselves and benefitted from their spectacular performance over the past few months are reluctant to urge others to follow suit.
    
The deterrent is the extreme volatility of cryptocurrencies, which appears to be driven by two polar convictions – they will either replace money and the banking system as we know it, or collapse as dramatically as the internet companies that went bust when the dot-com bubble burst at the turn of the millennium. 

Both views are probably correct, if history is anything to go by.  

The fact is that the market capitalisation of the more than 800 publicly traded cryptocurrencies has soared from $10bn at the start of 2017 to $160bn now, according to data provider CoinMarket Cap. 

Market leader Bitcoin, the only example known to the general public, broke the $4 500 barrier last month – which is incredible considering it was worth a fraction of a cent when it came into existence in 2009.
  
Detractors argue that digital currencies are behaving like speculative instruments with no intrinsic value, while advocates believe that they will eventually make banks obsolete. 

A study published by the Cambridge Centre for Alternative Finance in May estimated that there were at least 3m people actively using cryptocurrencies as a new form of cash, rather than just speculating in it. 

That number was much higher than previously believed, and is likely to have been significantly overtaken in the past three months.    

Put simply, cryptocurrencies are digital assets using decentralised technology to let users anonymously make secure payments of any value anywhere in the world with minimal fees, without needing to go through a bank or central authority. 

They run on a distributed public ledger called blockchain, which is a record of all transactions updated and held by cryptocurrency holders.  

Given those attributes, cryptocurrencies have become the tender of choice for illicit activities like tax evasion, drug dealing and money laundering, and are often associated with the dark web. 

But they have also excited libertarians who believe that blockchain technology will decentralise government and corporate power.  

Financial policymakers are in a quandary over how to regulate the industry, and as they deliberate, cryptocurrencies and their applications are evolving at the exponential rate associated with other forms of disruptive technologies. 

Cryptocurrency start-ups have begun to raise money through what is called an Initial Coin Offering (ICO) – which was how what is now the second-most popular cryptocurrency, Ethereum, was created.
   
If the funds raised do not meet the minimum required, the money is in theory returned to backers – but some ICOs are fraudulent and it may never be recovered.
   
Public trust in electronic money is expected to improve when governments move to protect consumers by introducing controls on exchange operators. 

In fact, price swings in cryptocurrencies can be linked to news reports indicating that this is either about to happen or is being delayed.    

In June the International Monetary Fund (IMF) released a discussion note suggesting that banks should take cryptocurrencies more seriously as the borders between intermediaries, service providers and markets have become blurred. 

The area of cross-border payment services was ripe for change, and could benefit from the new technologies, it pointed out.      

The IMF report also encouraged central banks to consider issuing their own digital currencies and put money on blockchain, partly to improve their operations and partly to keep their key role as lender of last resort.
    
“The introduction and potential proliferation of private virtual currencies might, in one view, threaten to erode the demand for central bank money and the transmission mechanism of monetary policy,” it warned. 

“A CBDC (central bank digital currency) may forestall such private virtual currencies or regulate them to a secondary role in the payments system.”   

Central banks in many countries are considering that option, including those in Britain, China, Japan and Sweden – as well as the European Central Bank.
   
But opinion is divided and US policymakers are not sure it’s a good idea. 

A member of the Federal Reserve board of governors, Jerome Powell, said in March that a central bank issuing digital currency would compete with innovative private sector products and could stifle innovation that would be more beneficial to the public over the long run.

At the end of August deputy Reserve Bank governor Francois Groepe told the Fintech Innovation Conference in Johannesburg that while virtual currencies had the potential of becoming widely adopted, the bank believed that for it to issue a virtual currency in an open system was “too risky”.

Nonetheless, the bank has created a three-member team to carefully study how digital currencies work and is looking to introduce virtual currency “sandboxes” so that businesses which provide cryptocurrency exchange services in South Africa can test new products.

Mariam Isa is a freelance journalist who came to SA in 2000 as chief financial correspondent for Reuters news agency after working in the Middle East, the UK and Sweden, covering topics ranging from war to oil, as well as politics and economics. She joined Business Day as economics editor in 2007 and left in 2014 to write on a wider range of subjects for several publications in SA and in the UK.

This article originally appeared in the 7 September edition of finweekBuy and download the magazine here.

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