When people think about cryptocurrency, we mostly think about Bitcoin but what exactly is cryptocurrency?
Cryptocurrency is a type of digital currency which is recorded on a blockchain that can be used in exchange for goods or services.
A blockchain is a specific type of database that stores information in blocks that are chained to the previous block. These blockchains are decentralised so no single person or group has control. Which means all transactions are permanent and viewable to anyone.
Cryptocurrency is discovered using a process called mining where large computing power is used to essentially discover individual coins using an algorithm that gets increasingly more difficult as each new coin is discovered. Bitcoin now requires incredibly large and expensive equipment just to mine a singular coin.
In layman’s terms, someone writes a math problem (that gets exponentially harder) and the person who finds it, and solves it first, wins the prize.
Anyone can make a cryptocurrency, but the popular ones are Bitcoin, Litecoin and Ethereum.
What are the benefits of Cryptocurrencies?
- Autonomy. Normal currency is held normally in a bank or in cash. With cryptocurrency these are held in a virtual wallet and requires no authority like a bank or government.
- Discretion. Transactions are anonymous and are less readily traced back to individual users. There’s no middleman approving the transaction and recording it in the ledger.
- Elimination of Bank Fees. While there are often still ‘maker’ and ‘taker’ fees as well as the occasional deposit and withdrawal fees, cryptocurrency has no account maintenance, minimum balance fees and no overdraft fees like a traditional bank would.
- Accessibility. Anyone with an internet connection is able to access and trade cryptocurrencies and allows those without traditional banking systems to send and receive payments in cryptocurrency.
What are the negatives of Cryptocurrencies?
- Scalability. While there is an infinite amount of cryptocurrency coins that can be mined this is dwarfed by the amount of VISA and Mastercard transactions that take place each day. Blockchains process each transaction one by one so processing these transactions can take a matter of hours to complete.
- Cybersecurity. Cryptocurrency can be kept in your own digital wallet which is linked to your hard drive or in an online trader database (similar to how you trade shares). As with all things internet related these can be hacked and transferred to another party with no way to track where it’s gone.
- Lack of Inherent Value. Gone are the days where currency is backed against gold but still, we know that the New Zealand dollar is backed indirectly to the New Zealand Government who will do what’s in their power to control its value for the betterment of the country. Cryptocurrencies however have no value directly to any tangible or intangible assets.
- Price Volatility. Cryptocurrencies are extremely volatile in price compared to normal currencies. Bitcoin for example started 2020 at $9,500 USD and ended at just under $40,000 USD at the end of 2020. This type of volatility has caused cryptocurrencies to be more of an investment rather than as a currency.
- Lack of Regulation. With cryptocurrencies being relatively new local and international laws are yet to catch up with cryptocurrencies. While we see IRD issuing releases on how they’re going recognise cryptocurrencies we are yet to set a full set of regulations around this.
My views on Cryptocurrencies
While Cryptocurrencies have been touted to eventually take over from traditional currencies, I cannot see this happening for a long while. There are obviously many advantages of replacing traditional banks with digital currencies but until we have proper regulations and technology in place this is not quite yet an achievable goal. China have come up with their own cryptocurrency this is also centralised, meaning only the bank itself issues the coins rather than them being mined. This currency is also traceable and backed against the Yuan.
As an investment if you’re willing to take the risk then there is money to be made, but as a digital currency there is still a long way to go before we see it replacing our dollar.