The digital age has offered us an opportunity to design new currencies to provide an alternative to government issued hard currency. Cryptocurrencies, or digital currencies, is a form of money that is securely created and stored on the computers of the world which can be traded directly for things of value or converted back and forth with traditional currency.
Currency serves two main functions, it facilitates exchange of value between parties and also serves as a means of storing value.
Before currency, trade was limited to the barter system, where goods and services were traded for other goods and services. While barter arrangements may be suitable in some situations, in most cases this is a very inefficient way to trade.
Both parties must have what the other wants in a barter arrangement, and in suitable proportions as well, to make the deal even reasonably efficient. For example, If someone has a cow, and they want to trade it for several pigs, they need to find someone who has pigs to trade and wants a cow, and has enough pigs to give for the cow. Perhaps the person with the pigs to trade wants some seed instead, but the person with the cow doesn’t have any to trade, someone else does but they want another good in return for it which the person does not possess.
So it’s easy to see that this very often restricts trade, and this is where currency comes in. If all of these goods can be traded for something called money, then people can trade all these goods freely, and that’s how things have worked for a very long time.
Currency also stores value, as opposed to just accumulating goods, and we measure one’s wealth to a great extent by how much money they have.
Metals used to be the primary form of currency, which eventually became minted into coins, and then paper money was invented, about 1400 years ago, to make exchanges even more convenient, and not have currency become dependent on a commodity.
Paper money has worried some people though over the years because theoretically governments could just print as much as they wanted, and this led to the idea of backing it with precious metals, mostly gold, in some countries, although this practice has fallen out of fashion.
Today’s money is called fiat money, which gains its power as legal tender solely by the way of government proclamation. Fiat is a latin term meaning “it shall be.” Since it is legal tender though, it does have the full power of money, and does have constraints upon it, from governments seeking to preserve its value by simply not printing so much of it that it becomes unacceptably devalued.
In the digital age, a lot of money changes hands electronically, and a lot of people don’t even use paper money anymore. The medium of exchange though is still government issued currency though, it’s just that physical money isn’t used by the parties so much anymore in exchanges.
There are various forms of alternative currency, things used to exchange items of value that does not involve using national currency, and this is not a new concept. Even the barter system is a form of alternative currency and barter arrangements still happen to some degree.
Alternative currencies have never been very popular though, until the idea of cryptocurrency emerged. With so many people having computing devices and connected to the internet these days, it became possible to design a medium of exchange that could be used by users directly with one another, in the digital realm.
So the internet has opened up access like nothing else we’ve ever seen, and this greatly enhanced access has now spread to the realm of currency. The term cryptocurrency is derived from the cryptology that is employed in these digital currencies, which serves to make both the currency and the transactions secure enough to be able to function properly.
Security is a big concern with any currency and this is why governments go to great lengths to make their money difficult to counterfeit, although counterfeiting still goes on to some degree.
With cryptocurrency, the degree of security that can be achieved is vastly superior to paper currency, mostly because digital currency is purely digital, and the extent that designers can go to protect it is far beyond what’s possible with physical products.
It’s not that people tend to be too concerned that paper currency is insecure, but any alternative currency would have to be at least as secure, and the fact that is even more so is certainly some sort of benefit.
Crypocurrency uses what is called block chain technology to validate and record every transaction ever made with the currency, with the transactions copied across all computers using the currency.
A lot of people have objections to a central bank regulating their currency, and currencies are certainly pretty tightly regulated, but cryptocurrency is regulated by market forces only. Its value is purely governed by the forces of supply and demand, and the supply side of this is constrained by a limited issue, preserving that side of the ledger.
The biggest worry people have with regulated currency is that the supply side of things gets manipulated, and governments do this all the time, either printing more or less money so to speak, to affect its value in concert with its fiscal policy.
In theory, governments could print so much money that the currency could end up grossly undervalued, as adding to the money supply is inflationary, and the currency could even crash. We have seen examples of this in the past and even in recent history we’ve seen currencies seriously undervalued by printing it far in excess.
Cryptocurrency solves this problem by capping the maximum amount of units that can ever be held in circulation, and the amount that’s held isn’t really an issue due to its infinite divisibility. So in time a unit will rise in value but one can just divide it up into smaller decimals. None of this is inflationary, devaluing in other words, like it would be with hard currency.
So in the long run, a unit of a cryptocurrency will buy you more and more, have more and more value, the opposite of traditional currency which tends to go down in value over time due to inflation. People certainly tend to find that pretty appealing.
This is truly money by the people for the people so to speak, without any interference from regulators, and this mere fact is another thing that cryptocurrency users find to be an advantage, even by matter of mere principle.
Many users also find the anonymous nature of cryptocurrency transactions to be a major benefit as well, and a lot of this tends to be based on matters of principle as well, but there are often advantages with this, in cases where one may not want the government to monitor these transactions.
So all of these transactions happen off the grid so to speak, and some people just object to their every move being tracked by Big Brother, or rather, potentially tracked, and while some people do make way too much of this, if they end up feeling better about the anonymity of cryptocurrency, then that’s a plus to them anyway.
Cryptocurrency also has the benefit of users saving transaction costs, and moving money between people can often involve much higher costs than the minimal ones involved with cryptocurrency transactions, since the role of intermediaries, like banks and internet wallets, is minimized.
The fact that cryptocurrency is purely dependent upon the market does make it far less stable than traditional currency, especially in its relative infancy of today. Hard currency does fluctuate in value relative to other currencies to a small extent, but cryptocurrency can fluctuate a lot, even over a period of days.
Over time, their relative value can take some pretty wide swings indeed, and therefore are more risky to possess and transact with. This is not always seen as a bad thing though, and in a sense cryptocurrency represents a type of investment, and investments often fluctuate in price like this.
This does allow for speculation though, looking to make a profit from holding it, like one would with forex trading, only with a lot more volatility.
Governments are of course complaining that cryptocurrency is perfect for criminals due to its anonymity, including those looking to evade taxes.
The biggest drawback with cryptocurrency though is its limited acceptance this far, and although this is growing somewhat, especially with the segment leader Bitcoin, it still suffers from very limited utility due to so few merchants accepting it.
So while this might be great to transfer funds between two Bitcoin users for instance, there aren’t many places you can spend this and users have to transfer back to hard currency to be able to use the money as legal tender.
Being unregulated, there’s also a lot of fragmentation in the cryptocurrency market, and there’s almost 800 different versions of cryptocurrency out there already. Most of the market is held by just a few major players, Bitcoin, Ethereum, Ripple, Dash, and Litecoin, with Bitcoin alone holding about two thirds of the overall market, There are a number of other players who hold at least a meaningful market share and therefore this does tend to get spread out a lot among different cryptocurrencies.
Cryptocurrencies are a great idea though that are catching on more and more with each passing year. This will likely continue, and we’ll have to see just how far this can go to rival so called hard currencies, and thus far cryptocurrencies have only been a mere ripple on the sea of money, about a tenth of one percent.
Cryptocurrency has even attracted the attention of some major banks these days though, who aren’t known for fooling around with flashes in the pan, as they see a real trend here. This is a trend that could end up growing quite a bit in time, although this will probably take quite a while to ever become a true competitor to traditional currency, but still may be worthy of at least some interest along the way.
Editor, MarketReview.com
Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.
Contact Andrew: andrew@marketreview.com
Areas of interest: News & updates from the Consumer Financial Protection Bureau, Trading, Cryptocurrency, Portfolio Management & more.
