Cryptocurrencies: revolutionary or dangerous?

 

Financial institutions all over the world have responded to the threat of these anonymous, self-regulating currencies with confusion and hostility. Many banks are questioning the impact that digital currencies will have on their business, however, as reported in bobsguide’s recent article on cryptocurrencies, some banking executives are starting to realise that cryptocurrencies could provide a way for banks to highlight the security of banking systems in comparison to cryptocurrency technologies.

News reports often highlight the volatility of digital currencies such as Bitcoin, due to its unstable trading value over the years. In 2013, Bitcoin’s value dropped from $215 to $63 only eight days later and then up again to $1,200 seven months later.

The low liquidity of Bitcoin also plays a part in how it has been welcomed onto the trading field, as liquidity often determines how many partners are willing to trade with it. Denis Borisovsky (CEO of PFSOFT) believes that the low liquidity of cryptocurrencies means they are often seen as a high risk investment.

“Because of low liquidity, cryptocurrencies are quite risky - we've seen flash crashes of very irregular, often extreme volatility. I would treat cryptocurrencies trading as a high risk investment."

Borisovsky also believes that although there is no way to reduce the risk of cryptocurrencies at the moment, Bitcoin professional traders are not put off by negative news reports. 

“The volatile nature of Bitcoin is a great risk for many investors and institutions, and as far as I know there is no good way to hedge that risk. Therefore, many institutions and brokers decide to stay away from it and that is understandable. On the other hand, I think that some professional or institutional traders are involved in Bitcoin, but these people can probably assess risks and filter out the noise (negative news) on a professional level.”

 

The global impact of cryptocurrencies

 

Although the UK Government has welcomed the idea of cryptocurrency trading, the Chinese Government has shown hostility towards digital currencies.

At the height of Bitcoin’s success in China, its value plummeted due to government scrutiny and restrictions. In December 2013, the Chinese Government banned financial institutions from trading the digital currency and regulators disallowed third party payment companies from buying or selling Bitcoin. This had a detrimental effect on Bitcoin’s success in China.

According to Zennon Kapron (Founder of Kapronasia) at the end of 2013 China was positioned as the largest global market for Bitcoin and its prices were found to be even better than those in western exchanges, however, this changed when the People’s Bank of China publically stated their opposition towards the digital currency.

“At the end of November 2013, China was the largest market for bitcoin globally as bitcoin's price on China's exchanges surpassed even western exchanges. In theory, China could be the world's largest market, but the regulations and clarifications from the People's Bank of China during the couple of months following the peak took a lot of the wind out of the sails and bitcoin's usage for anything besides speculation and mining was limited, and it's largely the same today.”

Kappron states that although Bitcoin is legal in China, it is extremely hard to use because of the opposition and restrictions imposed on Bitcoin trading by government and financial institutions.

He also believes that the biggest challenge for Bitcoin in China is acceptance and the attitudes will not change until the focus changes.

“The challenge for bitcoin in China is that most of the focus was on speculation and mining rather than actual acceptance. The value in any currency is based on the ability to exchange that for goods or services. Although some merchants accepted bitcoin in China, the ecosystem wasn't focused on developing acceptance, but rather fuelling and feeding speculation - even today, the exchanges are still focused on supporting speculators.”

So, why are some governments threatened by cryptocurrencies? Kappron believes that from a governmental point of view, digital currencies present potential risks to the economy of developing countries because they enable people to move large amounts of capital in and out of China.

“For governments Bitcoin and other virtual currencies introduce potential systemic risk. For example, if people were able to move limitless amounts of capital in and out of China using bitcoin, the Chinese economy would at least falter if not collapse. Controlling bitcoin now, while keeping tabs on its development globally allows regulators to control the near-term risk while still being open to long-term benefits.”

Some experts believe that digital currencies will disappear as quickly as they arrived, whereas others believe they will become a normal way of paying.

According to Kappron, even with the restrictions placed on Bitcoin trading, Chinese Bitcoin exchanges managed to overcome these challenges by setting up funding and withdrawals through personal accounts rather than through banks and payment providers.

“Like many Chinese companies, the Chinese bitcoin exchanges were very smart and resourceful in reacting to the regulations from the government. Within a week of their relationships with banks and online payment providers being shut down, the exchanges had setup funding / withdrawing through personal accounts and eventually vouchers, which continues today.” 

 

The competition heats up

 

Many governments and financial institutions seem to be having a ‘wait and see’ approach towards cryptocurrencies. Some experts believe that digital currencies will disappear as quickly as they arrived, whereas others believe they will become a normal way of paying.

As more digital currencies are introduced into the cryptocurrency market, there is greater opportunity for competitors to develop a cryptocurrency that overtakes Bitcoin. The cryptocurrency of the future might be the future of money if it can provide greater liquidity and stability than Bitcoin. However, at the moment digital currencies such as Litecoin and Dogecoin don’t seem to be able to offer enough differences to surpass Bitcoin’s influence.