In part 1 of this three-part series, we introduced cryptocurrency. In this second part, we will explore the challenges and opportunities that exist for earning, storing and spending bitcoin or similar cryptoassets.
The Crypto Possibilities
Because cryptocurrency is typically traded in peer-to-peer exchanges, it flows quickly and cheaply, with minimal fees and administrative hurdles. Ideally, cryptocurrency offers the potential to:
- Push Past Boundaries: Successful cryptocurrencies and underlying blockchain technology could offer a faster, cheaper alternative to conduct domestic and international commerce.
- Democratize Currency Exchange: Cryptocurrencies may offer alternatives to those who are not big fans of government oversight, or who live in a country without a dependable currency.
- Make Money More “Programmable”: By optimizing blockchain technology for different purposes, it may be possible to “program” a cryptocurrency to adhere to certain rules or conditions during an exchange. Some suggest, in the future, cryptocurrency could be programmed to act as a digital trust, contract, or escrow reserve, which could only be unlocked when certain conditions were met.
The Crypto Challenges
On the flip side, many of the same qualities that appeal to cryptocurrency holders can also create challenges, even for established currencies like Bitcoin.
- Competition: What if the cryptocurrency you are using falls out of favor? With no central authority in charge of safeguarding your ownership or preserving the worth of your cryptocurrency, its purchasing power is at risk. As one CIO observed in a Financial Advisor piece, “There is little in our view to stop a cryptocurrency’s price from going to zero when a better-designed version is launched or if regulatory changes stifle sentiment.”
- Theft: Recent evidence suggests bitcoin theft decreased dramatically in 2020 … or at least became harder to detect. Either way, cryptocurrency remains an appealing target for creative cyberthieves. Alternatively, there is government protection and insurance coverage in place for more regulated accounts.
- Loss: Your cryptocurrency “wallet” is typically secured through a password that you – and only you – know. If you lose it you may be able to pay a professional 10%–20% to recover your coins. Otherwise, your coins may be gone for good. A January 2021 BBC piece reported, “Currently, about $140bn worth of Bitcoin is lost or left in wallets that cannot be accessed.”
- Supply and Demand: A government can seek to stabilize its currency’s spending power by adding to or pulling back on supply as demand rises or falls. In contrast, Bitcoin’s supply is fixed and finite. With a maximum set at 21 million bitcoin, approximately 18.6 million are already in circulation as of January 2021, with no mechanism for reducing that supply when demand declines. Time will tell whether this model remains a sustainable way to store value.
- Government Regulation: Speaking of governments, since cryptocurrency was uncharted (unregulated) territory until quite recently, the rules of engagement are still largely under construction. As such, your cryptocurrency could suddenly become more or less appealing to hold, trade, or exchange, depending on countries’ rapidly evolving reporting requirements, taxable ramifications, judicial findings, and other regulatory acts.
- Energy Consumption: Last but not least, cryptocurrency mining centers around the globe are using enormous amounts of electricity. In December 2020, MarketWatch reported bitcoin production alone was annually “gobbling up the energy of a country of more than 200 million people.” The same report notes that most production is coming out of coal-fueled China, where “bitcoin production is likely to be particularly dirty.” Iran recently shut down most of its bitcoin processing centers as the country faced rolling blackouts and toxic smog in Tehran. In short, many cryptocurrencies are not exactly “green” money.
Still, there are many who believe cryptocurrency is here to stay. Are they right? Will cryptocurrency prevail, and ultimately become a widely accepted means of exchange? If so, which ones will sink? Which will swim? Under what circumstances?
Up Next: Trading Cryptocurrency
We would not bet your life’s savings on any particular outcome – which brings us to our next topic of conversation: Does cryptocurrency belong in your evidence-based investment portfolio? Our short answer is not yet. In part 3, we will explain why.