Cryptocurrency is a digital or virtual currency designed to function as a medium of exchange. The prefix crypto comes from the fact that cryptocurrencies use cryptography to secure and verify transactions as well as create new units of currency (coins).
Cryptography makes it easy to encode something that is easy to decipher with a key and difficult to decipher without a key, which means coins can be difficult to make but transactions can be easily verified.
At its core, Cryptocurrencies are entries in an immutable, pseudo-anonymous database – known as the blockchain – that no one can change (except in extreme circumstances when live editing is performed).
The blockchain is a public record that is verified by many different nodes, which makes counterfeiting coins extremely difficult or impossible. It also makes it easy to track certain transactions between individual accounts or wallets anonymously.
Other countries have strict capital controls to control the flow of money and / or impose high taxes. Cryptocurrencies can be used to circumvent capital controls and taxes. It is legal or not which has led to increased demand on the part of consumers and businesses. For this reason many countries have started cracking down on illegal use of Crypto for tax evasion or illegal buying or selling abroad.
Government Responses on Cryptocurrencies
The official response to cryptocurrencies is warmest across central banks and financial institutions. While there are several organizations that have supported Cryptocurrencies, many central banks remain cautious given the extreme market volatility. Tax avoidance and capital control issues have also raised some widespread concerns.
- United States Federal Reserve: US Federal Reserve Chair Jerome Powell believes that technical issues remain and governance and risk management will be essential before cryptocurrencies become part of mainstream society.
- European Central Bank: Former European Central Bank Vice President Vitor Constancio referred to Bitcoin as a “tulip” in reference to the 17th century bubble in the Netherlands and many other governors have expressed similar skepticism.
- People’s Bank of China: The People’s Bank of China believes that conditions are “ripe” for embracing cryptocurrencies. But the central bank wants complete control, and the authorities are cracking down on the cryptocurrency ecosystem in the country.
- Bank of Japan: The Bank of Japan does not see a market for cryptocurrencies.
Bank of England: Bank of England Governor Mark Carney calls cryptocurrencies part of a “revolution” in finance. Making the central bank one of the few government supporters of the technology.
The Venezuelan government, which faces restrictions on its own capital, launched its own Crypto in 2018, called a petro. That was allegedly supported by barrels of crude oil.
While official sources indicate that the country has raised billions of dollars, many analysts are skeptical of these figures and the United States has banned US citizens from buying Cryptocurrency.
Note: In 2020, the petro is still struggling to become a truly working currency.
Impact on Global Investments
This cryptocurrency has many benefits in terms of frictionless transactions and inflation control. But many investors add this currency as an asset to their diversified portfolios.
In particular, the uncorrelated nature of the market makes Cryptocurrencies a potential risk hedge similar to that of precious metals such as gold. Many products traded on cryptocurrency exchanges (ETFs and ETNs) have emerged for this reason.
On the other hand, some experts worry that the collapse of Crypto could adversely affect the broader market, similar to how mortgage-based securities triggered the broader global financial crisis.
However it should be noted that the total market capitalization of all Cryptos is less than that of many public companies such as Microsoft Corp. Which means that market capitalization may not have a meaningful impact on the global market.
Ultimately many investors view Crypto as a means of speculation or hedge against inflation, but market size does not represent systemic risk in 2020.