Cryptocurrency: the next financial crisis? (Part 1)
An analysis of the shortcomings of cryptocurrency and an assesment on its viability as a sustainable currency.
‘Cryptocurrency’ is defined as a digital currency in which transactions are verified and records maintained through a de-centralised system using cryptography, rather than by a centralised authority. The use of encrypted transaction records means the currencies are untraceable, which increases their value as an asset for legitimate and criminal reasons. Crypto has taken on a role as a currency of interest in the last few years as major corporations, wealthy individuals, and industries recognise its potential for growth, which was exemplified by the all-time high of Bitcoin – the most popular cryptocurrency currently in circulation – in 2021, whilst it is a frequent source of debate on social media.
Bitcoin (often abbreviated to BTC) is the best example of why the market seems so attractive for young, inexperienced investors, as well as being a great example of why cryptocurrency does not have long term sustainability in its current form. BTC was created in 2008 by an unknown person or group using the name ‘Satoshi Nakamoto’. The coins themselves are created by a process called ‘mining’, which involves people solving formulas and equations to keep records of the encrypted transactions that are made with the currency, which are stored in a ‘blockchain’. Cryptocurrencies are then bought by investors using regulated currencies on designated trading platforms, such as Coinbase, which made headlines when it made an initial public offering in early 2021.
Whilst this may seem without issue, difficult times are often suffered. Although Bitcoin’s value and popularity have been increasing steadily since its genesis, rising to a value of £45,500 in April 2021, this does not tell the whole story of the risk involved with investing in cryptocurrency. Since its apex, the value of BTC has halved, although it is starting to make a minor revival towards its previous value. This highlights the ‘boom/bust’ cycle that surrounds Bitcoin, a volatility that harms its sustainability and business continuity due to the massive amounts of speculation that are involved in investing in cryptocurrencies. This volatility and speculation stems from two places; firstly, the way cryptocurrencies are currently treated like a standard investment means the element of risk that is associated with the stock market comes into play; secondly, the currencies are not backed against any commodity, unlike standardised currencies, which means that uncertainty surrounding the coins is comparatively high. This volatility increases the likelihood of investors suffering devastating losses.
But that still doesn’t explain why the crash of cryptocurrency is inevitable. The lack of security in the digital coins, when compared to standard currencies, means the profits to be made from investing is incredibly uncertain. For example, Bitcoin’s daily price volatility over the last 3 years is 75%, expressing the risk involved. The reason for this, in comparison to conventional currencies, is that cryptocurrency is not supported by interest rates. Standard currencies are not speculative because their value can be predicted based off the interest rates which dictate it. Cryptocurrency, on the other hand, does not have these rates to support and supervise the value, and this unpredictability feeds into the price. Accordingly, currencies which are supported by the national banks have security in the Government to save it, should it fail. This means that the Government will bail out banks and other financial institutions to protect the money of its citizens. With cryptocurrency, there is no institution to fall back on, which increases the volatility as well as the risk of losing money should the currency collapse. This is exemplified by the failure of trading application Football Index. Football Index was a trading application where users buy and sell stocks in football players, making profit or losses based on the increase or decrease of the players’ values. The varying factors that affect the value of football players, and the capacity for unforeseen events to massively affect these stocks, means the risk is so high that it was regulated by the UK Gambling Commission, rather than being financially regulated. The uncertainty involved in trading on this application meant, like Bitcoin, the currency would never stabilise and this created a huge risk to investors. Football Index eventually crashed, causing a crisis situation and costing customers a total of £90m.
Other non-financial issues arise from trading like this. Coinbase is the most popular cryptocurrency trading app, for example, but, as aforementioned, trading cryptocurrency is essentially gambling. Like online betting platforms, Coinbase can offer its users huge gains, which seem enticing, but the counter to large gains is massive losses. This can lead to issues of addiction, depression, anxiety, and eventually even substance abuse. For investors with low liquidity, they are at risk from facing a financial crisis themselves in a matter of seconds, simply because the volatility of the market allows it. Here at MA-Change, our speciality is mitigating this sort of crisis before it even happens. Not only do we offer support for those with addiction or mental health issues, but we also have the best financial advisors on hand for those who want to make smart, secure investments so that crisis remains as far away from you as possible.