Cryptocurrencies - How are they different to "normal" currencies?

Venezuela’s “Petro” and the current state of Cryptocurrencies

Venezuela recently launched its cryptocurrency, the “Petro”. In a speech in February 2018 promoting the digital currency, President Nicolás Maduro said: “The future is now, Venezuela is moving forward as an economic powerhouse.” And, indeed, shortly after its launch, Venezuela’s government claimed to have already collected $3 bn in investments in the new coin.

While the overall number of cryptocurrencies exceeds 1’500 as of today, the “Petro” coin is the first of its kind: it is a state-regulated and oil-backed digital currency and nicknamed the “Bitcoin of Venezuela”. Its actual success in the future is still to be seen.

Although the “Petro” is a significant example of how cryptocurrencies are becoming more and more ingrained in the world’s financial infrastructure, so far, the crypto world is in a “wild west” state. In essence, most digital currencies lack the support from any government. Without any monitoring or regulation, new coins are being loaded onto the market in so-called ICOs (Initial Coin Offerings) every week. Even though some coins have managed to make themselves a known brand such as Bitcoin, Ethereum and Ripple, all are still struggling for adoption in the real world as a payment instrument and, ultimately, as a replacement for so called fiat currencies (Euro, USD, etc.).

Figure 1: Bitcoin - the new gold?

This raises the following question: are investors betting on cryptocurrencies’ adoption or are they just targeting speculative gains? Many experts argue that cryptocurrencies are rather a speculative bubble than a revolution behind the background that the overall market capitalization has been exploding over the last two years. To assess the question of whether or not cryptocurrencies are actually a threat for established currencies, we firstly have to analyze in which ways cryptocurrencies are different from fiat currencies as well as which are the benefits and downsides of cryptocurrencies.

What are cryptocurrencies and what’s so special about them?

According to Investopedia.com a cryptocurrency is a “digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of this security feature. A defining feature of a cryptocurrency, and arguably its most endearing allure, is its organic nature; it is not issued by any central authority, rendering it theoretically immune to government interference or manipulation.”

Given that definition, it becomes clear that the key differentiator between crypto- and fiat currencies is the decentralization. However, there are several other factors of differentiation as Figure 1 below demonstrates.

Figure 2: Comparison of Fiat and cryptocurrencies

What are downsides/benefits of cryptocurrencies as compared to traditional currencies?

Downsides

• Adoption: The currently low adoption of cryptocurrencies is the most persuasive argument of critics. Nowadays, cryptocurrencies are only accepted in very few stores, restaurants, etc. and with this regard there has not been any hockey-stick effect despite its exceptional boom in the media and in its value. (However, since cryptocurrency has only recently picked up pace regarding public awareness refutes this argument to some degree.

• Volatility: A look at the recent development of the market capitalization of specific coins shows how volatile the market still is. Monero [Figure 3] had 24h performances of more than 20% price increase/fall in the last 7 days as measured in USD. Considering the enormous price fluctuations, it is indeed understandable that companies do not want to accept cryptocurrencies just yet as a replacement for (relatively) stable fiat money.

Figure 2: Volatility of Monero; 7-day performance

• Anonymity: Transactions with certain cryptocurrencies (such as Monero) are often so well encrypted, that federal agencies have difficulties tracking cash flows. This leads to the belief, that cryptos are used by criminals in the dark web (hidden part of the internet). Given that infamous drug marketplace Silk Road, which was shut down some years ago, fully ran on Bitcoin payments, underlines this claim.

Benefits

• Efficiency: Usually, cryptocurrencies outperform traditional money regarding speed and transaction cost as Figure 4 suggests. The figure exemplarily shows Ripple’s XRP global cross-border transaction speed (4 Sec) in comparison to traditional payment settlement systems such as bank transfers which can take up to 3-5 days depending on geographical distance (e.g. Russia to USA). XRP’s global transaction costs are nearly 0,00 USD.

Figure 4: Speed comparison - XRP vs. ETH, BTC and traditional systems

• Decentralization: No central authority issues or governs cryptocurrencies - the governmental power over the currency lays in its users’ hands. Furthermore, entities such as banks become obsolete (at least for transactions) since all code is stored in the decentralized network (see our first blogpost for reference)

• Security: As discussed in our first blog post, the enormous security features of Blockchain are incorporated in all Blockchain-based cryptocurrencies which means that manipulations of claims/transactions are theoretically impossible.

• Universal acceptance: Everyone who has an internet connection can potentially obtain cryptocurrencies irrespective of their geographic location. Cryptocurrencies do not have geographic boundaries – (e.g.) Bitcoin could therefore (theoretically) become a truly global currency accepted in stores from the US to Nigeria and to Vietnam.

Verdict – Are cryptocurrencies a threat to established currencies?

Assessing cryptocurrencies in-depth shows that digital currencies’ benefits are substantial. If the current adoption of cryptocurrencies picks up in our everyday lives, we could surely assume that digital currencies will be a real game changer. For now it might be too early to ultimately conclude on whether or not cryptocurrencies are going to replace fiat money.

See you next time!

Author:

Manuel Ehmann