What is Cryptocurrency?

As credit and debit cards become ever more popular, it isn't hard to imagine the world without physical cash, but if ones and zeros are set to power our future payments, who's ones and zeros will they be? We're all familiar with the pound, and we know that other countries use different currencies. Why then, in ones and zeros, can't we use another currency, or for that matter a virtual currency? We can. In fact, the barter systems that run in parallel with traditional cash all over the world are a system of virtual money. As computing power has reformed the modern world, so technology looks set to reshape payments forever, with the emergence of 'cryptocurrency'.


What is cryptocurrency?

What is cryptocurrency?

Cryptocurrency is a form of encrypted decentralised currency. It is decentralised because no bank or government underwrites its value, as they do for traditional currencies. Instead, cryptocurrency draws its value from the collective agreement within a community.

Given that cryptocurrency is virtual, some may find it difficult to attribute any value to it whatsoever. However, unlike traditional currencies which are unlimited in volume, cryptocurrency is limited to a fixed number of units. As such it does have a scarcity value in the same way that currency linked to the gold standard once had.


How do cryptocurrencies work?

In many ways cryptocurrencies work like traditional currencies in that they enable people to buy and sell goods and services. Where cryptocurrencies differ is the way they are produced (not at the whim of a government or central bank) and the way transactions are recorded (fully, and publicly).

Cryptocurrency Production

Most cryptocurrencies are created through a process called 'mining'. Mining has nothing to do with digging but is the process used to verify transactions using cryptocurrencies. Miners use bespoke software to solve cryptographic mathematical problems. For their efforts, miners are rewarded with a small share of the total transaction value, creating more currency.

Transaction Recording

Once miners have solved the required cryptographic problems, their solution is tested within the community and submitted to a 'public ledger' which records the transaction as a block of data. This block is added to the previous data blocks to form a block-chain, each element verifying the others.


How many cryptocurrencies exist?

There are already over 100 cryptocurrencies in existence, and many more are expected to emerge as the popularity of the sector soars.

However, although there are numerous cryptocurrencies, they vary in popularity considerably. In fact, the most established and popular cryptocurrency, Bitcoin, has a market capitalisation greater than its next 100 cryptocurrency competitors.


Where can I use cryptocurrency?

Bitcoin is by far and away the most popular international cryptocurrency (accepted by 100,000 merchants worldwide), and London has Europe’s greatest concentration of businesses accepting Bitcoin.

That said, Bitcoin's merchant network is still dwarfed by the well-established payment processing networks of American Express, MasterCard and Visa, and very few businesses currently accept Bitcoin. What's more, many that do are foreign exchange companies that trade Bitcoin as they would other currencies. However, there are a few very large businesses that do accept Bitcoin, including Dell, Expedia, Microsoft, and Paypal, so more are likely to follow suit.


Benefits of cryptocurrencies

Although the take up of cryptocurrencies by merchants has been relatively slow, this could increase very rapidly, making them an attractive day-to-day payment method. Cryptocurrencies already have some benefits which have helped fuel the increasing interest in them, even amongst traditional banks.

Inflation-proof

Because of the way many cryptocurrencies are created, there is a limited and quantifiable supply, unlike traditional currencies who's value can be diminished over time (through government or central bank moves to increase supply). There can be no increase in the number of units of cryptocurrency, so they retain their value over time. Indeed, if anything, their value (unlike traditional currency) is likely to increase over time.

Lower Fees

Fees for transacting in cryptocurrencies are far lower than the interchange fees associated with traditional payment processors, so they are a far more efficient way for merchants to accept payment.

Payment settlement is also completed instantly, so recipients do not face lengthy delays while they wait for payments to clear, helping with business cash flow.

Fraud-proof

Cryptocurrencies cannot be counterfeited as traditional currencies can. Full and transparent ownership ledgers identify all the available coins/units and their owner. Also, cryptocurrency transactions are initiated by the holder of the currency, so they are not susceptible to merchants initiating transactions for incorrect amounts.

Mass Accessibility

Because cryptocurrencies do not recognise national borders, they are available to anyone with the digital technology to use them. This includes billions of people in the developing world with smartphones, who have historically seen their local currency suffer from high inflation (which rapidly erodes the value of any savings).


Disadvantages of cryptocurrencies

Although there are many benefits to be had from the emergence of cryptocurrency, it is not without its critics, and depending on your point-of-view, it does have some disadvantages when compared with its alternatives.

Adoption

Levels of adoption for cryptocurrencies are still low, although steadily growing. If the main benefit of all currency is the ability to buy and sell with it, then cryptocurrencies currently fall well short of traditional currencies.

No central bank

Although flawed, the central banks (like the Bank of England or Federal Reserve) help guarantee the value of their currency, helping it withstand financial panics, because it can always be used to buy goods to its marked value. Without a central bank, cryptocurrencies can be more susceptible to market volatility, which may benefit currency traders who can profit from day-to-day fluctuations in value.

Limits growth

Although the ability of central banks to increase the supply of money in the economy can reduce its value, it can help them to stimulate growth. Because cryptocurrencies offer a fixed number of units, there is no scope for governments to use them to help ignite a subdued economy.

Moral Neutrality 

Cryptocurrencies exist without political allegiance; they can, therefore, be used for good or ill and their creator has no recourse to prevent criminal activity. In contrast, the US Foreign Corrupt Practices Act (FCPA) permits US authorities to police international business transactions using the Dollar, bringing criminals anywhere in the world under US criminal jurisdiction.


The future of cryptocurrency

Although cryptocurrency use is not yet widespread, it is growing. The flexibility and transparency of cryptocurrencies means they are unlikely to go away, so traditional banks (including some central banks) have started to investigate how cryptocurrencies could be incorporated into the traditional banking framework. If this happens, we are likely to see them utilised with traditional banking products, so it may not be long before we see the first cryptocurrency credit card.

 

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