Cryptocurrencies – key details, risks and banking implications - Image

Cryptocurrencies – key details, risks and banking implications

Amongst the most notable financial trends emerging in recent months has been the swift rise of cryptocurrencies such as Bitcoin and Ethereum to fame. This week we’re exploring these controversial payment methods, including a look at their processes and technologies behind them, the risks involved with their unregulated transactions, what separates them from traditional banking facilities, and their potential future as governments and banks begin to take notice.

What are cryptocurrencies?

As shown in this infographic from industry blog 99 Bitcoins, cryptocurrencies are digital currencies which operate independently of a central bank. Where paper money or online transactions go through an intermediary – traditionally a bank – and are recorded either via bills or, more recently, ATM- or online-based electronic payment systems, cryptocurrencies like Bitcoin, Ethereum and Litecoin need no such go-between figure.

Blockchain technology and cryptocurrency growth

Enter the blockchain, which 99 Bitcoins describe – in somewhat divisive terms, as we shall discuss later in this blog – as a “public ledger of transactions that is trusted, secure and shared” between its traders. Accessing units of currency from this so-called digital “public ledger” takes a considerable degree of mathematical skill, however, hence why traders will – according to Investopedia – work with “miners” capable of solving the complex equations needed to unlock new chains and in doing so secure a reward in the form of digital coins.

The recent popularity of this challenging but potentially rewarding technological process will not likely have escaped the notice of any clients reading this blog in the past year. Indeed, last month cryptocurrencies reached an all-time high market capitalisation of $661.2bn, with single bitcoins fluctuating from $15,000 to $20,000 in value during late December and early January while close contenders like Ripple and Ethereum posted market value rises of 35,000% and 9,000% respectively compared to January 2017.

Often one would expect new markets such as this one to gradually grow in size over the course of several years, but recent data from Forbes showcases the rapidity with which Bitcoin – still the leading cryptocurrency as of this blog’s writing – has boomed in prominence over the past 12 months alone. After starting 2017 on a strong note with $200m worth of sales occurring daily in January, the frontrunner’s transaction value soared to over $700m by May and showed no signs of slowing down from there, hitting the $1bn mark in October to a staggering $2.8bn high in mid-November.

What’s more, the number of transactions occurring each day barely changed over the same period, meaning that traders simply began investing more and more funds into Bitcoin – amongst its other digital counterparts – rather than a substantial number of new players entering the field. Calculating the precise numbers of traders involved in such transactions is, of course, easier said than done, but it’s thought that over 100 cryptocurrency exchanges already exist across the world and this figure will only rise if demand continues to escalate.

Risks and fees

Investing in cryptocurrency – as with any form of tender – naturally comes with a price, as shown by 99 Bitcoins, Investopedia and BBC News’ recent coverage. All three sites report that traders completing transactions with Bitcoin or other digital currencies will incur fees, either as payment to miners or to those merchants willing to exchange these intangible funds into fiat currencies such as £ / $ / €. Indeed, BBC technology correspondent Rory Cellan-Jones notes that the latter charge has risen substantially of late in parallel with increased cryptocurrency demand, a trend therefore unlikely to diminish in the coming fiscal year.

Yet beyond uncertainty surrounding how related fees will evolve going forward, are there particular risks involved with cryptocurrencies which businesses should keep in mind when comparing cryptocurrencies with traditional bank facilities? We’ve compiled a list of potential pitfalls cited by CNBC, Investopedia, the Guardian, BBC News and further sources below…

  • Fluctuating value – one only need look at the recent rollercoaster upon which Bitcoin’s worth embarked between January 22nd and January 23rd, dropping 12%, to realise how volatile many cryptocurrencies are. International governments’ efforts to regulate or ban these markets can risk a business receiving little-to-no return on their investment should they exchange their funds for fiat currencies at the wrong moment
  • Manipulation dangers – the Guardian reported last month an exceptional but unsettling case where armed robbers forced a UK trader to transfer Bitcoin holdings to their accounts. Moreover, the New York Times (cited by CNBC) says that the unregulated nature of cryptocurrencies leaves them vulnerable to illegal market manipulation, an issue which proved cause for concern in December as digital exchange Bitfinex was accused of inflating prices
  • Money laundering – easily one of the foremost concerns for police is how susceptible cryptocurrencies currently are to crimes such as fraud and money laundering. It’s thought that criminals can sidestep conventional money laundering checks, with the lack of regulation involved enabling them to escape unscathed while traders struggle to hold merchants accountable
  • Insurance issues – Investopedia’s Bitcoin guide also notes that whereas banks will afford their customers with a degree of insurance to secure them against potential fraud activity, most cryptocurrency merchants offer no such guarantee, nor is there a government program in place – either here or in most other nations – to provide support in this regard

Ticking time-bomb or game changer?

With various analysts predicting both a bright and turbulent future for Bitcoin and other cryptocurrencies, the market reactions are equally disparate with some seemingly reducing its position and others strengthening it. Some banks such as Lloyds Bank, Halifax and Virgin Money are banning Bitcoin credit card purchases, the UK Treasury has vocalised the aim to introduce cryptocurrency into anti-money laundering regulation, the Indian Government’s intends to “eliminate use of these crypto-assets in financing illegitimate activities” and South Korea has banned anonymous trading.

Once an idea has surfaced and showcased its viability, however, quelling that idea entirely can fast become a losing battle. BBC News’ Rory Cellan-Jones cautions us against forecasting the death of cryptocurrency too hastily: “On its helter skelter ride towards $10,000 [in late 2017], there have been plenty of occasions where Bitcoin has seemed in trouble – splits in the community over how it should be governed, robberies at exchanges, warnings from regulators. But every time the pundits have warned the bubble is about to burst, the currency has stuttered for a few days and then gone charging higher.”

No-one thus knows for certain what’s ahead for the cryptocurrency market, regardless of its recent rise to fame or domestic and international regulators moving to combat the more dangerous implications of this fast-developing financial trend.

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