How Do Cryptocurrencies Operate?

It is a digital world with transactions being done by mobiles, computers in which payment of the currency you deal with is transferred online. But these currencies are issued by the central bank and are called centralised currencies, as the central banks are the issuers of these currencies. In 1983, the American cryptographer conceived an anonymous cryptographic electronic money called ecash. Later in 1995, he implemented it through digicash, an early form of cryptographic electronic payments which required software to withdraw notes from a bank and designate specific encrypted keys before it can be sent to the recipient. This allowed the digital currency to be untraceable by the issuing bank, government, or any third party. A cryptocurrency is a decentralised digital currency that can be used to buy goods and services but uses an online ledger with strong cryptography to secure online transactions. But most of the interest in the currency is to trade for profit (or loss) with speculators at times driving its prices waywardly. One needs to exchange real currency for the cryptocurrency to access the goods or services or to trade in them. Cryptocurrency is a medium of exchange that uses advanced technology for the security of the system. The currency is not real that is why the word Crypto means hidden. 

Types of Cryptocurrencies

The most common type of cryptocurrency is Bitcoin whose recent market cap exceeded $ 1 trillion. There are 9 other types of Cryptocurrencies but in terms of market cap and prices, Bitcoin is Number one, and Ethereum with a market cap of $ 225 billion is number two. All other 8 cryptocurrencies have a relatively very small market cap. 

Why Are They So Popular?

1. Supporters of Bitcoin see it as the currency of the future and are racing to buy them before they become more valuable.

2. A few people think that since Central Banks are not involved in this as they control the Money Supply thus reducing the value of the currency through inflation, the value of cryptocurrencies will be stable and higher. Since there are a finite amount of cryptocurrencies, their value keeps going higher as the demand increases. 

3. Other people like the technology adopted by these cryptocurrencies i.e. blockchain and are more secure than the traditional payment systems.

4. A few are interested in cryptocurrencies as their value always keeps going up.

5. Some people think that cryptocurrencies are a good hedge against inflation. 

Are They Good Investments?

Cryptocurrencies are mere speculation and not real investments. They do not have any underlying and do not generate any cash flow and for one to profit someone to profit the buyer has to pay more for the currency. A well-managed business increases its value over time by growing the profitability and cash flows from the operation but the same is not true for cryptocurrencies. Cryptocurrencies to be currencies of the future require certain stability. Recently bitcoin crossed a value of $ 50000 and in no time fell by $9,000 on comments that they are overvalued by Elon Musk owner of Tesla. Bitcoin rose to $20,000 in December 2017 and then fell to $3,200 in a year and by Feb-2021 was trading at a record level. Thus the basic faults of cryptocurrencies are that they have no underlying and the volatility in them is very high and the value is not defined by any fundamentals.

Disadvantages

1. Lack of regulation thus exposing it to illegal use.

2. Value can erode as fast as they rise and there is no stability.

3. High levels of volatility creating financial instability.

4. Not accepted in most countries.

Buying A Bitcoin

To buy cryptocurrency you will need a wallet an online app that can hold your currency. You create an account on the exchange and transfer real money to buy the cryptocurrency. Coinbase is one such wallet. Cryptocurrencies are legal in the United States, though China has banned their use. The legality of the currency depends on the individual country. Some fraudsters see cryptocurrencies as an opportunity to milk investors. 

Indian Scenario

There is no law prohibiting Indians from buying/selling cryptocurrencies. There was a banking ban from July-2018 to March-2020 due to which cryptocurrency holders were not able to hold Bank accounts. But the same was quashed by the supreme court. So at present, cryptocurrencies are legal in India. But in a recent interview, the RBI governor himself voiced major concern about cryptocurrency and has sent his views on the same to the central government. As per RBI the cryptocurrency trade could harm financial stability and could hurt the economy. The central government also seems does not favour having cryptocurrencies in the country and is planning a law to ban cryptocurrencies which will soon be introduced in parliament. The government has a view that cryptocurrencies could be used to launder a large quantity of money from the country and could also be used for terror-funding activities. The government can’t monitor cryptocurrency trading activity since they work in a highly secure environment.  The RBI is also planning to have a digital currency for India. However, the backers of cryptocurrencies say most of the above disadvantages can be fixed if governments around the world regulate and legalize the trade. 

The author is Head (Treasury), Finrex Treasury Advisors

DISCLAIMER: Views expressed are the authors' own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.