Cryptocurrency came into existence in the wake of the last economic crisis with the noble aim of removing the middleman, i.e. central banks, from financial transactions. Since then there has been much noise, but these means have also been mired in multiple controversies. In fact, it’s probably fair to say that post the initial hype they have not been able to take off and threaten sovereign currencies as many had predicted.
Cryptocurrency, in essence, is an internet-based medium of exchange for financial transactions leveraging the distributed and immutability features of the blockchain technology. It is not controlled by any central authority. This is why it is seen as competitive and, in the running, to threaten fiat currencies in the near foreseeable future.
One of the first issues with cryptocurrency is that it has not been able to generate widespread trust. Underneath the cryptocurrency, it is powered by software. And more often than not, software has bugs. It is also not as un-hackable as the advocates of cryptocurrency would like us to believe. The hackers have a knack of finding out the bugs and they have hacked into cryptocurrencies to devastating effect. Cryptocurrencies have no real asset value attached to them and the wide fluctuation in their valuations reminds us that this could be a bubble that is waiting to burst.
The second challenge is the remittance issue. Translated into layman's language it means that the ability to buy anything tangible using crypto is extremely limited. One major roadblock is that most central banks have refrained from regulating it. The dependency on technology has also become a roadblock for traders and wannabe-investors as it is not very frictionless. Due to this and the trust deficit, this currency cannot be used for most traditional financial transactions.
Then there is the added problem of volatility. To enable easy and frictionless trading one needs stable value. A central bank's endorsement would be great too! On top of that, the notional value of any cryptocurrency is solely based on speculation. All these challenges come together to make investing in cryptocurrency not for the faint of heart.
One point bears further exploration. One of the fundamental red flags is the huge propensity for speculation around cryptocurrencies. Warren Buffet once famously said that one should not invest in anything that one does not understand. In that light, the fog around exactly what bitcoin or any other cryptocurrency is, is still very dense, to say the least. This lack of clarity coupled with the roller coaster valuations ensures that only extremely specialized investors jump into this game.
Another challenge is access. There are only a few exchanges in some countries that enable trading in cryptocurrency. But what can an investor do when the exchange itself goes down and takes everything with it? Other instruments like mutual funds are regulated and hence there is a safety check. Fiat currencies have the backing of central banks. There is no such safety net for Crypto. Unfortunately, this is a field where panic is common. Panic leads to volatility. And that’s a massive issue.
Of course, one major deterrent is the possibility that major central banks will ban crypto. What then? Many major central banks are on the warpath with crypto. There is a general lack of trust within central banks about crypto and some of them have moved the courts to ensure a stop on their trading. Many have stated that these crypto are being used in a widespread manner for nefarious activities, an undeniable fact. True that fiat currencies are also used for the same, but the central banks can take regulatory steps. Alan Greenspan has compared crypto to the bills being used by the Americans during their American civil war. There are aberrations. For example, Venezuela recently launched its cryptocurrency, Petro. But most major world leaders and central banks have advised people against investing or trading in the same. That being the case, what happens if you want to cash out? How to trade your crypto for fiat currency to use it in the real world? With most of the countries and governing bodies not trusting this mechanism, where does one make the exchange?
And lastly, there’s the grim possibility of the whole crypto model going down and taking everything down with it. With no watchdog agency, the chances of fraudulent cryptocurrencies duping you are very high and then there would be nowhere to turn. Remember that there is no way or a mechanism to check whether a bitcoin is authentic or not.
Anecdotally, cryptocurrencies have made billionaires out of common folks. But when the currency is not regulated, you cannot buy anything with it, and not many have a clear understanding of the nature of cryptocurrency, it is best to stick to the sovereign currency. The overwhelming majority of investors do seem to agree.