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From bitcoin to non-fungible tokens (NFTs), it goes without saying that cryptocurrencies have really come to prominence in recent years. That said, if there is one thing that has ruled the crypto market throughout this period, it is volatility. Indeed, the value of digital assets has been defined by fluctuations, unpredictable crashes, and miraculous bounce-backs – in this way, the notion that virtual currencies might one day replace traditional currencies seems remote, especially given that it does not yet constitute legal tender in most countries. But will this always be the case?
Perhaps not. At least at the moment, the use of bitcoin is surging in Russia following its move on Ukraine – this could be put down to a couple of different reasons. With increasingly restrictive sanctions placed on the Russian economy, the crypto market offers regular Russian people a viable means of preserving their buying power as established banks and payment services like Visa and Mastercard have ceased to operate in their country. On the other side of the coin entirely, there are concerns mounting that oligarchs and members of the Kremlin’s elite could be flocking to crypto in order to bypass sanctions, given the relative anonymity that the currency provides.
Of course, this situation reflects complex arguments both for and against nascent virtual currencies. On one hand, they offer consumers secure and quick transactions – on the other, the ease at which the unregulated market can be used for more nefarious purposes is plain to see. Certainly, the crypto market has the potential to provide a financial lifeline for some people, but it’s clear that some important decisions need to be made when it comes to mitigating future security risks.
With these difficulties to maneuver, people might rightly see traditional currencies as a safer option when it comes to their trading and investment activities. However, it would be reductive to suggest that digital assets don’t present some intriguing opportunities. As such, it is important that traders and investors weigh up the various risks and rewards that the changing world of currency presents.
The history of currency
Indeed, if we look back to around 600BCE, the idea that a string of computer code would hold any sort of value would dumbfound the Lydians who minted the first gold coin. Until that point, humans had relied on bartering – the direct exchange of goods and services – for their purchasing power. When paper money was invented in China in 700CE, it took almost 1,000 years for it to make its way across the globe to Canada, where French colonial soldiers used playing cards as cash in 1684.
Fast forward to the 21st century and it is now uncommon to find anyone who doesn’t use some form of cashless payment such as Apple Pay on their mobile phones. In fact, it wouldn’t be much of a stretch to say that currency has come full circle. In a world where axes, animal skins, and mammoth tusks once determined an individual’s purchasing power, digital files, artwork, and even memes are now the assets of choice for a whole host of traders and investors.
Without a doubt, the emergence of Bitcoin in 2009 is perhaps one of the most significant developments in the world of currency in the modern era. Valued at over £1 trillion in November 2021, the hype around virtual currencies is driven by the likes of Elon Musk, as well as the appeal of low transaction fees and easy payments. Combined, this has all led to growing investment in digital currencies, with many Central Banks now weighing up the creation of their own (CBDCs).
Undoubtedly, further regulation is required before this can all come to pass, but it is important to note that digital currencies are already considered legal tender in El Salvador, with other countries set to hop on the crypto bandwagon in the near future.
The rewards of digital assets
Indeed, there are some potential benefits to trading and investing in digital markets that traditional currencies cannot offer.
Firstly, the nature of completing a transaction using digital currency means that the speed, cost, and security are much greater than a traditional bank transfer. Where stock trades and wire transfers to the United States might take up to three days at a cost of $20-$30, crypto transactions can be completed within minutes, at a much-reduced rate. Without the private key to a crypto wallet, it’s impossible for someone to access transactions or funds, and the blockchain system that verifies transactions increases security even further.
Indeed, for traders with large portfolios, investing in cryptocurrencies presents some interesting opportunities for diversification. It is obviously important to note the fact that where the success or failure of stocks and bonds are relative to other markets, prices in the crypto markets don’t seem to correlate in quite the same way. Whilst all investments come with an element of risk and cryptocurrencies are certainly not a safe bet, this sort of diversification can mitigate some risk for investors.
Despite the volatility, this can bring to a portfolio overall, some investors also believe that cryptocurrencies can also be used as a potential hedge against inflation. Unlike traditional currency (governments have been printing unprecedented amounts of money since 2008, which is now starting to impact the wider economy), there is a cap on the amount of Bitcoin that can be mined – it is a finite resource, which means that it offers an alternative to the fiat money system. Given that traditional inflation hedges such as gold and property are inaccessible to many investors, for many, crypto has been added into the inflationary hedge mix.
Indeed, some interesting opportunities lie ahead here, although it is important to acknowledge the fact that cryptocurrency is currently a relative newcomer to the global asset markets. As such, it is still establishing its characteristics as a reliable hedge.
The potential risks
As I have already mentioned briefly, investing in digital currencies carries a significant element of risk. As a relatively young currency, it’s impossible to predict how the market will evolve. By nature, it is a speculative risk asset – there is always a chance that these investments will not appreciate in value. With CFD trading, you only need to deposit a percentage of the value of a trade to open a position, and profits and losses are based on the full value of the trade. The high volatility of cryptocurrencies, combined with trading on the margin, means that traders and investors could face some significant losses.
Moreover, as a technology-based currency, investors should be wary of cyber-attacks. Once a Bitcoin or digital asset has been stolen or lost, it is impossible to get it back – even with the protection of a smart wallet, it is not uncommon for traders to lose their investments when exchanging or mining. Even if an investor is not the victim of a cyber-crime, losing or forgetting the key to their wallet can lead to huge losses that are nigh on impossible to retrieve. Likewise, as trading digital assets have grown in popularity, so too have fake exchanges – this is a factor that anybody interested in putting their money into bitcoin should be well aware of.
This leads to my final point. Cryptocurrencies will eventually pose a difficult challenge to central banks when the time comes to implement CBDCs and there is no way of predicting how this will affect the crypto market at large. Some investors fear that the introduction of CDBCs will rid purchasers of their privacy and displace the crypto market entirely, although this remains to be seen. On top of this, the use of Bitcoin in actual monetary exchanges is still fairly rare, although admittedly, the prospect of CDBCs entering the banking system does point towards the use of crypto as a currency and not just an investment instrument.
Final thoughts
No doubt, the crypto market is understandably surrounded by hype, as well as some interesting opportunities to diversify with crypto payments becoming more widely used. That said, there is no way of predicting how it will establish itself, or how the markets might look in a few years’ time. As with any trade or investment, it’s important that investors carefully weigh up the risk and reward of cryptocurrency – approaching digital assets with a clear strategy in mind.
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