Which scenarios will be more likely as the blockchain-based technology spreads and the markets mature?
Cryptocurrencies started off as a niche monetary product, being owned mainly by online traders, blockchain specialists and hackers. In the eyes of the public opinion, they were surrounded by an aura of illegality, especially after the Silk Road saga – with the subsequent arrest and trial of its (alleged) founder and manager Ross Ulbricht, now sentenced to life imprisonment.
The online black market was shut down in 2013, but bitcoin, which was and still is the most popular among online currencies, is more alive than ever and has succeeded in overcoming the skepticism of several investors and regulators.
Bitcoin: a monetary policy assessment
The Bitcoin protocol is, by definition, decentralised. Its technical characteristics allow BTC to serve as real currency without any physical regulator, such as central banks or states. The algorithm is the ultimate guarantor of its effectiveness, certifying transactions and avoiding double spending. The chain of digital signatures and timestamps verifies the chain of ownership. As a consequences, the parties involved in the transaction, instead of putting their trust in a third party, rely only on the cryptography.
“The protocol defines how to maintain a public ledger of transactions allowing for a safe and secure way to transfer a unique piece of digital property from one user to another: everyone knows that the transfer has taken place and nobody can challenge its legitimacy. This public ledger is called the blockchain because it is a sequential chain of blocks, with each block aggregating multiple transactions. It keeps a record of every transaction forever, tracing back to the very first genesis block .” (source: The cryptocurrency price stability solution by Ferdinando Ametrano)
Bitcoin has an additional feature that makes it substantially different from any other national currency: it has a finite monetary supply of 21 million coins. No matter what, this amount cannot be exceeded. It’s a scarce resource, available only in a predetermined amount. From this point of view, it’s more similar to precious metals. Bitcoins are potentially usable as a stock of value, like gold reserves. There is even a platform, Orocrypt whose purpose is creating “a crypto alternative as proof of ownership of precious metals.” They launched a crowdsale of their token on 14th of June, and are planning to issue “tokenized” precious metals starting from the third quarter of 2017.
The fact that there is no flexibility in monetary supply, however, has a critical consequence in terms of volatility. The demand for cryptocurrency increases, but the monetary policy remains rigid, without adapting to the new conditions: this causes a rocket appreciation of bitcoin – with respect to the US dollar and other national currencies.
The extreme deflationary volatility is one of the elements that prevents bitcoin from being broadly adopted in traditional commercial transactions. The possibility to regulate the monetary supply could help stabilising the course of the currency, mitigating the price volatility. How to combine the introduction of these monetary supply rules with the absence of a central regulator, therefore respecting the independence of the protocol from third parties and intermediaries? It’s a broadly discussed topic, among academic experts and banking professionals, and the solution is not certain yet.
Are cryptocurrencies a bubble?
Bitcoin is experiencing an extraordinary boom in pricing. While I’m writing, one bitcoin equals 2668.85 US dollars. Ether (the token developed by Ethereum) equals approximately 325 USD. Ether is gaining a significant market share in the cryptocurrency scenario, showing that the supremacy of BTC will soon be challenged. The collective market now has a total value of 80 billion US dollars (source: The Economist) The expansion is pushing many investors to diversify their portfolio, investing in digital tokens different from Bitcoin and Ether, such as Ripple.
The question of whether digital monetary assets are to be considered a speculative bubble remains crucial. The trend seems to suggest a cryptocurrency mania. An increasing number of firms (mainly blockchain businesses) are using the issuance of digital token as an initial way of financing their activity, through the practice of ICO (Initial Coin Offering). ICO is widely considered as a quick way to achieve enormous gains.
The extreme volatility may encourage speculation, but the system of cryptoassets seems still too far behind in popularity to cause a financial crash. “Investors could lose their shirts; a crash in one asset class could spread to others, creating wobbles in the financial system. But in the case of cryptocurrencies such risks seem limited. It is hard to argue that those buying cryptocurrencies are unaware of the risks. And since they are still a fairly self-contained system, contagion is unlikely.” also writes the Economist.
Other commentators are not as optimistic. According to Tama Churchouse on Business Insider, the current cryptocurrency bubble is similar to the first dotcom bubble of the late 1990s. In other words: it’s deemed to blow up, even if nowadays few people own and use digital currencies for everyday commercial transactions.
In order for cryptocurrencies to become a day to day payment method, the fear of the bursting bubble must be, somehow, overcome. Consumers and investors need to trust not only the algorithmic system, but also the overall stability of the currency itself. The public is guaranteed against double spending by the blockchain and the public ledger. It’s now crucial to make sure that the price of BTC and Ether is not going to crash, causing a catastrophic loss for thousands of owners.
Developing digital & mobile payments: a window of opportunity for cryptocurrencies
Digital payment technologies are becoming increasingly popular in developing and newly industrialised countries.
An excellent example is the IndiaStack, a set open APIs for developers aimed at “solving India’s hard problems towards presence-less, paperless, and cashless service delivery”. The most successful application of the project is Adhaar Auth, a digital authentication system that assigns to every citizen an identification number, matched with biometric and demographic data available at the Central Identity Data Repository. The project is managed by the Unique Identification Authority of India (UIDAI), a governmental entity. Another API developed thanks to IndiaStack is UPI (Unique Payment Interface), that “enables all bank account holders in India to send and receive money instantly from their smartphones without the need to enter bank account information or net banking userid/ password.” UPI users create a Virtual Payment Address, linkable to any bank account, that can be used for peer – to – peer , Peer – Merchant or B2B transactions.
Online payments are considered a frictionless method ideal for widening the market of developing countries, where central banks and bureaucratic authorities can hardly be trusted. M- Pesa is a money transfer service, launched in 2007 in Kenya and Tanzania, today active in more than 10 countries. All the transactions are processed by smartphone. M- Pesa is also a service for micro- financing. In 2014 it had over 18 million active subscribers (Source: The New York Times) In 2o12, M-pesa’s mobile transactions reached a value of 37 USD billions, 31% of l Kenyan GDP. A similar case is Stellar, another mobile application conceived for citizens living in rural or underdeveloped areas, that allows them to transfer money in a quick and secure way.
Mobile payments have a large impact on developing economies, reducing transaction costs and cutting off oxygen to cash – based criminal activities.
Developing countries are an excellent testing ground for potentially global fintech innovations, including cryptocurrencies. If in Western countries the use of bitcoins and Ether is a way for libertarians, hackers and traders to make money going around the big financial actors, for the South of the world it may be actually a solution to a problem. They can be used as real mean of exchange, instead of as only a financial asset.
Cryptocurrencies offer a channel for storing and spending money without owing a bank account (a quite common condition in the developing world) and without incurring in absurdly high transaction costs. For instance, African migrants face an average remittance cost of 12.4% for each transaction to non – african countries; the fees are even higher when it comes to intra- african payments, peaking around 20%. (source: World Bank). These costs could be overcome by the use of the frictionless blockchain technologies, allowing more remittances to reach African countries.
Developing countries can benefit enormously from peer – to – peer approach, distributed platforms and decentralised applications. Digital currencies have the technical characteristic to become more than nearly – speculative financial tools for investors. They can become real means of exchange and re – design the system of payment and money transfer around the world.
Challenges ahead
Certainly the cryptocurrencies’ journey is just starting and a lot of issues are still to be raised. Regulators and governmental entities are still far behind in coping with innovative financial technologies. But something is on the move. Japan has decided to treat bitcoins just as any other currency; by 1st October any alternative monetary asset must be submitted to the supervision of the Financial Services Agency (FSA). Will bitcoin lose its nature of “hacker” currency from the moment it starts being subject to national or supranational regulations? Or will it abandon its “anarchic flavour” and be therefore more appealing to the average consumer?
Finding a balance between the core, original nature of cryptocurrencies and their inclusion into traditional economic systems is not going to be an easy task for tomorrow’s policy makers. Moreover, bitcoin and Ether will need to find a way to get rid of the speculative pressures and the extreme price volatility.
All the conditions for a radical change in the nature of money are on the table. The revolution of payments and finance doesn’t seem far ahead. And this time, it might not start in the Western countries.
proactive and always up for new experiences.