With a track record of more than a decade, cryptocurrencies are clearly more than just a fad, but they remain largely misunderstood by many people, with lingering doubts about their true value, practical use and long-term application.
There is also a lot of concern about their volatile nature and potential for exploitation. According to data from Scamwatch, between January and May of this year, Australians lost $158 million in investment scams, the majority of which involved “investments” in cryptocurrency.
In the true sense, cryptocurrencies are a digital medium of exchange that uses cryptography as a form of security. In recent times, however, the term “cryptocurrency” has evolved into a surrogate description for, more generally, a decentralized financial system (DeFi), a highly volatile asset class that can fall or rise on the back of a Tweet, a space for malicious actors to steal the identities and funds of vulnerable investors, and a form of digital payment.
Traditional investors, as well as Australian financial institutions, are also more than fleetingly interested in cryptocurrencies.
Commonwealth Bank is testing crypto trading through its banking app, ANZ recently minted $30 million Australian stablecoins called A$DC, and National Australia Bank (NAB) will also release its own stablecoin (pegged to the currency). dollar) by the end of 2022. However, concerns about the security of cryptocurrencies as an investment class remain a major concern for financial regulators around the world.
The simple answer is that they don’t fall outside the boundaries of blockchain technology, which we’ll get to later.
More fundamentally, the current legal status of cryptocurrencies varies widely from country to country. While the use of cryptocurrencies within the European Union is unfettered, some countries, such as Turkey, have banned payments in cryptocurrencies.
In Australia, cryptocurrency is legal, but largely unregulated. Many crypto and other digital assets are generally not considered financial products, so the platforms where you buy and sell crypto may not be regulated by the corporate regulator, the Australian Securities and Investment Commission (ASIC).
The Australian Prudential Regulation Authority (APRA), which regulates financial services, provides a policy roadmap for financial entities engaged in crypto activities. A draft standard is expected by the end of 2022. However, APRA has emphasized that it will not stifle innovation, with chairman Wayne Byres saying in a speech reported by The Australian Financial Review newspaper: “Like our approach to climate risk, its underlying message is above all: ‘innovate by all means , but proceed with caution and with full awareness of the risks”.
The Australian tax authorities are also developing a policy framework for the taxation of transactions and assets involving cryptocurrency.
Consumer group CHOICE, meanwhile, continues to push for better consumer protections, some of whom have lost huge sums of money to crypto scams or market volatility.
“As it stands, enforceable protections in the unregulated cryptocurrency market fall somewhere between negligible and nonexistent,” says CHOICE.
“In a submission to the federal government, CHOICE calls for a regulatory regime to end consumer harm.”
Most cryptocurrencies operate without the support of an authority, such as a central bank or government. This fundamentally distinguishes them from traditional currencies, such as the US or Australian dollar.
Instead of government guarantees, the functioning of cryptocurrencies is based on so-called blockchain technology (see below).
Rather than existing as a physical stack of bills or coins, cryptocurrencies are limited to the Internet. Think of them as virtual tokens, whose value is determined by market forces generated by people who want to buy or sell them.
Today, about five thousand cryptocurrencies exist. Bitcoin is by far the largest, followed by Ethereum and Tether. The market capitalization of a cryptocurrency is equal to the unit price of a currency multiplied by the number of existing units. Even after the cryptocurrency collapse in May 2022, the market was still valued at around $910 billion.
Cryptocurrencies can be purchased with traditional cash, such as Australian dollars, and can then be used on their own to purchase a growing number of everyday goods and services. Cryptocurrencies have the same value in every country, allowing for person-to-person transfers around the world, while negating the problem of exchange rates.
Only a limited number of Bitcoins exist – cryptocurrencies are compared to a digital form of asset such as gold, where a perceived store of value is then subject to the laws of supply and demand.
Currently, this is the main appeal of cryptocurrencies: that they can be traded on exchanges similar to how stock market investors buy and sell stocks and other commodities.
What is blockchain technology?
Essentially, a blockchain is a type of database. Blockchain first gained prominence as the technology underlying Bitcoin when the cryptocurrency was first discussed in an article on peer-to-peer electronic payment systems in 2008.
The article was attributed to Satoshi Nakamoto, who was allegedly the pseudonym of a person or group of people. Part of the cryptocurrency’s design meant only 21 million Bitcoins would be created.
The blockchain is essentially a public record of every bitcoin transaction that takes place. A recording is spread over many computers and cannot be changed or modified afterwards. According to cryptocurrency proponents, blockchain transactions are more secure than traditional payment mechanisms.
New currencies such as Bitcoin are produced on the blockchain through “mining”, which requires huge amounts of computing power and therefore uses significant amounts of energy. Environmentalists have warned that the proliferation of cryptocurrencies could have a significant impact on global efforts to reduce energy consumption.
The most common places to buy Bitcoin and other cryptocurrencies are specialized exchanges. This includes a range of trading platforms and apps that allow investors to buy cryptocurrencies using traditional currencies and/or other cryptocurrencies.
To open an account, potential traders are usually asked to provide their passport details, a phone number, and an email address. Trading fees may vary from exchange to exchange. Some providers charge a flat fee per transaction, while others charge a percentage of the total transaction amount.
The performance of cryptocurrencies can be notoriously volatile with ups and downs on roller coasters. In 2013, an individual bitcoin was worth just a few dollars. At the time of writing (July 2022), the price was just above $20,000 — a huge increase from nine years ago, but far from its all-time high of nearly $68,000, which it reached by the end of 2021.
What is cryptocurrency mining?
Cryptocurrency mining refers to the process of generating crypto and verifying new coins. It is an extremely complex undertaking, involving many decentralized and global computer networks, and, as many environmentalists note, it is carbon intensive.
In the United States alone, Bitcoin mining is estimated to generate some £40 billion in carbon emissions.
Australian Hunger for Cryptocurrencies
Despite the risks and lack of regulation, Australian investors have embraced cryptocurrency in recent years. A report from US crypto exchange Gemini found that nearly one in five Australians (18%) bought digital currencies by 2021.
according to Gemini State of the world cryptography report, 43% of Australians will have invested in crypto for the first time in 2021, with many citing inflation as the main reason. In addition, about 54% of Australians viewed cryptocurrency as a good way to diversify their assets, with 81% choosing to hold their crypto investments for the long term.
Data from trading platform eToro shows that more than a quarter of Australian investors aged 18-34 have at least 10% of their portfolios invested in cryptocurrency, making the asset class particularly popular among Generation Y.
What happens now?
Even before the 2020 pandemic upheaval and the crypto price crash that began in November 2021, many experts questioned their security, practicality and long-term viability. Hence the stern and repeated warnings from financial regulators and consumer groups that people should approach investments in this area with extreme caution.
If more traditional investment firms dip their toes in the cryptocurrency waters, we could see the value of digital assets increase, with their use normalized and widespread. It also remains to be seen how the industry will react to the financial regulation being discussed in Australia.
In the uncertain times we live in, it is also possible that the entire concept of cryptography may prove vulnerable or unsustainable in the face of yet unforeseen challenges.
To paraphrase regulators: “buyer beware”.
This article is not an endorsement of any particular cryptocurrency, broker or exchange, nor does it constitute a recommendation of cryptocurrency as an asset class.