Cryptocurrencies – Separating fact from financial fiction

Sam Reed from IT experts Air IT, takes a look at the truth behind the cryptocurrency trend…

Last year, the value of the Bitcoin hit an all time high that sparked all manner of predictions about how cryptocurrencies would revolutionise the financial world.

However, now the frenzy has abated, it is clear that the future of cryptocurrencies is uncertain.

Before we dive into the truth behind some of the areas of speculation, I’ll clarify what typifies a cryptocurrency. To begin with, the currencies are digital and at the moment they are generally unregulated. You don’t need a bank account to use them and they can be used anywhere in the world.

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Are users anonymous?

Bitcoin was the original cryptocurrency and one of its biggest draws was that it afforded relative anonymity to those who used it. The whistleblowing site Wikileaks is among those that encourages payments to be made in Bitcoin, so their donors can’t be traced. Unfortunately, anonymity also makes Bitcoin particularly appealing to those involved in criminal activities, such as ransomware.

Bitcoin users are considered to be anonymous because they make transactions under a pseudonym that is not tied to their real name, or any personally identifiable details like their physical address. Most bitcoin software allows you to create a unique pseudonym for each transaction, which makes it even harder but not impossible to trace users.

A system called blockchain is widely used to keep the transactions secure. Because blockchain acts as a public ledger, anyone can readily see the records of all of the transactions ever associated with a particular bitcoin address. Blockchain analysis firms have already been set up to uncover people’s identity by looking for patterns in their transactions.

Does blockchain have other uses?

Blockchain is made of a chain of interconnected transaction blocks. If a change is made to one block in the chain the whole network will know about it. This makes it incredibly difficult to corrupt the data it holds and because it has no single point of failure it is inherently reliable too.

Even if crypto-currencies don’t survive into the future there are those who believe that blockchain could still be used in other scenarios.

Finance companies are already looking at how they can use blockchain for their transactions and some of the world’s biggest banks have funded a start up called Digital Asset Holdings to help with this.

Some believe blockchain could also evolve to be used for other applications where data security is important, such as medical records. Others believe it may be used to create a digital identity which could be used to securely log into sites, such as online banking websites, or even for digital voting.

But not everyone is convinced about the value of blockchain. Martin Walker, the director of the think tank for the Centre for Evidence Based Management recently told the Treasury Select Committee that blockchain is a fad in finance. He said: “In terms of demonstrable benefits [blockchain technology offers] little to nothing.”

 Will it replace credit cards and/or cash?

In 1999, Professor Milton Friedman, winner of the Nobel Memorial Prize in Economic Sciences said: “I think the internet is going to be one of the major forces for reducing the role of government. The one thing that’s missing but that will soon be developed is a reliable e-cash.”

Some proponents of bitcoin believe that moment has come as some high profile companies like Virgin Galactica and Expedia are among those accepting payment in the cryptocurrency. Richard Branson said: “Sometime in the future, innovative payment models such as Square, Clinkle and Bitcoin will become serious challengers to traditional banks, which will spur more competition and give customers even more options.”

But a few hurdles need to be overcome before cryptocurrency payments can go mainstream. For starters, cryptocurrencies can only handle a few transactions at a time, compared to the tens of thousands handled by traditional payment systems. Although a solution to this is being worked on, it is still far off.

Transaction fees for making payments are also continually rising and have therefore lost the appeal of being free, like they originally were.

Are cryptocurrencies beyond the reach of the law?

At the moment, cryptocurrencies are unregulated in most parts of the world but this is unlikely to be the case for much longer.

Japan has already set up a regulatory body for its cryptocurrency exchanges and other countries are likely to follow suit.

China has also introduced a series of regulatory measures to control the use of cryptocurrencies, including a ban on internet and mobile access to all things related to cryptocurrency trading.

The UK and EU are also making plans to avoid cryptocurrencies being used for money laundering and tax evasion. Traders will be forced to reveal their identities while online platforms will have to report any suspicious transactions.

The bottom line

Cryptocurrencies may bring changes to the financial world and beyond but what they hold for the future is still being worked out. We are unlikely to see them overtake mainstream currencies any time soon.

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