What is Cryptocurrency?
Cryptocurrency is a medium of exchange for various accepted currencies like the US dollar. The most popular cryptocurrency, Bitcoin, first made an appearance in January 2009. Since then 14 million Bitcoins have entered circulation into the digital market. Similar to the US dollar, cryptocurrency does not have intrinsic value. However, cryptocurrency has no physical substance, it is not legal tender, nor is it backed by any government. Finally, supply of the currency is decentralized and it is not governed or managed by a central bank. The crypto part of the word stems from its use in public-key cryptography making communication secure between parties. The following are some of the most important attributes of cryptocurrencies:
- Code resistance to counterfeiting
- Limited supply and ability for the market to divide units into smaller units
- Instantaneous transmission of value without a need for an intermediary
- Personal data security enabled by public-private key cryptography
Current Market for Cryptocurrency
Recent developments confirm that cryptocurrency is not a fad. The currency has gained acceptance by a large number of investors, regulators, merchants, and consumers alike. More importantly the technology possesses the potential to disrupt standard financial markets. The ability for consumers to access global payment systems anywhere, anytime, with the only restriction being access to technology could be a game changer. No longer is the question of whether the currency is viable but instead it is how will it change behavior and when does it reach maturity.
Growth up to this point has been driven by venture capitalists investing in technology infrastructure profiting from price fluctuation instead of use by the consumer market. There is a significant amount of uncertainty associated with this type of adoption. Volatility has been tremendous. Bitcoin as compared to the US dollar is five to seven times more volatile than traditional foreign exchange.
Other developments also threaten the legitimacy of the currency and have served to keep Bitcoin and other cryptocurrencies in a fragile state. The Liberty Reserve and Silk Road money laundering schemes coupled with the most recent cybertheft that pushed a Bitcoin exchange (Mt. Gox) into bankruptcy are examples. Along with terrorists entertaining the idea of using cryptocurrency, serious issues have come up in relation to this new technology. Although the positives of the technology are promising a darker side has been exposed through its use by hackers and other criminals.
How is the Market Expected to Grow?
For the market to grow consumers need to accept and adopt cryptocurrency. This development will occur once consumers gain better knowledge of it, see improved availability, reliable cash exchanges are made, and some form of consumer protection is implemented. The biggest roadblock currently for cryptocurrency is the lack of consumer awareness. According to a PwC 2015 Consumer Cryptocurrency Survey, only 6% of respondents expressed that they were “very” familiar with cryptocurrencies.
On the business and merchant side, cryptocurrencies offer low transaction fees and lower volatility risk due to instantaneous payment and elimination of paying credit card processing fees. These benefits are expected to be diluted once increasing amounts of regulation are passed to protect the consumer. Another challenge to the currency is the volatile price. Current cryptocurrency markets struggle with illiquidity and high volatility which are indicators of a thinly traded commodity rather than a legitimate currency. Furthermore, there are “toll charges” or exchange fees which happen at the point where the cryptocurrency is traded for the US dollar or other accepted forms of money.
Investors and Financial Institutions Views
At this point in time investors appear to be confident about the opportunities presented by cryptocurrency. Recent interest by institutional investors and Wall Street attention confirm this idea. Venture capitalists to this point have been the driver of cryptocurrency growth. These investors are betting that at some point in the future consumers will use the currency in increasing numbers.
Banks in the traditional sense supply money to people who need it. In recent years though the middleman continues to see himself cut out as internet banking, gift cards, and PayPal are on the rise. These new systems still rely on traditional financial institutions to at some point process the transaction. Where cryptocurrency radically changes this trend is that it dramatically limits the role of standard financial institutions of clearing and settling payments. As cryptocurrency gains traction, in theory, it is possible that the traditional bank intermediary will no longer be needed. Cryptocurrency is not expected to fully replace banks but could change how they operate.
Regulation in the United States and Abroad
Regulation by the US Federal Government has been limited unlike in other parts of the world where in some cases the currency is banned. For cryptocurrency to gain traction in the United States it must navigate five regulatory frameworks:
- Financial crimes-related regulations like the Bank Secrecy Act (BSA), USA PATRIOT Act, and the Office of Foreign Assets Control (OFAC)
- State banking departments
- The SEC
- Commodity Futures Trading Commission (CFTC)
- Internal Revenue Service (IRS)
In the international arena government attitudes have been inconsistent and erratic depending on the country.
- Australia, Canada, and Singapore or looking into releasing tax guidelines on how to treat the currency.
- The UK government in an annual budget announced a focus on building financial crime regulations for digital currency companies.
- On a global level the Financial Action Task Force (FATF) is engaging in discussion of financial crime standards as they relate to cryptocurrency.
What this Means for Business
Cryptocurrency is still in its early stages. Large growth may occur in international markets first rather than in the United States due to the fact the US maintains a strong and stable currency already. The PwC survey confirms that cryptocurrency is at this point in time a niche product but that in the future it may become something more. In the near term there are many challenges for cryptocurrency; including its dark side, consumer skepticism, and the relative dearth of reliable exchanges. An important take away from cryptocurrency is its blockchain public ledger technology. This technology introduces a way to verify transactions without the need of a third party to do so. Any system that relies on third party verification is subject to this disruption if companies realize the importance and ramifications of such a system. In future publications, PwC will continue to explore this technology and elaborate in greater detail.