Volatile asset: bitcoin is one of many cryptocurrencies to have plunged in value in recent months

The cryptocurrency market is in upheaval, in concert with, and reflecting investor concerns in managing traditional capital market volatility.

Cryptocurrency is the latest evolution in the chain of mediums of exchange.

There have been numerous adaptations from the beginning of man and trade of what we would consider modern currency: shells, livestock, iron, copper, obsidian, lead, amber, gold, silver, precious stones, harvests and more.

Today’s transactions still involve some physical coinage, paper money, digital debit and credit cards representing virtual cash. Significantly, the overwhelming usage of computer technology, in some countries such as Sweden, has virtually eliminated physical cash trading hands.

Money as a stable value

Fiat (from the Latin for “let it be done”) money, so called paper money including digital cash, is sometimes touted as having no value just “another government printing money”, and is still a topic of debate when compared with the value of non-default government-backed bonds.

However, fiat money derives its value as a decree of legal tender by the backing of the government that issues it. This monetary structure also involves government and economic oversight of its value, regulations, and taxation implications.

Mediums of exchange

Fiat money, then legal tender with a determined value, became an asset to utilise to buy, sell, or exchange other assets, or services of value. These transactions between people and entities became either informally implied or formal contracts backed by a country’s finance and related legislation, thereby providing a certain stability as well as access to recourse for non-performance.

Avoiding government oversight

Then, the new, new thing showed up!

After years of popular discussion about individual trust and privacy with central banks, the alternative of a fully independent system of exchange, digital / cryptocurrency emerged: faceless, sightless, intangible (no touchable coinage or paper), anonymous, unbacked by, and unregulated, at first, by governments and financial exchanges, but also requiring comfortable computer technology in utilising digital wallets, private key management, and related structures.

First there was Digicash, then E-Gold, but neither could achieve decentralisation, a very important factor in cryptocurrency methodology that is designed to work as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or bank, to uphold or maintain it.

When implemented with decentralised control, each cryptocurrency works through distributed ledger technology, typically a blockchain, that serves as a public financial transaction database.

In 2008, bitcoin was created by Satoshi Nakamoto (in a computer code mining operation) as a vote against trust in conventional currency. Thousands of various imitators soon followed into a now crowded investing arena.

Coins are developed by a utility absorption-hungry computer mining procedure, utilising a code that “seeks to calculate the right answer”. Those systems that do so first are awarded a digital coin that has value among its cryptocurrency peers, then subsequently, was deemed to have future value as an investable asset.

This is a very basic interpretation of bitcoin mining procedures to reflect that only about 5 per cent of US persons understood the mechanics of bitcoin structure, but that more than 45 per cent had invested or (Bermudians may be similar) intended to invest in some form of cryptocurrency.

Bitcoin, then, is also neither commodity money since it has no intrinsic value, nor is it pegged to something of value, nor fiat money, as it is not backed by the government. It is of its own kind, which we call decentralised money.

“The value of bitcoin is solely determined by the market equilibrium between the people who trade it. The subjective theory of value,” states “The History of Money, From Fiat to Cryptocurrency”, an excellent article from www.crypto.com.

Causes of volatility

Capital markets of the past couple of weeks have been volatile and disconcerting – as your author stated last week, it is not the first time, nor will it be the last. Bitcoin investors are exposed to such uncertainty, too, and it can become contagious as it feeds on itself in a self-fulfilling prophecy, driving values down.

It is also important to understand that there are market interests that employ usage tactics: leverage to exaggerate profits – euphoric in an up market, e.g. 2-1, 3-1, 4-1, and conversely, significantly distressing with impactful losses. Some are exposed to borrowing and lending against, and shorting the security in anticipation of lower valuations. Fraud in financing illegal activities, fraud by hackers stealing private keys or digital wallets and the subsequent concern about recovery of assets if a crypto company business falters due to selling liquidity issues are further concerns.

Investment failures that might arise in the cryptocurrency markets have few, if any safety nets, such as bank deposit or securities investor protection insurance.

These factors singly or collectively, along with ruminations about a recession, can heighten volatility and impact impulsive selling.

Now might be a good time to think about crypto insurance

Another observation is that decentralisation can be viewed as the trade-off between government regulation and regulation free. It’s great in good times to have full control, but in uncertainty?

You have your answer above!

That, too, is facing change as globally, governments and financial exchanges are scrutinising this new business more, while implementing some controls, particularly, in the taxation of profits.

Final thoughts

El Salvador’s president, Nayib Bukele, fully embraced the everyday usage of bitcoin for the entire citizenry, buying up massive quantities of the digital coin and disseminating it to the entire population.

Bitcoin was labelled as the new currency of exchange, with ATM-like machines and accompanied with the benefits of investing in the future. A novel experiment that everyone, including yours truly, interested in this new technology has been watching with great interest.

The news late last week reported that El Salvador lost half its investment in bitcoin as cryptocurrencies plunged.

In the next column on crypto: the difference between stablecoins and bitcoin or imitators.

References

“Alternative Currencies”, sustainableandjust.org/

Cryto.com website

• Martha Harris Myron is a native Bermudian writer, author of the Bermuda Island Brilliance Blog, illuminating all things financial Bermuda and Bermuda’s First Financial Literacy Primer: The Dawn of New Beginnings, now available at Bookmart, Bermuda.