Bitcoin Briefing: 4 Traits That Define Today’s Cryptocurrencies
From ordering and paying for coffee through an app to integrating student IDs with credit cards and watches, how we pay has come a long way from cash transactions.
And while far from mainstream, cryptocurrencies are gaining steam. New Zealand recently became the first country to legalize salary payments to employees in cryptocurrency. Days later, the People’s Bank of China announced that it was “close” to releasing its own digital currency. Facebook’s June 2019 announcement that it would introduce its own cryptocurrency, Libra, looks set to spark broader consumer interest in cryptocurrencies.
Cryptocurrencies exist only in digital form and are stored on distributed ledger technologies, such as blockchain. These various currencies have demonstrated some volatility and still face scrutiny from a range of regulators. That said, cryptocurrencies’ global market capitalization stood at more than $300 billion in early August 2019, compared with $11 billion in 2017.
As cryptocurrencies become more widespread – both with the general consumer and business – numerous risks with issuing, processing and accepting them must be considered.
“These currencies are not going away,” says Ward Ching, managing director at Aon. “We’re going to see the development of new ones coming from different parts of the world. As we’ve seen with various new technologies, having a solid grasp of emerging technologies – both the risks and opportunities presented – keep businesses relevant.”
Jackie Quintal, managing director, Financial Institutions Practice at Aon, agrees: “Innovation brings forth opportunity, and it’s important for organizations to continue to capitalize on them while appropriately evolving their approach to mitigating the associated risks.”
Unlike government-issued or fiat currencies, cryptocurrencies aren’t managed by any central banks. The technology behind these digital assets is blockchain – a public ledger of every transaction that cannot be tampered with or changed retrospectively. Advocates of the technology say this makes cryptocurrency transactions secure and safe.
The most well-known cryptocurrency, bitcoin, was released in 2009. Today, there are thousands of different cryptocurrencies with their own use cases.
Beyond financial institutions like banks or payment-card companies embracing the cryptocurrency world, traditional investors might be opening up to digital assets as well. As China–U.S. trade tensions roiled other markets in early August 2019, there were indications that investors were turning to several cryptocurrencies as sanctuary investments.
Diverse though they are, today’s cryptocurrencies share four defining traits.
1. Security: Essential To Cryptocurrencies – Yet Challenges Remain
Cryptocurrencies’ underlying distributed ledger technology, blockchain, was originally built for bitcoin. Due to the security it promises, some of the world’s largest organizations – including those that carry personally identifiable information, such as banks or health care organizations – have implemented broader blockchain solutions or intend to do so.
In theory, as the technology continues to mature with the goal of additional security for the end user, the challenges for the criminal increase. When users send digital currency, they are signing over ownership of the coins into another cryptocurrency “wallet” – all documented within the blockchain ledger.
Ching explains the general sequence of events necessary for a successful breach: “You’d need to be able to break the series of keys and passwords and get in; extract the hot wallet; then take it back into a new blockchain, reidentify it, and put it somewhere else in a fraction of a nanosecond,” says Ching. “There’s a tremendous amount of intellectual firepower needed to do that and, inherent to the technology itself, large safeguards against it.”
However, despite the strong technology backbone and high levels of traceability, headlines of cyber criminals successfully absconding with cryptocurrencies are becoming more common. Indeed, hacks, breaches and fraudulent fundraising known as “exit scams” have led to losses up to $4 billion in the first half of 2019 – more than doubling the amount for all of 2018.
James McCue, managing director, U.S. Financial Services Group at Aon, explains: the theft of cryptocurrencies most frequently occurs when the currencies – including their “private keys” – are not stored with “adequate controls and safeguards.” It is much easier for a cyber criminal to steal cryptocurrencies from a “hot” wallet (one that is stored online) versus from a “cold” one (stored offline and protected with comprehensive storage protocols).
2. Volatility: A Function Of Cryptocurrency Markets
Although some investors turned to cryptocurrencies in early August 2019, the digital assets have displayed considerably more volatility than other, traditional investments such as government bonds. Regulatory issues and changes in market perceptions of the digital asset’s viability as a store of value – and to transfer that value – can contribute to rapid shifts in cryptocurrency values.
That volatility can be a source of opportunity – or a headache – for investors. But because of the swings in value of cryptocurrency versus that of fiat currencies, insuring a cryptocurrency exchange or an organization’s cryptocurrency holdings can also be a challenge.
“Given the volatility and variance of cryptocurrency relative to fiat currency, the amount of protection that you have for, say, crime coverage for a cryptocurrency varies tremendously, depending on whether that currency is trading at $10 or $100,” says Eric Boyum, managing director, U.S. Technology & Communications Industry practice leader of Aon. “So people are looking for a more correlated way to insure cryptocurrency risks. One answer could be to use and develop a cryptocurrency to insure cryptocurrency.”
3. Hidden Expense: Cryptocurrencies’ Big Energy Bill
Although cryptocurrencies exist in a virtual space, creating and using them comes with a real-world impact: massive energy consumption.
The huge amount of computational activity involved in “bitcoin mining” – the process of solving massively complex problems on the bitcoin network to earn new bitcoin, thereby making the network safer – uses a large amount of electricity. In fact, the Cambridge Bitcoin Consumption Index, which estimates the amount of energy used by the bitcoin network, found bitcoin to be a higher consumer of energy annually than many countries.
Government response to the energy issue has varied. For example, some Canadian governments have offered economic incentives to cryptocurrency miners in the form of reduced electricity prices; whereas officials in China have considered banning mining on the grounds of excessive or irresponsible natural resource depletion.
4. Regulation: Inconsistent Cryptocurrency Oversight Worldwide
Similarly, while Facebook’s Libra announcement drew attention from policymakers around the world, the regulatory climate to date for the digital assets has been inconsistent.
In the U.S., cryptocurrency is viewed as property by the Internal Revenue Service but as commodities by the Commodity Futures Trading Commission.
The European Central Bank recently announced a plan to create a framework for monitoring the cryptocurrency market, principally to protect the traditional financial system and economy from cryptocurrency risks.
In the U.K., in July 2019, the Financial Conduct Authority finalized its guidance on cryptocurrencies: though anti–money laundering laws will still be enforced, cryptocurrencies are not regulated.
“There is going to be a lot of regulatory oversight – or at least attempts to regulate,” says Ching. “My expectation is that this is going to be a prolonged effort.”
The Currency Of The Future?
The cryptocurrency market is growing dramatically, yet numerous questions remain unanswered. Regulation seems likely, both governments and consumers can be expected to seek action across various areas, from data-privacy concerns to broad economic implications.
As with all emerging technologies, one thing remains constant: the more consumer demand, the greater adoption by businesses.
“The cryptocurrency space is evolving, and it’s also choosing to disrupt,” says Ching. “Disruption is not chance. It’s methodical. Adapting to change – or driving one – is critical to staying ahead of the risks and capitalizing on the opportunity.”