Image description: gold bitcoin superimposed upon computerised background with graphs showing share prices
Modern history has borne witness to several major milestones in the evolution of trade and commerce. With emerging technologies shifting civilization in new and unforeseeable directions, finance seems ever in the wake of a digital remodelling. In the last decade, we have begun to witness yet another extensive transition in the form of cryptocurrencies.
As of November 2021, there exist over 7000 cryptocurrencies, all of which revolve around decentralized finance (DeFi) – a networked form of finance that does not rely on central financial intermediaries. Any centralised system will have a central administrator, like a bank, that holds the authority to maintain and update a ledger of transactions.
In contrast, a DeFi system will have a distributed ledger such that everyone in the network holds an identical copy of the database, known as the ‘blockchain’. New blocks – blocks of data containing information about transactions – are verified and added to the blockchain via a consensus mechanism. A consensus mechanism refers to any number of methods used to achieve agreement, trust, and security across a decentralized computer network.
Let’s take a look at the pros and cons of this system.
One major benefit of cryptocurrency technology is that it does not require intermediaries. In fact, the principal motivation for making digital currencies was to eradicate the need for intermediary parties, who in reality are responsible for a very slow and inefficient financial system.
You’ll save time and money when trading cryptocurrencies.
Usually, third parties would be required for trust and verification purposes and charge sizable fees for providing these services, but the deterministic and fully automated nature of encryption protocols allows for a completely secure system. Removing these third parties thus enables much faster transaction times and massively reduced transaction fees. You’ll save time and money when trading cryptocurrencies.
Cryptocurrencies also boast incredibly high security. The immutability of blockchain technology ensures levels of security considerably higher than those offered by banks. In its 12 years of existence, the bitcoin blockchain has not processed a single faulty transaction. While crypto transactions do not require permission to be granted, fraud in the UK costs the government approximately £150 billion a year.
One clear downside of this unchecked commerce is its enabling of criminal activity, namely the financing of illegal goods and services. Inadvertently, the anonymity and ease of access provided by cryptocurrency platforms is a magnet for criminal behaviour. This poses many questions for necessary future regulation of such currencies.
A further deterrent to going crypto is its susceptibility to extreme market volatility. Since most cryptocurrencies do not function as standard companies, they do not sell products or earn revenue, so evaluating the success of such assets becomes very difficult. A lack of backing reserves and no central authority to control prices when required also increases the risk of owning these assets. Again, insufficient regulation of these markets allows for easier price manipulation, which creates further instability.
The anonymity and ease of access is a magnet for criminal behaviour.
There are also issues with scalability. Thus far, many of these currencies have proven impractical for processing high volumes of small transactions. Bitcoin currently manages around 7 transactions per second in comparison to Visa’s 1700. This is probably the biggest technical challenge facing cryptocurrencies, but the newest tokens have incorporated protocols to combat this.
To those increasingly concerned by climate change- hopefully the vast majority of us- cryptocurrencies are massively energy inefficient. The process of ‘mining’ involves iterating huge amounts of code via trial and error to solve the next block encryption. Therefore, the more powerful your computer, the more likely you are to find the next hash code and the more likely you are to reap the rewards.
Consequently, PoW networks use huge amounts of energy and are incredibly inefficient. The CBECI estimates bitcoin mining consumes 0.37% of the total global electricity produced every day. The next generation of cryptocurrencies are, however, implementing consensus mechanisms aimed to drastically reduce this figure.
So, should you splash out on Crypto or do ethical concerns outweigh investment opportunities?
At the moment, Bitcoin doesn’t seem far from fostering some new model of libertarian capitalist utopia, but this begs a serious question of legitimacy. And as history and common sense dictate, utopia is not possible. It seems almost certain that, as the Crypto platform grows, governments and authorities will introduce stronger regulations. By doing so, they will hopefully bring some stability and sense to this untamed market.
Interestingly, many prolific investors are drawing similarities between the explosion of popularity in cryptocurrency investments to that seen during the 2000s in the early adoption of the internet. If such a trend is taking place, it is difficult to see a strong future for many altcoins (alternative coins) who are only profiting off the success of larger ones, much like we saw at the start of the millennia with thousands of website businesses collapsing when the so-called dotcom bubble popped.
There is no debating the fact that blockchain technology is extremely powerful and these networks are almost certainly here to stay. However, there is much to consider and still more to be learnt to ensure the development of such an infrastructure remains sustainable and ethical. There are still large disparities in the general understanding of this technology which has inexorably led to an imbalance in who profits off its use.
The truth is that cryptocurrencies are still in their infancy
How do we reconcile ourselves to such shortcomings?
Having a means of direct peer-to-peer business where all individuals are fully responsible for their own assets seems foolproof on paper, but the truth is that cryptocurrencies are still in their infancy. They clearly provide a strong alternative to traditional monetary methods, but there remains a key balance to be found between transparency and accountability.
Looking forward, breakthroughs in quantum computing and continuous advancements in ‘dApps’ (decentralised applications) make us wonder what’s in store for this game-changing new market.
Image credit: André François McKenzie via unsplash