Cryptocurrency made the leap from being an academic concept to virtual reality with the creation of Bitcoin back in 2009. Bitcoin attracted a growing following in subsequent years, as well as investor and media attention. In April 2013 it peaked at a record $266 per bitcoin after surging ten-fold in the preceding two months. Bitcoin reached a market value of over $2 billion at its peak, but a 50% plunge shortly thereafter sparked a debate about the future of cryptocurrencies in general and Bitcoin in particular. So, will these alternative currencies eventually supplant conventional currencies? Or are cryptocurrencies a passing fad that will flame out before long? The answer lies with Bitcoin.
Bitcoin is a decentralised currency that uses peer-to-peer technology, which enables all functions such as issuing currency issuance, transaction processing and verification to be carried out collectively by the network. While this decentralisation renders Bitcoin free from government manipulation or interference, the flipside is that there is no central authority to make sure that things run smoothly or to back the value of a Bitcoin. Bitcoins are created digitally through a ‘mining’ process that requires powerful computers to solve complex algorithms and crunch numbers. They are currently created at the rate of 25 Bitcoins every 10 minutes and will be capped at 21 million, a level that is expected to be reached in 2140.
Whilst on holiday last week in the Lake District, I was thinking about the whole concept and trying to get it straight in my mind. Sad I know, but the relaxation of my holiday made me think that these new cryptocurrencies are not much different to those that we have been used to for millennia. Our coins and notes in our pockets have no intrinsic value but are backed by the Bank of England and hopefully by the government of the day. We are lucky that we have a stable economy unlike some countries, such as Venezuela! Which means that our savings are relatively save.
Whilst cryptocurrencies exist as an intangible concept, another good analogy is with gold. Gold needs to be mined, it is a rare commodity and difficult and expensive to acquire. The value of gold fluctuates up and down, but its value is reliant on the fact that someone else wants it; if no one wanted the gold, potentially it would have no value. Likewise the value of a Bitcoin is wholly dependent on what investors are willing to pay for it at a point in time. If a Bitcoin exchange becomes worthless, users have no recourse to get them back.
Cryptocurrency’s main benefits of decentralisation and transaction anonymity have also made it a favoured currency for a host of illegal activities including money laundering, drug peddling, smuggling and weapons procurement. These may be one of the main reasons that the whole concept will attract the attention of government agencies.
Despite its recent issues, Bitcoin’s success and growing visibility since its launch has resulted in a number of companies unveiling alternative cryptocurrencies, such as:
- Litecoin – regarded as Bitcoin's leading rival at present, and it is designed for processing smaller transactions faster. It was founded as "a coin that is silver to Bitcoin’s gold.” Unlike the heavy computer horsepower required for Bitcoin mining, Litecoins can be mined by a normal desktop computer, with a maximum limit of 84 million – four times Bitcoin’s 21-million limit – and it has a transaction processing time of about 2.5 minutes, about one-fourth that of Bitcoin.
- Ripple – was launched in 2012. Like Bitcoin, Ripple is both a currency and a payment system. The payment mechanism enables the transfer of funds in any currency to another user on the Ripple network within seconds, in contrast to Bitcoin transactions, which can take as long as 10 minutes to confirm.
- MintChip – Unlike most cryptocurrencies, MintChip is the creation of a government institution, specifically the Royal Canadian Mint. MintChip is a smartcard that holds electronic value and can transfer it securely from one chip to another. Like Bitcoin, MintChip does not need personal identification; unlike Bitcoin, it is backed by a physical currency, the Canadian dollar.
Some of the limitations that cryptocurrencies presently face – such as the fact that one’s digital fortune can be erased by a computer crash, or that a virtual vault may be ransacked by a hacker – may be overcome in time through technological advances.
While the number of merchants who accept cryptocurrencies has steadily increased, they are still very much in the minority. For cryptocurrencies to become more widely used, they have to first gain widespread acceptance among consumers.
Should you invest in cryptocurrencies?
That is for you to decide, it is obviously high risk!
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