Cryptocurrency’s Impact on Financial Markets
Because of the decentralized concepts they symbolize and the potential for huge rewards, cryptocurrency has increased in popularity. Despite this, their volatility remains significant, and cryptocurrency assets carry a bigger risk of loss than many traditional assets. For example, the value of Bitcoin rose from around $1,000 to more than $19,000 in 2017, before plummeting to below $3,000.
Fundamentals of Cryptocurrency
Cryptocurrency is a type of digital or virtual money that can be used to do business. The “crypto” prefix alludes to the fact that cryptocurrencies use cryptography to secure and verify transactions as well as create new currency units (coins). Cryptography allows you to encode anything that is easy to decode with a key but difficult to interpret without one, which means that while coins are difficult to generate, transactions are simple to verify.
Cryptocurrencies are, at their most basic level, entries in an immutable, pseudo-anonymous database known as a “blockchain” that no one can alter. The blockchain creates a public record that is validated by several nodes, making money fraud extremely difficult or impossible. It also makes it straightforward to track specific transactions between anonymous user accounts or wallets.
Cryptocurrencies are a user-friendly digital version of fiat currency. Cryptocurrencies may appear creative to consumers in the United States or the European Union, but many countries have bungled their own currency. For example, Venezuela’s despotic government has become infamous for its skyrocketing inflation, which has worsened living conditions for millions of people who lack access to foreign cash.
Other countries impose strict capital controls and levy considerable levies in order to manage the flow of money. Cryptocurrencies may still be used to avoid capital regulations and taxes, regardless of whether they are legal or not, which has fuelled consumer and company demand. As a result, a number of countries have begun to crack down on the use of cryptocurrencies for tax evasion or illegal purchases or transactions in other countries.
Reactions from the government
The official response to cryptocurrencies has been lackluster at best among central banks and financial institutions. While some organizations have expressed support, many central banks have remained cautious due to the market’s extreme volatility. Public outrage has also been stirred by tax evasion and capital limitations.
The Federal Reserve Bank of the United States is a central bank of the United States.
Technical problems exist, according to US Federal Reserve Chairman Jerome Powell, and governance and risk management will be necessary before cryptocurrencies become mainstream. Former European Central Bank Vice President Vitor Constancio compared Bitcoin to the Dutch tulip boom of the 17th century, and many other governors have expressed similar concerns.
China’s People’s Bank (PBOC)
The People’s Bank of China believes that the time is “perfect” for cryptocurrency adoption. Nonetheless, the central bank wants complete control, and officials are cracking down on the bitcoin ecosystem in the country.
The Bank of Japan believes that cryptocurrencies do not have a market.
The Bank of England is the central bank of the United Kingdom. Former Bank of England Governor Mark Carney labeled cryptocurrencies as part of a “financial revolution,” making the central bank one of the technology’s few official advocates. Cryptocurrencies were created primarily to escape the supervision of the banking system, according to the Reserve Bank of India (RBI). These should be cause for concern, according to RBI vice-governor T Rabi Sankar.
The Implications for Global Investments
Cryptocurrencies provide a number of benefits, including frictionless transactions and inflation control, but many investors are incorporating them into their diverse portfolios. Because of the market’s noncorrelated nature, cryptocurrencies can be used as a risk hedge, similar to precious metals like gold. As a result, a number of cryptocurrency exchange-traded funds (ETFs) and exchange-traded notes (ETNs) have arisen.
Other analysts, on the other hand, are concerned that a cryptocurrency price drop may have a detrimental impact on the entire market, similar to how mortgage-backed securities precipitated a global financial crisis. It’s worth noting that the total market capitalization of all cryptocurrencies, which is present between one and two trillion dollars, is still less than the market capitalization of numerous large public companies, such as Meta (formerly Facebook) or Amazon. Cryptocurrencies, on the other hand, are a new and dynamic asset class that might go anyway. Finally, while many investors view cryptocurrencies as a means of speculation or a hedge against inflation, the market’s size as of 2021 does not constitute a systemic concern.