Cryptocurrencies have become very popular in the last several years and have attracted significant attention from various stakeholders including governments. The cryptocurrencies have been promoted as digital currencies. Even after several years since their inception, especially the most famous cryptocurrency, Bitcoin, cryptocurrencies are not widely used as currency. Cryptocurrencies fulfill some functions as currency but lack other attributes of currency while having serious drawbacks namely volatility, high energy usage and vulnerability to theft. Given their drawbacks, it is highly doubtful that cryptocurrencies can ever become viable currencies.
Unlike conventional forms of currency, cryptocurrencies are decentralised; this essentially means governments and central banks do not control formulation, creation and management of cryptocurrencies. This feature of cryptocurrencies is quite appealing to its users. Also, transacting with cryptocurrencies offers anonymity which is also popular among its users. Unfortunately, this feature of anonymity has attracted criminals to conduct illegal financial activities, money laundering, etc. using cryptocurrencies.
Inspite of the hype surrounding cryptocurrencies, they have serious drawbacks that may very well limit their use as viable currencies. According to the Bank for International Settlements (BIS), the decentralised nature of cryptocurrencies which is touted as its main strength by its advocates, is its greatest weakness. Trust in the stability of value is a central feature of a good currency. However, the bank argues that the decentralised agreement through which cryptocurrency transactions are recorded makes reaching consensus vulnerable so that trust can quickly disappear and the cryptocurrency can lose its value.
While the bank identifies three shortcomings of cryptocurrencies which are scalability (size of ledger grows with transactions making payments cumbersome), unstable value and shaky foundation of trust in cryptocurrencies, it mentions that the underlying technology, blockchain technology, can be used in other aspects like global remittance flows. Therefore, the BIS report points out serious flaws of digital currencies.
Cryptocurrencies have been characterised by extreme volatility of value. Bitcoin has experienced significant volatility. Within a year, the price of Bitcoin increased from below US$1,000 to almost $20,000. while the current price is over $6,600. This shows extreme price volatility of the most well-known cryptocurrency. The characteristic of significant price fluctuation is shared by other cryptocurrencies as well. The extreme price volatility can be attributed to speculation and bubbles. However, for a cryptocurrency to be accepted as a viable currency, it must have stability of value which none of the cryptocurrencies have demonstrated yet. This is a serious drawback for cryptocurrencies to be accepted as viable currencies.
Watch: The future of cryptocurrencies
Also, an important feature of a currency is unit of account, the price at which goods and services are priced in a country. People prefer not to think in more than one currency in one country. But, with so many cryptocurrencies, it will be quite difficult to use them as units of account in one location. Again, the extreme price volatility will hamper the use of cryptocurrencies as units of account as the prices of goods and services in terms of cryptocurrencies will constantly vary, making it impossible to price goods and services in cryptocurrencies.
Another drawback of cryptocurrencies is significant energy use. Mining, which is the validation of cryptocurrencies, is an integral part of cryptocurrencies and miners are rewarded with new cryptocurrencies. However, mining is energy expensive and, according to BIS, Bitcoin mining consumes as much energy as Switzerland, which it has termed as an environmental disaster.
The pace at which cryptocurrencies' contribution to electricity consumption and environmental pollution has been growing is astonishing and worrisome.
In January 2018, Bitcoin mining resulted in 20 megatonnes of carbon dioxide emissions, which is approximately equal to one million transatlantic flights. This indicates the size of environmental pollution by cryptocurrency mining. Estimates by Credit Suisse indicate that at a bitcoin price of $1.1 million, bitcoin mining will attract all the electricity generated in the world. When the price of cryptocurrencies drop, cryptocurrency mining will become less financially profitable and that will decrease their energy consumption.
It must be mentioned that large technology companies and conventional forms of money consume substantial energy and contribute to environmental pollution. Large technology companies have useful contributions and they are striving to reduce their carbon footprint. But, the pace at which cryptocurrencies' contribution to electricity consumption and environmental pollution has been growing is astonishing and worrisome. On the other hand, supporters of cryptocurrencies suggest conventional methods of financial system consume significant electricity as well. It has been argued that 3.6 million ATMs in the U.S. consume 700-800 watts of electricity in standby mode and many cryptocurrency mining operations operate in abandoned industrial sites so that they are using unused energy.
While it is true that conventional forms of finance consume significant electricity and contribute to environmental pollution, it is doubtful they would compare to cryptocurrencies' use if the later become the dominant form of money. Even though Bitcoin mining consumes as much energy as Switzerland, Bitcoins are far from being a widely used form of currency.
Another significant drawback of cryptocurrencies is that they are vulnerable to theft given existing blockchain technologies. There are many examples of cryptocurrencies worth significant sums of money being stolen. This is a major drawback of cryptocurrencies as people will be reluctant to hold them for fear of theft, which is an obstacle for cryptocurrencies to become viable currencies.
Some central banks are exploring the idea of issuing their own cryptocurrencies. Central bank cryptocurrencies (CBCC) will have the institutional backing of the central bank. BIS points out that CBCCs may offer efficiency gains in terms of payments, clearing and settlement while possible risks like cyber-resilience of CBCCs, effects on the financial system, wider economy and implications for monetary policy need to be considered.
The Bank of Canada is exploring digital currencies and considering the risks and benefits. According to the Bank, some challenges are digital currency may be used for illegal transactions and create obstacles for financial intermediation. Other countries like China and Russia are researching to issue their own digital currencies. CBCCs will be centralized and the government can see citizens' spending, thereby, removing all privacy. It has been argued that CBCCs will reduce transaction costs. Therefore, central bank cryptocurrencies are an interesting idea that have their own benefits and challenges.
In conclusion, cryptocurrencies have drawn attention from various stakeholders. But, they have severe challenges like volatility of value, scalability limitations, trust issues and vulnerability to theft that may severely limit them being adopted as viable currencies. Also, cryptocurrencies use significant energy and contribute to environmental pollution. Even though central banks research issuing their own cryptocurrencies, there are considerable risks of that as well. The underlying technology, blockchain technology, may have utility in global remittance flows and other financial processes. However, it is highly doubtful that cryptocurrencies as they are now with their substantial drawbacks can ever become and be accepted as viable currencies.
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