Cryptocurrencies such as Bitcoin and Ethereum have featured prominently in financial news in recent years, creating large divides in investing communities as their value continues to increase astronomically with no signs that it will slow down in the near future.
What are they?
Rather than a physical currency like the AUD or USD, cryptocurrencies are exclusively digital currencies that use peer-to-peer software to track movements of the currency between parties. Rather than the ledger of historical transactions (blockchains) being stored in a centralized location such as a bank, they are stored by each individual user – virtually every user has a complete record of every transaction made. This massive network allows transactions to be verified by millions of users simultaneously to prevent the unauthorized creation of currencies and prevent double spending.
Why do people use them?
Although every crytocurrency transaction is stored in the blockchain, the identities of the parties involved are not. This anonymity makes them a popular medium through which to conduct illegal activities such as purchasing illicit drugs and laundering money. However, there are also many legitimate uses for these currencies and their popularity has come about as a result of the demand for them in the transaction of legal goods and services rather than those on the black market. More interestingly, they have become a popular quasi-asset class, with investors holding portfolios of these currencies purely to speculate on their future value rather than the desire to conduct trade using them.
Benefits and drawbacks
In mid-2010, Bitcoin was trading at $0.06 [all values are USD], and in August of 2017 it reached $4257.95 – a compound annual growth rate of 393.18%. Similarly, Ethereum was launched in September 2015 at $1.27 and is currently in the mid-$330’s – returns of 1528.90% per year. Heavy speculation with a bullish attitude towards the continued growth of these cryptocurrencies and their importance to modern society has allowed phenomenal historical returns.
Additionally, crytpocurrencies have an extremely low correlation with most other major asset classes due to their unique nature. This could make them a desirable asset for an investor looking to construct a well-diversified portfolio.
However, Bitcoin et al. are very recent innovations and not yet fully understood by the market. There has yet to be a price discovery for these assets, meaning there is not a general consensus for their true value and volatility should be expected by investors looking to add it to their portfolios. Furthermore, their rapid rise has also fuelled fears of a bubble à la the Dot Com collapse in the early 2000’s.
Whether you are bullish on the future of crypto’s or think they are bubbles waiting to burst, they unarguably show that innovation is alive and well in the financial industry.