Digital Currencies or “cryptocurrency” is a virtual currency that uses advanced encryption technologies known as cryptography for its creation and to ensure security of transactions involving its use.

Converting this concept of digital currency into reality all started with the creation of “Bitcoin” in 2009.   Currently there are circa 1,265 cryptocurrencies in the market although bitcoin is the most widely used and accounts for the majority of the total market capitalisation.  Bitcoin are created digitally through a mining process that requires powerful computers that can solve complex algorithms. Bitcoin thus uses peer to peer technology which enables the network to do all the functions such as issuance of currency, processing of transactions and security and verification. The currency is expected to be capped at 21 million bit coins a level expected to be reached by 2140.

As cryptocurrencies are decentralised they are free from government manipulation or interference. On the flipside, there is no central authority for monitoring or supporting such transactions or their value.

This sparks a debate on whether these digital currencies are an alternative to real money or is it just a mechanism for making speculative gains for some at a huge price for others.

The answer lies around the acceptance of such currencies as a payment mechanism. Currently there are very few businesses in the U.K. and across the world that use these cryptocurrencies as money i.e. a payment mechanism. There is a greater use of these currencies for trading or investing as opposed to it being a payment method. There are many cryptocurrencies emerging, each with distinctive features, and they are a rapidly evolving field technically and regulatory.  There is a benefit around decentralisation and transaction anonymity, but this also makes these cryptocurrencies a host for illegal activities and therefore will attract a lot of attention from powerful regulatory and other government agencies. This coupled with issues around investments in infrastructure make these currencies less beneficial and understandably businesses are nervous about introducing them in their business activities.

While the number of merchants who accept cryptocurrencies has increased they are still relatively few. For the currencies to be more widely used there is a need to have that widespread acceptance among consumers. Given their relative complexity compared to traditional currencies, coupled with huge investments, and other regulatory aspects, this is likely to deter most people and organisations alike.

Investing in cryptocurrencies should be treated as any other speculative investment in that you run the risk of losing the investment. Cryptocurrencies are currently very volatile as they have no intrinsic value supporting them and with these huge price swings, cryptocurrencies are an investment not for the faint hearted.

Cryptocurrencies that aspire to become part of the mainstream financial systems need to satisfy a variety of criteria. They should be able to preserve the anonymity of transactions without being a conduit for various illegal activities; easy to understand for consumers but relatively complex for fraudsters; decentralised but with adequate consumer protection; and robust infrastructure and regulations but with relatively minimal costs. Dealing with these challenges will determine the future of these cryptocurrencies in the years ahead.

Blog written by: Riten Choksi