Cryptocurrencies: Reviewing benefits and major challenges
“Cryptocurrencies have emerged as strong digital currencies facilitating decentralized transactions. By eliminating the need for centralized monitoring or intermediaries, cryptocurrencies offer more power to the users and ensure better privacy. However, this new currency is still struggling to gain a respectable, publicly approved position in the mainstream financial system. In this article, we will review the major challenges for cryptocurrencies, but before that, let’s take a quick overview of this new-age decentralized currency.
What is Cryptocurrency?
Cryptocurrencies are powered by blockchain, a self-autonomous framework that records transactions, prevents duplication/tampering and validates transactions without any mediator or a central authority like banks. Bitcoin is one of the most popular and widely accepted/transacted cryptocurrencies, but recent years have seen some other prominent cryptocurrencies as well, like Ethereum. Along with that, there are hundreds of other cryptocurrencies of varying sizes.
Utility profile of Cryptocurrency for individuals, businesses, and nations
Extreme and unpredictable volatility is one of the major challenges that restrict the utility profile of cryptocurrency. Neither businesses nor customers are comfortable using such a highly volatile currency for obvious reasons. An item sold for $10 in the morning, for instance, may end up effectively fetching the merchant just $7 by the evening due to significant value depreciation on the day of the transaction.
On a positive note, pro-investors are investing in cryptocurrency to diversify their portfolio for quicker and bigger gains. Sure, the strategy is not without its challenges, but the high reward potential makes it worth taking risks.
Pro investors also consider Bitcoin investment as a safe way to mitigate the effects of fiscal currency inflation, as it is deemed unaffected by incidents in the fiscal currency market. However, some instances suggest otherwise, like the depreciation of Bitcoin value at the same time when the stock market was suffering losses during the last year.
Cryptos like Bitcoin are gaining remarkable acceptability in countries with weak currencies or high/unpredictable depreciation like Zimbabwe, Vietnam, and a few Latin American countries. In a few such countries, the government and/or populist leaders are proactively supporting Bitcoin, offering it rights and recognition at par with fiscal currency. The residents can use cryptocurrencies to settle taxes, pay government duties, purchase government services, etc.
DeFi: Financial Ecosystem of Cryptocurrencies
DeFi, a popular acronym for Decentralized Finance, refers to the financial ecosystem comprising blockchains and cryptocurrencies. DeFi projects empower crypto users and businesses to invest and transact in cryptocurrencies with similar ease they expect from the share market or other financial institutions. This ecosystem facilitates transactions in a decentralized manner without the need for centralized authorities or intermediaries.
Major challenges for Cryptocurrencies
Despite their promised benefits, cryptocurrencies still lag far behind the fiscal currency. There are many reasons behind it. Let us review the major challenges:
A preferred currency for illegal transactions
The recent years have experienced a surge in ransomware attacks where hackers invade internet networks to virtually freeze websites and demand a huge sum of money to unlock them. They mainly prefer cryptocurrency to maintain anonymity. Along with that, real-life threat, actors have also started using cryptocurrency in their illicit operations like drug dealing. Darknet, an online ecosystem where sensitive/illegal information and transactions take place, also uses cryptocurrency as the primary currency for transactions. Being tied to so many illegal activities often creates a nefarious ring around cryptocurrency, which negatively affects its public image.
Extremely energy-intensive mining process
Powering and running cryptocurrencies involves mining, which demands an enormous amount of energy, thus playing a negative part in climate change. It has created a negative image of cryptocurrencies among environmentally-conscious people and organizations. Thankfully, several cryptocurrencies like Ethereum are innovating systems that consume relatively much less energy. Likewise, some pro-crypto countries like El Salvador are finding ways to use renewable energy for mining to reduce energy consumption. Hopefully, it will help in reversing the cryptocurrency’s image within the environmentally conscious community.
Paves the way for evading taxes
Decentralization, the major strength of cryptocurrency, is ironically weakening its image in society. As mentioned in a few pointers above, not everyone uses decentralization in a positive way; many people utilize it as a tool to fool central authorities. Users can intentionally resort to cryptocurrency transactions to launder their illegally obtained money without raising alarms or being tracked by central authorities like finance and taxation. It is also an easier method for technically advanced fraudsters to steal money, as no government/central authorities are involved in the transaction process. There have also been rising concerns about cryptocurrencies being used by political parties/leaders to influence the public mindset, especially in smaller or politically unstable countries. It can concentrate the distribution of power from neutral government organizations like banks and tax departments to a specific party. Also, its effects on the economic profile of a country are quite alarming, as decentralized cryptocurrency can pave the way for tax-free businesses and reduce the revenue sources for banks. Though such apprehensions are hypothetical as of now, the rapid popularity of the currency can convert them into real threats.
Unstable trading exchanges
The high volatility of cryptocurrencies not only affects investors but can also topple entire exchanges. Tracing back the recent history, we can find the likes of FTX, once a powerful crypto exchange that declared itself bankrupt in the aftermath of heavy crypto devaluation during 2022. Conventional exchanges like Nasdaq or Wall Street demonstrated extreme stability and support to withstand such heavy challenges like Black Friday and COVID without experiencing any permanent damage.
Government’s role (and challenges) in promoting Cryptocurrency
While cryptocurrency is struggling with many challenges, several of them can be overcome if the government creates strict regulations and clarifies its legal status. It will not only ease public hesitation but will also discourage its misuse. Instead of creating a win-or-lose situation, the government authorities and cryptocurrency evangelists should meet halfway and coordinate to develop a feasible nationwide financial ecosystem for all. It will also contribute to extending real-life benefits to underserved and unbanked communities.
While some countries legally accept cryptocurrencies and others support them as preferred national currencies, we can still observe a significant lack of global consensus. Not only the government, but even the public at large is unaware or uninterested in using this currency. The attempt by cryptocurrency companies to present them as a better replacement for fiscal currencies actually multiplies challenges as the government sees them as threats to democracy. Intentions aside, in real life, there is less hope for a business to thrive publicly if it outright challenges the established government systems.
The current regulatory framework is not sufficiently structured to create clear regulations for DeFi. Also, its heavy volatility and lack of centralization further complicate things. Without some central control, it is next to impossible for authorities to legally track the transactions in real-time and take actions to avoid fraud. With limited powers in hand, authorities are reluctant to take liability, which questions the very objective of creating regulations. However, the authorities have started developing a few ways to regulate the broader DeFi ecosystem by mandating standard practices like KYC for cryptocurrencies, which can play a key role in tracking financial frauds. Government organizations are also educating their officers on blockchain and its use for tracking suspicious activities and analyzing financial frauds. Demonstrating its practical benefits, the FBI successfully recovered a partial ransom in the notorious case of the Colossal Network Hack in 2022.
Need for a thorough review and guidelines
The challenge for cryptocurrencies is not limited to the reluctant approach of governments. Even the governments that actively adopted cryptocurrencies have started taking contrary measures to limit their usage and discourage investors, which actually does more harm to their reputation. China, once a prominent pro-crypto country, has started discouraging its use after (possibly) realizing its real-life complications.
CBDCs: The Government-backed Alternative for Cryptocurrencies
The central banks of several countries are now launching a government-backed equivalent of cryptocurrencies called CBDC. These digital currencies enjoy the same rights as legal tenders while offering the operational benefits of cryptocurrencies like speed and privacy. However, it still remains under the precincts of doubt as to if and how these authority-backed CBDCs will support decentralization in real-life transactions. The path of CBDC isn’t less challenging either. The concept of cryptocurrency that lacks government backing boasts of having a heavy impact. Creating similar currencies with government backing can extend its impact to an international level. Digital Yuan (in the CBDC version), for instance, can empower China to challenge the sovereign status of the dollar and emerge as a strong alternative to the internationally accepted standard currency. Disturbing the standard status quo in the financial ecosystem can have global implications, triggering cascading effects. Another issue with issuing CBDC is that it multiplies the gateways for fraud, thus demanding complicated regulations. Creating the ideal infrastructure and recruiting reliable manpower, in addition to educating present staff, aren’t easy tasks, especially in the context of colossal pan-government organizations with multiple departments.
Conclusion
Cryptocurrencies have emerged as a new-age digital currency working on a decentralized ecosystem without any need for centralized agencies. However, this non-fiscal currency has its own set of challenges. While people have started realizing the real-life benefits of cryptocurrencies, it still needs support from the government and approval from the masses as a utility currency to gain sustainable success.”
