Everyone’s heard of Bitcoin, and along with other cryptocurrency options, it’s garnered quite a following over the past few years. Although it’s difficult to know with certainty due to their anonymity, the Judge Business School in Cambridge estimates that there are five to ten million users globally. Users’ identities are kept secure, and only a nominal processing fee is involved compared to charges levied by traditional banks. And as most cryptocurrencies are not under the control of Federal Governments or central banks, their different mediums of exchange are outside the realms of state monetary policy and remain unaffected by their actions.
The Benefits of Using Cryptocurrencies
To provide security: As cryptocurrencies are digital and encrypted in nature, counterfeit copies cannot be produced, as is possible with traditional payment methods.
No personal information is shared: No cryptocurrency transactions carry personal data about the user; privacy is sacrosanct.
No middleman, low fees: Through cryptocurrencies, users eliminate middlemen like brokers and lawyers from the arena, who usually charge service fees on the transaction.
Swift and easy payment: Users simply require the address of the other person to transfer funds. As a result, processing time is almost negligible and the whole transaction is completed in a matter of seconds.
A decentralized network: The users are always in control of their currency units and there is no central authority in the network.
Universally recognised: Digital currency is recognised all over the world at a particular value so there is no exchange rate risk.
Major Players in the Cryptocurrency Market
Bitcoin was the first cryptocurrency. It launched in 2009, and is based on a peer-to-peer digital payment system. Since then, numerous cryptocurrencies have emerged in the landscape, claiming they are improved versions of Bitcoin. These are called alternative cryptocurrencies (altcoins). They all use decentralized control of Bitcoin’s blockchain transaction database in the role of a distributed ledger. However, Bitcoin remains the de facto leader in the cryptocurrency space.
The main objective of Bitcoin is to be a currency devoid of any central authority; one which can be transferred electronically with very low transaction fees. Transactions are confirmed by nodes on the network and recorded in a publicly distributed ledger termed as a ‘blockchain’. Bitcoins are produced over the network by a process known as ‘mining’. It involves solving difficult puzzles to discover a new block. This is added to the blockchain, and in turn miners are rewarded with Bitcoins. A typical feature of Bitcoin is the limited supply. There are only 21 million Bitcoins that can be created, irrespective of the earth’s population and corresponding demand. However, they can be further divided into smaller parts. As increasing numbers of Bitcoins are created daily, the difficulty level of the mining process also increases. This calls for more advanced units and systems.
Factors Leading to Exponential Growth in the Cryptocurrency Market
Cryptocurrencies like Bitcoin were created in the aftermath of the global financial crisis of 2008 to operate freely without any intervention from governments, banks or other financial institutions. Over these nine years, Bitcoin has experienced its share of volatility, facing both criticism and support, and continually fluctuating markets. The initial demand for cryptocurrencies stemmed largely from Asian and European nations following their economic and monetary problems. Investors who were looking for alternative investment options started buying into cryptocurrency.
Bitcoin was the best performing asset in 2016 and has enjoyed a great start to this year. This recent performance was driven by increasing demand from Asia. The buzz surrounding Bitcoin is the primary main driver for now. Major gains came in the second quarter of the year after it received support from key governments and institutional investors. Over the past year, Bitcoin has soared more than 250%, reaching an all-time high of $3,000 in June.
The Japanese Government passed a law accepting Bitcoin as a legal payment method in April, with major retailers giving support. Since then, the nation has been a huge driver for this unprecedented rally. Trading in the country increased as investors rushed to swap Yen for Bitcoin. Additionally, Russian Deputy Finance Minister, Alexey Moiseev, suggested that authorities could legalise cryptocurrencies in 2018 to tackle money laundering. South Korea announced plans to introduce a regulatory framework for digital currencies, whilst according to one report, the People’s Bank of China and the Danish Central Bank are currently evaluating the use of cryptocurrencies and running trials for the same.
Meanwhile, a group dedicated to bitcoin development has established the ‘Crypto Valley Association’ in Switzerland with the government’s support. Their aim is to further promote growth in blockchain and other allied technologies. PwC, UBS, Thomson Reuters and Lucerne University are some of the major entities backing this organisation.
Growing interest from companies
Bitcoin’s main rival, Ethereum, launched in 2014, has also recorded a bull run this year, soaring more than 2,000%. The latter has found support from major corporates who want to use the underlying technology for smart contract applications. An association called the ‘Enterprise Ethereum Alliance’ has been formed to connect big firms to technology vendors in order to work on projects using blockchain. JPMorgan, Microsoft and Intel have joined this alliance.
Possibility of Bitcoin ETF
Cryptocurrencies also surged in the May-June period on hopes that the Securities and Exchange Commission (SEC) would approve a Bitcoin exchange-traded fund backed by the Winklevoss brothers.
Positive developments regarding underlying technology
In recent years, interest in cryptocurrencies has shifted to Blockchain, the underlying technology powering them. It is poised to bring significant disruption to the financial markets. In April, a change was made in the code that runs another cryptocurrency, Litecoin, called Segregated Witness (SegWit). This system helped in increasing the speed of transactions on the network. Since then it has been hoped that such changes will be introduced to the Bitcoin network as well, helping to speed up processing time and solve the current scaling problem.
New channel for money outflow
Chinese buyers have been using Bitcoin as a channel to transfer large amounts of cash from the mainland, therefore bypassing tough regulations on capital outflows. People in China have acquired Bitcoin by using Yuan to sell them on another exchange for Dollars or Euros. Trading in Bitcoin rose after major Chinese Bitcoin exchanges lifted restrictions on withdrawals after a four-month hiatus.
Why Have Cryptocurrencies Dropped Recently?
The cryptocurrency sector has lost substantial market capitalisation in recent weeks, pushing it into bear market territory. According to data from coinmarketcap.com, the cryptocurrencies market dropped to around $80billion, from the $115billion reported on 14 June. Unlike previous shocks to the market, there were no major factors, like a hacking event, which caused the significant decrease. It simply indicates the deflation of a bubble created by speculators who had rushed into the market in May and June.
In July, Bitcoin fell below the psychological $2,000 barrier for the first time since May as traders grew concerned that its dominant status in the digital currency market would be challenged by other players. The recent spurt in Bitcoin trading volumes has led to decreases in transaction speed, making an urgent case for updating the software. It also came under severe pressure amid a growing split between developers and miners within the community about how to increase trading capacity. Various solutions were proposed, but no consensus has been reached.
One of the solutions proposed was a Segregated Witness (SegWit) system, but it required 95% support from miners and the Bitcoin community to be added to the blockchain. Concerns are growing that two rival groups might implement competing software updates on the network at the end of July, splitting Bitcoin in two. This uncertainty weighed on demand in recent weeks.
Last week however, cryptocurrencies have recouped some of their losses. The development came after another solution was suggested, known as the Bitcoin Improvement Proposal 91 (BIP 91). It allows miners to activate SegWit with only an 80% majority. If the miners use this new technology consistently until 31 July, the whole Bitcoin community will have no choice but to accept it. So far, this solution has received almost 100% acknowledgement and has alleviated fears regarding a split. Meanwhile, some financial firms have maintained bullish stances on Bitcoin and expecting it to reach the $3,000 mark again.
So, there is no doubt that the recent surge in cryptocurrencies has raised a red flag amid fears of a bubble. However, the technology behind it cannot be ignored it seems primed for a bright future. History tells us that new technologies generally experience a series of booms and busts before being widely recognised by the global community. Cryptocurrencies, it seems, are currently going through this phase.
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