Why cryptocurrencies will not take over fiat currency within the next 5 years. 20 pages double spaced 12 font
No global consensus on regulation
o U.S. regulations
• European regulations
o European Comission
VP contemplates cryptocurrency regulation for European Union
o U.K sanctions
Online crypto derivative firms must abide by stricter standards
• Asian regulations
o South Korea
Crypto currencies are digital alternatives to traditional government-issued paper monies. The main question in everybody’s mind is, given the recent advancements in technology and uncertainties vis-à-vis the future purchasing power of current monies, why have crypto currencies unsuccessfully gained widespread acceptance? I will try to offer different descriptions based on maintenance of value and medium of exchange. In order to comprehensively communicate the problem crypto currencies face, I employed different models to demonstrate that agents may fail to adopt an alternative currency based on different factors, even when all agents come to an understanding that the current currency is inferior. The imperfect success of Bitcoin (almost undoubtedly the most common crypto currency to date)—helps to illustrate this. After comprehensively surveying events of unsuccessful monetary transitions, I come to a conclusion that crypto currencies like Bitcoin are less likely to generate extensive acceptance due to either the absence of significant monetary instability or lack of government support.
Crypto currencies have continued to soar in popularity since 2008. Today, more than one thousand different types of crypto currencies are in existence with most if not all with an aggregate value more than the market capitalization of IBM. However, the big question still remains whether they will ever become mainstream currencies in the world. Companies as well as individuals still need to pay tax receipts via government-issued currency (Guadamuz & Marsden, 2015)
Interests in crypto currency have grown significantly due to the increased demand by individuals as well as companies to digitally transact secure, anonymous, and also outside the influence of the government. The volume in the usage of crypto currencies have exploded since 2008 with over 5,500 markets available worldwide with a whopping aggregate value of approximately 150 billion USD; the most prominent crypto currency being Bitcoin (Guadamuz & Marsden, 2015). However, in my views, the rise in crypto currency valuations over the past months is some kind of a speculative bubble.
So what are crypto currencies, and why should we use them?
Before indulging deep into reasons as to why crypto currencies will not replace and take over fiat currency, it is important to first get the meaning of the term “crypto currency”. Crypto currencies are defined as digitally coded scripts that attempt to replicate government-backed currencies that we know of today. However, contrary to government-backed currencies which are tracked by banks or other central clearing houses, crypto currency related transactions are tracked by a publicly-viewed, digital ledger known as block chain.
The major component of the crypto currency network comprises of individuals or syndicates referred to as miners, who apply a highly complicated and efficient computer networks that solve complicated mathematical sequences in exchange for a transaction fee. Crypto currencies have some advantages that I tend to briefly discuss some of them in this part. For example, crypto currencies have a distributed kind of set up that advantages them over government-backed currencies. The first advantage is that, this kind of set up allows transactions to be done directly between two parties. Secondly, raising funds through crypto currencies is more straightforward compared to a traditional initial public offer (IPO). The last advantage of crypto currencies is brought about by their pseudo anonymity nature (that is the accounts are known but the owners of these accounts are not known), and the fact that they are non-governmental; this has attracted people who are more concerned about their privacy (Guadamuz & Marsden, 2015)
THE VOLATILITY OF CRYPTO CURRENCIES
Crypto currencies have of late gained a lot of interest from different investors, central banks and governments worldwide. However, lack of any system of regulation concerning their market makes them be far from being effective; they require new systems of as soon as possible. From an econometric point of view, the development behind the evolution of the volatility of crypto currencies has proven to exhibit both differences and similarities when compared to other financial time–series such as foreign exchanges returns (Lánský, 2016). However, it is important to note that since volatility cannot be observed and realized, volatility measures are not clearly defined. To clearly understand this issue of volatility it is important to investigate four of the most traded crypto currencies:
- Litecoin and
The extraordinary volatility of Bitcoin (one of the popularly used crypto currencies) is well-documented. For instance, using GARCH models, researchers found extreme price jumps for Bitcoin, however, volatility has been decreasing since 2015. This development is however not new in an emerging market. Concurrently, using a descriptive evaluation design, unusually high returns and high volatility of Bitcoin is witnessed. They argue that Bitcoin may be used as a hedge in crises, which may add to its attractiveness for investors. The positive association between Bitcoin and gold supports this view. However this view did not stay for long especially for the short period before the Bitcoin crash in December 2013 by exhibiting risk reduction capabilities especially when added to different equity portfolios.
Bitcoin does not fundamentally correlate with the other assets. This validates the hypothesis that Bitcoin is largely used as a speculative investment that depends much on sentiments. In line with this, Bitcoin prices and values associate negatively with values of stock, indicating a speculative behavior; that is one need to invest in Bitcoin to receive higher returns. Crypto currencies have been found to have high volatility as compared to gold and the USD.
In terms of volatility, most crypto currencies do not seem to qualify as an alternative to most currencies. Possibly, this might be the case in specific sectors of goods and services, or as a trading currency. Bitcoin just like other crypto currencies reacts rather equally to, but not exactly to other currencies in general. Being decentralized and unregulated, Bitcoin (and other crypto currencies as well) do not react exactly like other types of currencies (Lánský, 2016).
Even though crypto currencies have advantages and not forgetting the fact that they utilize an underlying block chain technology there are still many doubts if they will ever become mainstream currencies. Understanding crypto currency volatility is important for governments, stakeholders and regulators. With an advanced understanding of the value and volatility of this crypto currency there can be better regulations for its official use in different economies around the world. Understanding these aspects of crypto currency could reduce the risk of using and investing with this currency. Fiat currencies have two major roles that crypto currencies lack.
- Failing as a medium of exchange – why crypto-currencies will never be used for a majority of transactions
The first and the most important role of any currency are to act as a widely accepted medium of exchange. In themselves, currencies have no value at all. For example, gold when used by itself is as worthless as a piece of paper or some wooden sticks. Currencies only become of value when used to buy things that are important and useful. In this perspective, fiat currencies carry a big advantage over crypto currencies. Fiat currencies are used to pay taxes set by the government; and tax is the largest single payment in almost if not in every economy (Lánský, 2016). For example, in developing countries with developed economies, more that third of economic activities annually are paid to the government in form of tax.
In concept, a corporation could accept a crypto currency for goods sold. But it would still force them to pay company tax, payroll tax and sales taxes in government-backed currency. Furthermore, the corporation would be taking an additional exchange rate risk. For example, if the government backed currency increased in value against the crypto currency, the corporation would be higher risk of substantial loss. Similarly, if a company decides to start paying its staff in bitcoins, they would still be expecting the staff to take on an exchange rate risk, something which is less likely to be acceptable to most employees.
However, this does not deter crypto currencies from being recognized as a limited form of medium of exchange. Nevertheless, if governments do not recognize crypto currencies for tax payments (the sole most significant transaction in an economy), then it considerably reduces the demand for crypto currencies. Governments are less likely to ever take this step. Governments usually prefer taxes to be paid in the same currency as their obligations, and also usually prefer to issue liabilities in the same currency that they can control them if need be. This further reduces the likelihood of crypto currencies being used for major transactions in an economy.
- Failing as a store of value – why crypto-currencies will never be used as a store of value
The second role that a currency should have is acting as a store of value. People need to have that believe that what their money can buy today will still be able to buy it tomorrow. The central bank plays a vital role in maintaining the currency value by controlling inflation. This is usually done by controlling the demand and the supply for the currency to make sure that the match. If this balance is maintained, the currency keeps its value. However, individual crypto currencies find it extremely difficult to achieve this balance. The supply of crypto currency does not and cannot go down. Therefore, a fall in the demand for an individual crypto currency causes its value to significantly collapse due to the fact that supply outstrips demand.
The store of value of a crypto currency is further worsened by tax risks. Holding a currency commonly has a different tax behavior to holding an asset. Whereas the supply of a single crypto currency cannot be easily changed, the supply of crypto currencies generally can be interminably increased. Crypto currencies encounter few barriers to entry. Any individual who feels and wants to set up a new crypto currency can easily do so. This means that whereas there are limits on how much of a distinct crypto currency can be created; there are no limitations on how many diverse crypto currencies can be generated.
This likelihood that there can be limitless supply of different types of crypto currencies further worsens the risk of further downfalls in value. If a new type of crypto currency gets created which is easier to mine than the already existing one, and allows more trades to occur more quickly, the demand for that crypto currency unsurprisingly increase. The already existing crypto currencies on the other hand experience demand fall; a crypto currency that has been old-fashioned by a new crypto currency with superior technology has less value. The sad thing about this is that the supply of the already existing crypto currencies cannot fall to be at par with the decline in demand. Consequently, the value of the existing crypto currencies significantly declines.
Although most crypto currencies are not used in carrying out major transactions in an economy, they are undoubtedly used in some purchases. It is quite interesting if you come to realize the possible role played by crypto currencies in illegal transactions. Due to advancements in banking regulations and associated transparency, money laundering can easily get identified if done through government-backed or fiat currencies; crypto currencies therefore become a good alternative and easily fill the role. However, there is still a problem with crypto currencies being used to transact criminal or illegal businesses. The “criminal economy” is not entirely closed to function on its own. There will a situation where crypto currencies will need to be transferred from money to assets; this will definitely require an interaction between crypto currencies and government-backed currencies thereby landing into the same hands of law enforcers that they were avoiding in the first place.
The main role of any financial system is to enable the exchange of goods and services, possibly through time. The financial system contains a sundry range of institutions and currencies for aiding such transactions. To provide context for this discussion of crypto currencies, we briefly discuss three payment mechanisms:
- Legal tender
CRYPTO CURRENCIES SCALABILITY PROBLEM
The growing attractiveness of block chain-based crypto currencies has made the issue of scalability a major and one that requires urgent concern.in this section I will critically analyze how essential and inferred tailbacks in Bitcoin limit the capability of its current peer-to-peer intersection network to support considerably higher outputs and lower latencies. The Increasing acceptance of crypto currencies worldwide has raised major concerns regarding their ability to scale. Essential protocol redesigns are needed for block chains to scale considerably while still retaining their decentralization. To comprehensively discuss the issue of scalability, I employed the following keywords to further my explanation: maximum throughput, latency, bootstrap time, and cost per confirmed transaction (CPCT).
The maximum throughput refers to the full rate at which the block chain can confirm transactions. Today, Bitcoin’s maximum throughput is three to seven transactions per second. This number is limited by the maximum block size and the time between blocks.
Latency refers to time taken for a transaction to confirm. A transaction is considered confirmed when it is reflects in a block, roughly ten minutes in expectation.
This is the time it takes for a new node to download and complete the process; the history is a very important in validation of the current system state. Currently, the bootstrap time for Bitcoin is in line with the size of the block chain history, and is approximately four days.
Cost per Confirmed Transaction (CPCT)
CPTC refers to the cost in USD of resources spent by the entire Bitcoin system in confirmation of a single transaction. CPCT incorporates several separate resources, all of which can be further disintegrated into operational costs (such as electricity) and capital equipment costs.
As the adoption of crypto currencies increase, more users enter into business with the currency. The network is consequently forced to process additional transactions each second. Awkwardly, the protocol itself has an in-built limit regarding the number of transactions (blocks are currently restricted to 1MB) and a characteristic transaction takes up around 0.5 of a KB (Luther, 2015) These restrictions mentioned above together with an inter-arrival time of ten minutes indicate a rate of about three to four transactions every second. If more transactions are to be processed, two things must take place: one the size of blocks must increase; secondly, the rate of block creation must increase. The two mentioned situations mean that there will decreased security protocol.
Most current crypto currencies suffer from several limitations; one of them being the issue of scalability; for example, Bitcoin network has the ability to handle only seven transactions per second. The major challenge is now the inability to raise this rate higher than it is already is. This is way much low compared to a network like PayPal which has the ability to handle over 100, and Visa which handles around 7,000 transactions (Luther, 2015) This lack of scalability is mainly due to the fact that they rely too much on broadcast.Another type of scalability problem associated with crypto currencies is fact that more and more block chain based applications keep coming up, and each one of them comes with their own small remote block chain thereby increasing the vulnerability to attacks.
NO GLOBAL CONSENSUS ON REGULATION
Internet has brought about tremendous changes in the world especially the manner in which people do businesses and interact through the introduction of new technologies. The introduction of crypto currency has eased how international transactions are conducted. However, it has also led to the imposing of numerous regulations. Although numerous countries have come up with measures on how to regulate these systems, they have however, failed to provide precise answers on the manner of treating the instruments. There exist no norm on the utilization of Crypto currencies on the global scale; therefore, individuals ought to air their thoughts and opinions on the matter. Among the countries whose crypto currency regulations are favorable include the United States, Canada, Japan, as well as numerous countries across Europe (R.E. & I.V., 2018)
Within the Western Countries, permissive regulation has benefitted Bitcoin. However, the Asian countries have greatly restricted this type of payment. In China for instance, Bitcoin banning has resulted into depression of the prices of Bitcoin globally. Global acceptance of Bitcoins would therefore, help in driving crypto currencies’ value. Equally, numerous studies call for the need to regulate as well as secure these systems because this will allow for adoption by numerous financial institutions. International deregulation is likely to impact these currencies at various levels. The last three years has seen rapid evolution of crypto currency, making it attract a debate globally (R.E. & I.V., 2018)
The federal government of the US has not used its constitutional power to ensure the regulation of block chain, making many states to ensure the introduction of their regulations and rules. New York for example, passed legislation in 2015, making recognition of block chain as a means of record keeping. By 2017, approximately eight states across the US had come up with bills that promoted or accepted the utilization and block chain technology or Bitcoin. Some of these states including Arizona, Chicago, and Vermont have already enacted these laws (Khvan, 2016).
Behind the scene, the central banks of G7 are sluggishing traders who tend to buy and sell marketable securities, same foreign currencies, SDR (special drawing rights), as well as gold. These institutions follow the policy of investment enforced by the committee of investment with specific targets of asset allocation.
The US has put in place measures to regulate crypto currencies by freezing assets belonging to Arise Coin. The move is the first in the US history for the government to seizure properties belonging to initial coin offerings (ICOs) which is said to be fraudulent. The country is yet to make decisions about whether certain currencies can be termed as securities (Khvan, 2016). The market of crypto currency is in a constant fluctuation, and numerous regulators globally are devising means of controlling it. Crypto currencies are opposed to the traditional systems of finance since a central authority does not regulate exchanges or govern transactions. Such a move makes the currency has little protection in case of attack of digital system such as cyber-attack. Since 2015, approximately $400 million have been stolen from the investors through cyber theft (R.E. & I.V., 2018) SEC (US Security and Exchange Commission) has strengthened measures towards protecting consumers from such scams. The commission has for instance failed to approve crypto currencies related products or trading (Khvan, 2016).
Moreover, it has also failed to register any ICOs to date. SEC aims at offering protection to the investors, maintenance of efficient markets, as well as facilitating capital formation. The crash of the stock market in 1929 led to the creation of SEC by congress upon the realization that numerous companies had falsified about future prospects and their performance to investors. Since that time, SEC main role has been the authentication of statements from corporations. Subsequently, they ensure that security stitutions such as dealers, exchanges, and dealers are subjecting investors to fair and honest treatments.
CFTC (Commodities Futures Trading Commission), another US body works towards fostering open, competitive, transparent, and economically sound markets. The commission works towards avoiding risks of the system thus protecting market users, consumers and the general public from manipulation, fraud, as well as abusive practices linked to derivatives. On 19th January this year, a case involving two cases of fraud involving crypto currency was filed by CFTC. IRS (Internal Revenue Service) fails to see crypto currencies as property for the purpose of tax (Khvan, 2016).
The UK and the EU regulation
Both the EU and the UK have developed measures to shut down this trading because it is perceived it to be linked to fraud. The approach aims at discouraging the development of these currencies in various ways. The UK was the first country in Europe to show interest in offering support to decentralized technologies. The measures imposed by the country include the regulation aimed at preventing money laundering. The regulation of this currency in Belgium is through the utilization of law similar to that applied in digital money. Germany on the other hand is at the verge of recognizing tokens as a form of private money. Subsequently, there has been the adoption of crypto currencies as traditional currencies.
Apart from Argentina, numerous countries across South America fail to favor crypto currencies. The Central Bank of Bolivia forbade bitcoins circulation in 2014 (Lánský, 2016). The situation is similar in Ecuador whereby the government banned other types of crypto currency, having issued its own block chain. The government of Mexico has not imposed a ban on digital currencies. However, the country is conversing with regulators to make efforts of introducing its own bitcoin as well as block chain. Brazil is yet to make response to this system of payment and this is attributed by low reception within the region.
Asia is characterized by numerous cultures, economic growth, and political regimes. Over the past few years, numerous governments around the world have expressed concern over Initial Coin Offerings (ICOs). The United States Securities and Exchange Commission, for example, released an investor bulletin on July 25, 2017 to warn consumers about the potential risks of ICOs. The United Kingdom Financial Conduct Authority, the Monetary Authority of Singapore and Hong Kong Securities and Futures Commission were also not left behind; they also published similar consumer advisory reports. However, China seems to have taken it a notch higher by adopting the strongest regulatory measures concerning to ICOs (Chohan, 2017). They issued a complete ban and criminalized the situation. ICOs are therefore regarded as illegal fundraising activities without official authorizations. ICO issuers, promoters and sponsors might be prosecuted for criminal offenses, including illegal issuance of crypto currency and securities. The Crypto currency regulations also require ICO platforms and other relevant bodies to halt ICO activities in China with immediate effect, and also return assets held in investors’ accounts to investors.
An announcement was made by the Ministry of Justice to ensure the closure of exchanges involving crypto currency. The move is meant to target the currently that were against the country’s law. Moreover, the country has also banned crypto currency related virtual accounts. The country has, however, permitted new trades to utilize legal bank accounts. In short, FSC (financial service commission), Korea Financial Intelligence Unit (KOFIU), and FSS (Financial Supervisory Service) are proper gating for this form of currency to be under traditional structure of finance (Chohan, 2017).
Both China and South Korea have termed this form of currency as “disruption to the financial order”. On third December 2013, out of a deep concerns concerning money laundering and a threat to China’s financial steadiness, the People’s Bank of China and four other government offices cooperatively issued the Notice to Stop or minimize the Risk of Bitcoin. During these closed-door meetings between the People’s Bank of China and crypto currency trading platforms at the start of 2017, the bank mandated these platforms to enforce anti-money laundering measures and also enforce foreign exchange regulations. However, these closed-door meetings did not have a significant influence on the price of crypto currencies (Chohan, 2017). The Chinese government has imposed sanction on bitcoin transfers leading to its fall by 20%. Most Bitcoin traders in the country are planning to bid farewell to China following the move by the government to interfere with their trade. The prices of these currencies have greatly dropped from approximately $5,000 to about $4,175. After closing the crypto currency exchange following the concern that it is associated with fraud, China is considering stopping any activity related to Bitcoin.
The Crypto currency Rules not only banned ICOs in China, but also enacted restrictions on crypto currency trading boards. Pursuant to the Crypto currency regulations, crypto currency trading platforms shall not:
- Help clients convert legal tender into crypto currency, or vice versa
- Purchase or sell crypto currency or virtual currency
- Set a price for crypto currency or virtual currency, or provide other related agent and commission services.
Furthermore, the government of China shut down the websites, and delisted mobile applications from app stores, relating to online crypto currency trading platforms; also they requested that SAIC to suspend the business licenses of these online trading platforms.
Through the enactment of Virtual Currency Act, the Japanese Financial Service Agency authorized the utilization of digital currency as a means of payment. The law identifies Bitcoin as an asset as well as a method of payment. However, the law was not clear on its legality as currency (Lánský, 2016). As a way of protecting the consumers and enhancing transparency, the regulators have approved 17 currencies and 11 operators for trading.
As a way of fighting tax evasion, strict regulation of crypto currencies has been introduced by the French government. According to it, crypto currencies are associated with financial manipulation and this call for the need to ensure strict measures. Some individuals have been using it as a way of evading tax and numerous governments across the globe are taking precautions against it following the 2017’s rise of price of Bitcoin. Many governments across Europe have followed suit in cracking down any fraudulent activities associated with crypto currencies. Although it is not likely to ban the currency, the government has taken a lead in urging people to avoid the utilization of this form of payment system. Both Germany and France have initiated a mutual oppression on the crypto currency markets (Lánský, 2016). Crypto currency is said to interfere with decentralized and local regime and this is a great threat to the sovereignty of any country. On its part, the European Union had at one point perceived this system as a security threat associated with laundering of money as well as terrorists.
Although the commission is fully aware of the technological development, one of its roles is to offer protection to the investors, ensure the integrity of the market, and financial stability. According to the commission, block chain technology is significant to the financial market. To maintain its competitiveness, the commission urges its member states to accept this innovation. The current speculation about crypto currencies has exposed the investors and consumers to various risks such as the loss of their investment. The commission therefore, calls for the need to have a clear and frequent risk assessment on these currencies across the various jurisdictions. Although this is an opportunity, it comes along with a lot of risk including failure to have transparency especially the identity of the user. It is important to identify the areas of crypto currencies that are regulated at the moment. The commission also indicates that this system is associated with money laundering and the provision of finances to illicit activities. Finally, the commission aims at monitoring the market to ensure that the money laundering activities are not occurring.
This paper explored the many reasons, challenges in scaling, regulations and the volatility of crypto currencies in general. Supported by several critically analyzed measurement studies, I showed that crypto currencies are not able to match and replace fiat currencies in the near future. Bitcoin is only in the first steps toward substantial throughput and latency improvements while retaining significant system decentralization (Lánský, 2016). For example, more aggressive scaling will require important protocol redesign. Although numerous countries have come up with measures on how to regulate these systems, they have however, failed to provide precise answers on the manner of treating the whole crypto currency idea in totality. There exist no norm on the utilization of Crypto currencies on the global scale; therefore, individuals ought to air their thoughts and opinions on the matter.
With the arrival of block chain and crypto currencies being as fresh and world-shattering as it is, predicting the five-year projected value of major crypto currencies such as Bitcoin requires consideration of numerous factors. Through a combination of qualitative analysis and literature review conducted through comprehensive scrutiny with industry professional articles, it is evident that Bitcoin and crypto currencies in general can influence their existing user base and most likely experience more growth in the five-years (Lánský, 2016)..
The adoption process of crypto currencies is not progressing as fast as it was thought to be. Payment behaviors change very slowly, just look at the quantity of transactions that is still done with cash (only fifty-percent). The adoption of crypto currencies is predisposed to many different factors, meaning that there is a lot of uncertainty about the future for crypto currencies. There is a complex interdependency among the above identified factors (Lánský, 2016). Certain barriers have to be overcome in order for crypto currencies to be adopted on a large scale and even if these barriers are removed this is no guarantee for success.
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