With a track record dating back a decade, cryptocurrencies are clearly more than just a fad, but they are still widely misunderstood by many people, with still doubts about their genuine value, practical use and long-term use.
There is also considerable concern about their volatile nature and potential for exploitation. According to data from Scamwatch, Australians lost $ 158 million on investment fraud between January and May this year, most of which was related to ‘investments’ in cryptocurrency.
In the truest sense, cryptocurrencies are a digital exchange that uses cryptography as a form of security. But in recent times, the term “cryptocurrency” has evolved as a stand-in description for, more generally, a decentralized financial system (DeFi), a highly volatile asset class that can plunge or rise behind a Tweet, a room for bad players to steal the identities and money of vulnerable investors, and a form of digital payment.
Ordinary investors, as well as Australia’s financial institutions, are also more than temporarily interested in cryptocurrencies.
Commonwealth Bank tries crypto trading through its banking app, ANZ has recently minted $ 30 million of Australian stack coins called A $ DC, and National Australia Bank (NAB) is also expected to issue its own stack coin (linked to fiat currency, the Australian dollar) within the end of 2022. However, concerns about the security of cryptocurrencies as an investment class remain central to the minds of financial regulators around the world.
How are cryptocurrencies regulated?
The simple answer is that they are not, outside the framework of blockchain technology, as we will come to later.
Even more fundamentally, the current legal status of cryptocurrencies varies considerably from one country to another. While the use of cryptocurrencies is unhindered within the EU, specific countries, such as Turkey, have banned payments in cryptocurrencies.
In Australia, cryptocurrency is legal, but largely unregulated. Many cryptocurrencies and other digital assets are not generally considered to be financial products, so the platforms where you buy and sell cryptocurrencies may not be regulated by the Australian Securities and Investment Commission (ASIC).
The Australian Prudential Regulation Authority (APRA), which regulates the financial industry, has plans for a policy roadmap for financial entities engaged in crypto-activity. A draft standard is expected by the end of 2022. However, APRA has been keen to point out that it will not stifle innovation, with chairman Wayne Byres saying in a speech reported by The Australian Financial Review: “Just like our approach to climate risk, its underlying message is first and foremost one of “by all means innovate, but proceed with caution and with full knowledge of the risks.”
Australia’s Board of Taxation is also developing a policy framework for the taxation of transactions and assets involving cryptocurrencies.
The consumer group, CHOICE, meanwhile, continues to rally for better protection for consumers, some of whom have lost huge sums in crypto fraud or due to market volatility.
“As it stands, enforceable protection in the unregulated cryptocurrency market is somewhere between insignificant and non-existent,” says CHOICE.
“In a submission to the federal government, CHOICE is asking for a regulatory regime to help end consumer harm.”
How do cryptocurrencies work?
Most cryptocurrencies operate without the support of a government, such as a central bank or government. This fundamentally distinguishes them from traditional currencies, such as the US or Australian dollars.
Instead of government guarantees, the way cryptocurrencies work is underpinned by something called blockchain technology (see below).
Instead of existing as a physical stack of banknotes or coins, cryptocurrencies are limited to the internet. Think of them as virtual tokens, whose value is determined by market forces generated by people who want to buy or sell them.
Today, there are an estimated five thousand cryptocurrencies. Bitcoin is by far the largest, followed by the likes of Ethereum and Tether. The market value of a cryptocurrency corresponds to the unit price of a currency, multiplied by the number of units that exist. Even after the crypto-meltdown in May 2022, the market was still valued at around $ 910 billion.
Cryptocurrencies can be purchased with traditional cash such as Australian dollars and can then be used to buy a growing range of daily goods and services. Cryptocurrencies have the same value in each country, making person-to-person transfers around the world easier, while eliminating the issue of exchange rates.
In fact, only a limited number of Bitcoins exist – cryptocurrencies are compared to a digital form of an asset such as gold, where a perceived stockpile is then subject to the laws of supply and demand.
At the moment, this is the main idea of cryptocurrencies: that they can be traded on exchanges that are similar to the way stock market investors buy and sell stocks and other commodities.
What is blockchain technology?
Essentially, a blockchain is a type of database. Blockchain first emerged as the technology that underpinned Bitcoin when cryptocurrency was originally mentioned in an article on peer-to-peer electronic cash systems in 2008.
The newspaper was credited to Satoshi Nakamoto, believed to have been a pseudonym for either an individual or a group of people. Part of the design of the cryptocurrency meant that only 21 million Bitcoins would ever be created.
The blockchain is essentially a public ledger for every Bitcoin transaction that takes place. An entry is distributed on a number of computers and cannot be tampered with or changed afterwards. According to supporters of cryptocurrencies, blockchain transactions are more secure than traditional payment mechanisms.
New currency units such as Bitcoin are produced on the blockchain through “mining”, which requires enormous amounts of computing power and thus consumes significant amounts of energy. Environmentalists have warned that the proliferation of cryptocurrencies could have a significant impact on global efforts to reduce energy consumption.
How do you buy cryptocurrencies?
The most common places to buy Bitcoin and other cryptocurrencies are specialist exchanges. This includes a number of trading platforms and apps that allow investors to buy cryptocurrencies using either traditional currencies and / or other cryptocurrencies.
To open an account, potential merchants are usually asked to provide passport details, a phone number and an email address. The cost of trading can vary from one exchange to another. Some providers charge a fixed fee per trade, while others will charge a percentage of the total transaction amount.
How have cryptocurrencies performed?
The performance of cryptocurrencies can be notoriously volatile with roller coaster peaks and troughs. In 2013, an individual Bitcoin was worth only a few dollars. At the time of writing (July 2022), the price was just above the $ 20,000 limit – a huge increase from nine years ago, but some distance from the all-time high of almost $ 68,000 it achieved towards the end of 2021.
What is cryptocurrency mining?
Cryptocurrency recovery refers to the process of generating crypto and verifying new coins. It is a hugely complex business, one that involves loads of decentralized and global computer networks, and as many environmentalists point out, is carbon intensive.
In the United States alone, Bitcoin mining is estimated to generate around £ 40 billion in carbon emissions.
Australian appetite for cryptocurrencies
Despite the risk and lack of regulation, Australian investors have embraced cryptocurrency in recent years. A report from the US crypto exchange Gemini found that almost one in five (18%) of Australians bought digital currencies in 2021.
According to Gemini’s Global state of crypto The report first invested 43% of Australians in crypto in 2021, and many cite inflation as a key cause. Furthermore, around 54% of Australians saw cryptocurrency as a good way to diversify their assets, with 81% choosing to keep their crypto investments for the long term.
Data from the trading platform eToro reveals that more than a quarter of Australian investors aged 18-34 have at least 10% of their portfolios invested in cryptocurrencies, making the asset class particularly popular with Millennials.
What happens afterwards?
Even before the pandemic upheavals of 2020, and the fall in cryptocurrencies that began in November 2021, many experts have questioned their security, practical use and long-term viability. Hence the strong and repeated warnings from financial regulators and consumer groups that people should approach investing in this area with extreme caution.
If more ordinary investment houses dive their toes into the water of cryptocurrency, we can see digital assets improve in value, with normalized use and more widespread. How the sector will react to the aforementioned financial regulations in Australia is also yet to be seen.
In the uncertain times we live in, it is also possible that the whole crypto concept may prove to be vulnerable or unsustainable in the face of as yet unforeseen challenges.
To paraphrase the regulators: “buyer beware”.
This article is not an endorsement of any particular cryptocurrency, broker or stock exchange, nor does it constitute a recommendation of cryptocurrency as an investment class.
