Indroduction of Cryptocurrencies
Cryptocurrencies were originally conceived as a replacement for the fiat currencies issued by central banks. However, actually existing cryptocurrencies do not fit most accepted definitions of currency or money.
Too few things can be bought with them for them to be useful as a unit of exchange – at least in the formal economy. At the same time, they are too volatile to function as a store of value. As such cryptocurrencies are more accurately categorised as financial assets or securities, and are hence sometimes described by the label “crypto assets”.
The first and best-known cryptocurrency is Bitcoin (BTC). At the time of writing 1 Bitcoin is worth ~$16646.30 and there are ~19,203,231 coins in circulation, implying a market capitalisation of ~356.52B. The total supply of Bitcoin cannot exceed 21m coins – a deflationary feature built in by its pseudonymous creator, Satoshi Nakamoto.
Bitcoin can be obtained by exchanging fiat currency at cryptocurrency exchanges like Coinbase and Binance and trading apps like eToro, or by mining it. Bitcoin mining involves solving computational puzzles. As the complexity of the puzzles increases, more and more computing power is required. Based on today’s prices, the value of Bitcoins still to be mined exceeds $88bn, creating strong economic incentives for mining. Bitcoin mining has become highly professionalised: miners use specialised rigs and routinely migrate to locations where electricity is cheapest, implicating Bitcoin in energy crises in places like Kazakhstan.
Why do people buy Bitcoin?
As it operates outside the financial system and offers a degree of anonymity, Bitcoin is useful for illegal transactions (for example, purchasing drugs), and for laundering the proceeds of crime. It can also be useful for circumventing foreign exchange controls, and for hedging against hyperinflation and currency devaluations in emerging market economies.
But for UK investors, the main non-criminal rationale for purchasing Bitcoin is to speculate on short-term movements in its price, or to buy-and-hold in the expectation of long-term appreciation (known in crypto parlance as hodling). While an estimated 114m people globally own Bitcoin, the majority of holdings by value belong to hedge funds and other professional investors.
The next largest cryptocurrency after Bitcoin is Ethereum ($377bn market cap). Importantly, Ethereum’s platform can be used to create new cryptocurrencies (see Blockchain Primer), which has led to a proliferation of altcoins, including Dogecoin ($20bn market cap). The use-cases for altcoins are identical to Bitcoin.
Stable coins are a subcategory of cryptocurrencies which are pegged to fiat currencies (typically the US Dollar), and exist to offer investors a haven from market volatility and facilitate the exchange of cryptocurrencies back into fiat currency. The best-known stable coin is Tether ($78bn market cap), which has drawn regulatory attention due to its low dollar reserves (see Policy Implications).