Cryptocurrency Popularity Raises Interesting Opportunities, Dangers and Further Questions

Commentary, Economy, Ian Madsen

Of late, the dollar value of cryptocurrencies such as Bitcoin and Ethereum and others, have hit new record highs, in the thousands of dollars per unit. The price escalation has attracted more speculators, which have further boosted the price over the past several months. Much of this is ‘FOMO’ (Fear of Missing Out). While these currently rising prices certainly increase the allure of these products, it does nothing to reduce their risks, which are considerable; but it does raise some interesting opportunities.

It is impossible to calculate any realistic value of Bitcoin and its sister ‘currencies’, just as it is hard to value any other speculative or high-growth asset, such as a much-hyped technology stock. The touted benefits of Bitcoin are the same as they were when it was trading in the hundreds of dollars.  

Those benefits are several: a form of money that is impossible for any government to debase via inflation; a way to pay for things anonymously; counterfeiting is impossible; avoidance of intermediaries (such as money transfer companies) in transactions; another asset class that with its own merits, without being managed or rated by investment firms; a secure store of value that cannot be stolen while indirect possession; the potential to supplant some or all other currencies in pricing other things.

It is this last promoted benefit that could be elusive or even delusional. Although some companies, notably Tesla, recently, have priced their products in Bitcoin or other digital currencies, it remains very difficult for companies or their customers to base sales or purchases on a price that can fluctuate wildly.  

Someone would be bound to feel cheated and the seller of the merchandise or service could face major losses if the digital money fell in value while the firm’s expenses in ordinary money remained the same or even went up in cost. It is this problem, along with the slowness of transactions using digital money, that makes it unlikely for these cryptocurrencies, in the short term at least, to supplant traditional specie.

There are ways around this. The company offering goods or services for cryptocurrency could price its wares very dynamically; changing them instantly as the quoted digital money price changes. This could frustrate the customer however and time lags could present the risk of changes for one party or the other, creating great uncertainty and loss of confidence in the whole process.

Another way to make things more certain or at least, not entirely wildly unknown is to use options or futures to hedge the price of the digital coinage. While this introduces another significant cost, it increases trust for both the buyer and seller that the agreed-upon price will be firm and gives certainty of profit to the seller. These derivatives, as they are called, already exist, with just speculative appeal thus far. However, they could be key to making Bitcoin and its sister currencies viable in transactions. 

As the problem of slow transaction and currency ‘mining’ will remain, this means that the likely use will be in large commercial transactions, such as international trade. Oil, LNG (liquefied natural gas), grain and metals could be priced in cryptocurrency to lower foreign exchange costs, in some instances. 

Given the uncertainties of the potential of using digital currencies to price ordinary consumer goods and services, since the slowness of transaction confirmation versus conventional money will not be resolved soon, there would seem to be limited potential for cryptocurrencies to escalate further. So far, central banks’ imitations of cryptocurrencies are unattractive, as they are suspected of being just glorified ordinary money and many do not offer anonymity. There is likely little desire for the People’s Bank of China’s new digital yuan. 

However, leaving aside the aforementioned speculative frenzy, which can feed upon itself longer than anyone can realistically imagine, there is a legitimate role for digital money. Strangely, it is an actual risk-reduction tool in investors’ wealth portfolios. Bitcoin and other cryptocurrencies’ returns have a very low correlation to the returns of stocks, bonds, real estate or other asset classes. Adding them to a portfolio greatly reduces its overall volatility, the most common measure of risk in financial markets.

So, the other touted benefits of ‘crypto’ notwithstanding, its strongest selling point is that it is just so different and contrary inherently that it is very attractive for improving safety, the very opposite of how its erratic and wild performance in recent months has appeared. Wild indeed.

 

Ian Madsen is a senior policy analyst with the Frontier Centre for Public Policy.

Photo by Art Rachen on Unsplash.