December 3, 2019/5:30pm/Meristem / Header Image Credit: Arts & Collections
Cryptocurrency has generated a lot of buzz in recent times, but what exactly are they? What is their value proposition as a medium of exchange? What risk does their adoption pose to the current financial system and can they, someday, replace traditional fiat money? It goes without saying that when people hold money, they expect that it would store value for them, act as a medium of exchange and a stable unit of account. Money, in serving its purpose has evolved from the exchange of one commodity for another in the primitive age to the fiat system of today. The movement from the barter system to fiat was fostered by the rapid expansion in commerce, which demanded a more robust financial system where trusted entities (banks) are needed to create trust in the system by intermediating transactions between people.
Trade expansion also brought about the need to create trust between banks and maintain a central ledger that settles transactions between them, a function performed by the apex bank. It is important to note that beyond this, the apex bank also acts as bankers to the government and acts on its behalf. The essence of this is clear; since fiat does not have intrinsic value, there is the need to have it backed by the full faith of the government and the apex bank represents the government in the regard. Hence, the money system is based on trust; the people trust the banks, and the banks trust the apex bank. Cryptocurrency is a form of digital money designed in an encrypted manner to make transactions secure, by relying on blockchain technology which ensures that the process is decentralized, immutable and transparent.
Cryptocurrency, for example, Bitcoin, emanated from the opportunity to automate the "trust process" through distributed ledger technology as against trusting in banks. The technology ensures consensus on transactions between entities while maintaining the database of transactions across all participants. Without a doubt, cryptocurrency offers some benefits to the payment system. Its application into payment has the potential to drive down the cost of transferring assets through tokenization, make transfer seamless while efficiently managing the database of transactions. This is very applicable to cross-border payments and could reduce the time it takes to settle international transactions from days to just a few hours. This could accelerate the international trade and commerce process which has become more sophisticated today.
Despite the possibilities, the question remains; will cryptocurrency gain popular adoption? Will there be an increased willingness to adopt it as a medium of exchange? Will regulations support its widespread adoption? For people to be willing to accept cryptocurrency, in the very least, it needs to match the efficiency of the present alternatives. In this regard, scalability, the ability to efficiently process a high volume of transactions, is a major area where crypto lags. For example, Ethereum, the fastest cryptocurrency can only process 15 transactions per second, compared with VISA which can process about 24,000 transactions per second.
This technical weakness is a deterrent to mainstream adoption because, in the payment industry, payment processing power is important. The inability to function effectively at scale will limit the popular adoption of crypto. Lastly, regulatory challenges might be the biggest hurdle for crypto. Currently, there is no applicable regulatory framework for cryptocurrency, and they are not accounted for in the supply of money as they are beyond the purview of the central banks. Hence, the mainstream adoption of crypto could weaken the effectiveness of monetary policies.
Regardless, we expect the underlying blockchain technology to be a game-changer in diverse industries, bringing about decentralization, transparency, and accountability which are important in building robust systems.