The emergence of new technologies in the financial world has transformed the way societies manage currency as a medium of exchange between various entities. One of the most remarkable technologies thus far relates to digital currencies. Today, digital currencies have attracted considerable attention in the society, with many embracing distributed ledger innovations while abandoning centralized fiat systems. Popularly known as cryptocurrencies, digital currencies are difficult to counterfeit because of their stringent security features. Their defining features are the most appealing attractions as they render them immune to government control and interference. Even so, cryptocurrencies have various disadvantages. This paper explores their aspects, including denotation, opportunities, challenges, and risks, as well as advantages and disadvantages. Additionally, the paper covers the relevance of cryptocurrencies in the business world. Cryptocurrencies are a promising replacement for fiat currencies, but their future remains unclear, yet they are essential in a tech-savvy globalized world where fiat currencies face the risk of insignificance.
What are Cryptocurrencies?
Cryptocurrencies are digital coins or assets that function as a medium of exchange (Bailis, Narayanan, Miller, & Han, 2017). A typical cryptocurrency is created and controlled via cryptography technology, a process where ordinary information or plaintext is converted into unintelligible text or cipher-text through high computing power. The practice of cryptography involves complicated mathematical problems that necessitate the use of a high processing power in an activity called mining. In essence, mining is defined as a process in which crypto-miners compete to solve complex mathematical problems using powerful computing equipment (Ramachandran, Saketh, & Vaibhav, 2015). These mathematical problems usually result in the verification and addition of cryptocurrencies in a blockchain digital ledger, which functions as a public financial database (Bailis et al., 2017). Cryptography ensures secure transactions, consistent units, and certified transfer of funds. The first cryptocurrency was created in 2009. Since then, over 4000 alternative cryptocurrencies have been established. According to Lansky (2018), a standard cryptocurrency has six distinct characteristics: (1) it does not require a central governing authority, (2) the system maintains a record of units and their ownership, (3) the system determines the number of units that can be created, how they should be created, and their ownership policies, (4) ownership can only be proven through cryptographic means, (5) only an entity that proves the current ownership of a unit can issue a transaction statement of that specific unit, and (6) the systems performs at most one instruction when two different instructions are issued to change the ownership of the same units. Generally, cryptocurrencies are a subset of digital currencies and a subcategory of alternative currencies.
The decentralization of cryptocurrencies allows entities within a system to create coins based on a predetermined rate and set of rules which are normally publicized. This is the opposite of a centralized system where governments, central banks, and corporate boards oversee the distribution of money and management of ledgers. Decentralized systems do not allow central authorities to produce new units or provide backing for assets that are measured within the system (Li & Wang, 2017). The underlying foundational system that allows the functioning of decentralized cryptocurrencies was created by Satoshi Nakamoto (Pseudonymous) in 2008 at about the same time when the world’s most popular decentralized cryptocurrency, Bitcoin, was established.
The system through which Bitcoin operates is the foundation on which other cryptocurrencies operate. Bitcoins are seasonally chains of transactions from an owner to another owner, where each owner is recognized through a public key or an address that serves as a pseudonym. For a transaction to occur, the current owner must sign using a secret signing key that corresponds to the hash of the last transaction they performed when obtaining the bitcoins. The transaction is then added in a group of instructions that form the bitcoin. Since each transaction is linked to the previous transaction, many transactions form a chain. The validity of a bitcoin can be evaluated by checking the authenticity of each signature in a chain. A user must identify all transactions in order to avoid double spending. Double spending occurs when the user attempts to transfer a coin that has they have already transferred. Normally, bitcoin transactions are grouped in blocks to enable the recognition of which transaction as well as to provide s timestamp for the transactions contained and their authenticity. Each block is then added to the chain, a process that eventually yields a publicly available blockchain (Narayanan, Bonneau, Felten, EMiller, & Goldfeder, 2016). This system is the foundation on which bitcoin and its altcoin (alternative cryptocurrencies) cousins operate.
Besides the decentralization feature, cryptocurrencies differ from fiat currencies in a number of ways. The latter represents a legal tender that is backed by a central authority and can take physical form (e.g., Federal Reserve notes) or electronic form (e.g., bank credit). In contrast, cryptocurrencies are not legal tenders, and their form mimics bank credit without the bank. While cryptocurrency transactions are immutable, fiat currency transactions are duplicable. Cryptocurrencies are also recorded in a publicly available ledger, providing a high level of transparency as opposed to fiat currencies which are essentially anonymous. In fact, cryptocurrency transactions are performed over the internet, meaning that the address of each owner is publicly known.
Relevance of Cryptocurrencies in the Business World
Many cryptocurrencies are still in their early stages of development. This makes their future unclear to many investors and businesses. Among those with mixed feelings about cryptocurrencies as a medium of exchange are economists, scholars, and authors. On the other hand, those who share a libertarian perspective are optimistic about their potential and have begun investing in them. Optimists are encouraged by the ability of cryptocurrencies to facilitate faster transfer of funds between individuals securely. Additionally, the rate of fees charged in cryptocurrency transactions are much lower than those charged in conventional banking systems. Many countries are working toward accepting cryptocurrencies as a valid medium of exchange, especially countries that have an inclination for paperless money. Proponents of bitcoin and other cryptocurrencies argue that the market capitalization of crypto coins has become very intense, leading to a powerful market which would lead to dire consequences if banned. Then again, opponents of cryptocurrencies maintain that crypto coins are volatile and are susceptible to abuse by money launderers and persons who conduct illegal activities. Tymoigne (2015) claims that cryptocurrencies are not viable for various reasons. First, he maintains that crypto coins such as Bitcoin have demonstrated their high instability. He also notes that crypto coins are liquid and lack a central issuer, over and above, their creation lacks an economic foundation, rendering their discounted cash value as zero.
As mentioned earlier, some businesses are considering cryptocurrency as a method of transacting with suppliers and customers. In fact, select companies already accept certain crypto coins. One advantage of using cryptocurrencies in business transactions is that they apply the same algorithms as those used on online banking. The only difference lies in the absolute transparency in cryptocurrency networks where all transaction data is disclosed for the public to see. Although these networks do not publicize identifying information of the sender and recipient, all statistics and pathways of coins are clearly shared on the basis of when and how the transactions occurred. This implies that a user’s private data is secure and safe from identity thieves. Another plus is that cryptocurrencies are not susceptible to inflation since there is a set maximum number of units that the whole system is bound to produce. There is no governing body that can disrupt this order, hence there is no possibility of encountering inflation forever. What is more, peer-to-peer cryptocurrency networks are not controlled by a master server and exchange of funds is conducted between two or more clients, which provides autonomy and freedom from spying.
Users of cryptocurrencies normally use specific software in order to mine and share coins and, each client is required to keep a record of the transactions they have committed together with the total funds they own in their wallets. When carrying out transactions, instructions are sent to hundreds of servers among which no entity controls. As opposed to the case of fiat currencies, cryptocurrency networks do not restrict the number of transactions that a user can perform. Moreover, there are no boundaries and payments cannot be canceled. Crypto coins cannot be duplicated, counterfeited, or spent twice. These capabilities render the integrity of cryptocurrencies intact. A significant reason why many businesses are accepting cryptocurrencies is their low operating costs. They work like physical cash and necessitate no payment in fees and commissions as bank currencies. Their main input is mathematics which essentially needs no financial input. Commissions in cryptocurrency systems are significantly low and mostly amount to 0.1% of the entire transaction.
The absence of a central authority in the network means that each computer is a member of the system and no power can dictate rules whatsoever. When a user goes online, the system remains stable. Furthermore, cryptocurrencies are easier to use than fiat currencies since their practicality does not necessitate the user to open a bank account. Instead, a user requires approximately five minutes to open a wallet. Perhaps, one of the most pulling advantages of cryptocurrencies is their transparency, speed, and security. Cryptocurrency networks utilize a sequential block-chain record of past transactions that have occurred. Hence, if a user has publicly used bitcoins, everyone can access the number of coins owned. Nevertheless, if the address is not confirmed publicly, then a user can retain an anonymous identity. The level of anonymity can be further raised by using a unique address for every new transaction. Finally, there is no likelihood of identity theft since no personal data is used.
On the contrary, cryptocurrencies can be puzzling, particularly to new users who do not understand their inner workings. Cryptocurrencies are not yet popular. In fact, they have a very low rate of acceptance around the world. People who invest in cryptocurrencies without proper knowledge can lose money to a venture they did not learn about. Losses may occur due to lack of knowledge on market dynamics or technologies that control transactions. Investors need to ensure that cryptocurrencies are accepted in a particular region before investing, failure to which they are likely to incur losses. Cryptocurrencies can be very volatile since all “ups” and “downs” of the coin’s value depend on the rules that a specific country or economic region has set. Cryptocurrencies are also susceptible to risks such as terrorism, money laundering, and illegal activities, all of which arise from the lack of a central governing authority (Ivashchenko, 2016). Nevertheless, this is difficult to predict, a lead that motivates researchers and professionals to view cryptocurrencies as a viable medium of exchange for removing intermediaries and barriers and reducing the cost of transactions (Vora, (2015). Still, it is important to note that cryptocurrencies are vulnerable to hacking risks.
Cryptocurrencies have not yet had a significant reception in most countries, which is a major drawback for their proponents. However, this new currency is slowly and steadily gaining ground in both developed and developing countries. Even countries with stringent laws like China and Russia are regulating and legalizing the use of cryptocurrencies in order to allow their citizens to invest and spend them. To date, Switzerland and Singapore are the most tolerant countries for cryptocurrencies. With the current trends, cryptocurrencies are likely to impact future economies and may become a central medium of exchange for future generations.
In conclusion, this paper has explored the aspects of cryptocurrencies, including their denotation, opportunities, challenges, and risks, as well as pros and cons. The author has covered the possible applications of cryptocurrencies in the business world and concluded that cryptocurrencies are a promising replacement for fiat currencies, but their future remains unclear. Yet, they remain essential in a tech-savvy globalized world where fiat currencies face the risk of insignificance. The main advantages of cryptocurrencies include open code for mining, the limited possibility of inflation, peer-to-peer transfer, unlimited possibilities of the transaction, low operation costs, decentralization, ease of use, high speed of transaction, and transparency. Disadvantages comprise strong volatility and large risks. Cryptocurrencies have a potential of replacing conventional currencies because of their numerous benefits. However, they must offer distinctive value in order to overcome a number of challenges such as the lack of regulation. Although this may not happen in the near future, it is likely to happen as soon as the world fully embraces digital technologies.
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