Cryptocurrencies Under a Government Lens

Cryptocurrencies have evolved rapidly over the past few years from an experimental technology to a powerful asset class with a market capitalisation of trillions of dollars. Not only are Bitcoin and other coins traded as investments, but they are also used to pay for a variety of goods and services, from software and games to digital real estate, insurance, and even art and herbal remedies.

Cryptocurrencies have disrupted traditional banking and financial systems, but their unregulated nature has made them unpopular with governments. In response, some countries have allowed citizens to use digital currency, while others have taken a more extreme stance and outright banned them. Many governments, including the US, are looking to introduce their digital currencies to compete with the burgeoning cryptocurrency industry.

Critics of cryptocurrencies have pointed to the FTX collapse and other similar cases as evidence of the potential for criminal activity and market manipulation. Furthermore, these events have served as an impetus for governments to take action to protect investors. In reality, however, human greed and unscrupulous participants in the crypto ecosystem are to blame for these failures, not the technology itself. Criminal activities were present long before cryptocurrencies, and digital assets have done nothing to increase their prevalence nor enable them. In fact, with programmable currencies, crime may be diminished, and if we shift to decentralised networks, the opportunity for criminal activity will be further reduced.

Cryptocurrency users can enjoy unparalleled financial freedom thanks to the revolutionary power of blockchain technology. Cryptocurrencies provide individuals with a secure, decentralised system for exchanging virtual coins. Transactions are validated through public blockchains, which prevents duplication and disintermediates third-party verification from banks. This technology is significantly transforming how safe financial transactions are carried out, which is made possible through an open-source framework. Bitcoin, the first cryptocurrency developed by the mysterious Satoshi Nakamoto in 2009, has reached a trillion-dollar market cap, and Ethereum is beginning to close the gap. We are witnessing a digital currency revolution that will undeniably shape the future of our financial landscape.

Cryptocurrency users can send funds to one another in complete confidence, thanks to the power of blockchain technology. Transactions are securely stored as a sequence of numbers – essentially an electronic record book with no names or physical addresses attached- making it hard for even the most cunning investigator to trace back who sent what and when. Some cryptos go further still; Monero promises extra layers of privacy that make transactions untraceable if ever discovered.

The limited supply of Bitcoin maintains the value of the cryptocurrency, unlike the typical erosion of worldwide fiat currencies as they are printed into existence on command. Bitcoin miners work diligently to secure the network, using an energy-intensive process known as ‘Proof of Work’ involving complex math problems. Every ten minutes, a transaction block is added, and new coins are distributed – mining rewards diminish over time due to bitcoins’ limited supply of 21 million. However, not all cryptocurrencies deploy such constrictions; Ethereum takes cues from “Proof of Stake” for its validation mechanisms.

In cryptocurrency, a few coins have kept their heads above water – prominently known as “stablecoins”. Pegged to traditional currencies such as dollars, they usually claim an exchange rate of $1 per coin. Despite this promise of stability, many were unceremoniously thrown off course during the market volatility boom in 2022. Nevertheless, the quick growth rate and market interest in cryptocurrencies from consumers, investors, banks and large institutions began to send red flags to governments and monetary authorities when they realised that if unchecked, crypto could someday become the preferred means of trade and exchange.

The rise of cryptocurrency and blockchain technology is revolutionising the traditional banking and finance system, challenging conventional fiat currencies and central banking institutions. Cryptocurrencies are decentralised, meaning any government or other authority does not oversee them, which can make them difficult to regulate and open up the possibility of illegal activities. Furthermore, no intermediaries are involved when using cryptocurrency, which reduces processing costs and makes payments faster. This allows users to benefit from an alternative asset class not linked to any particular country or currency, protecting their wealth from potential political and economic turmoil.

Some cryptocurrencies also have built-in mechanisms that make inflation impossible due to finite supply caps on tokens like Bitcoin, eliminating the risk of governments manipulating their currency supply. As more people opt for cryptocurrencies, traditional fiat currencies and banking systems could be left behind in terms of speed, cost, security, and convenience. To remain competitive, banks and governments may need to adjust their policies to keep up with these innovative digital alternatives.

As more governments push forward with their own Central Bank Digital Currencies (CBDCs), it is important to recognise the immense potential of such initiatives and the potential risks that could arise. CBDCs offer the promise of a digital or virtual currency that, unlike cryptocurrency, is issued and fully backed by central banks. While some CBDCs may be touted as a digital native replica of traditional notes and coins, a growing body of evidence suggests that some governments see CBDCs as far more. From changes in retail payments to fluctuations in capital flows, CBDCs can have significant unintended macroeconomic consequences.

CBDCs are still emerging and could take on many forms, each influenced by the payment systems, monetary policy settings and level of financial stability in the host country. Particularly vulnerable to disruption from CBDCs are nations with a high reliance on retail deposits and cash payments. Central banks in these countries must consider the scope of risks presented when introducing CBDCs, such as instituting caps or not offering returns. We can only ensure the successful economic management of CBDCs worldwide through comprehensive risk analysis.

For citizens, CBDCs could provide better access to banking services, faster transaction speeds, and lower payment costs, especially for those in developing countries with limited access to financial services. With CBDCs, governments could also allocate funds directly to citizens in the event of a financial crisis or natural disaster.

Central Bank Digital Currencies (CBDCs) have the potential to revolutionise the way governments manage their money supply, enabling greater control over economic stability and inflation rates. Some governments even view CBDCs as programmable money, allowing them to implement socio-economic policies to limit access or use of money based on specific events or behaviours. Furthermore, CBDCs would make tracking spending easier, detecting suspicious activity such as money laundering, and preventing terrorist financing.

The introduction of CBDCs also has the potential to create competition within the financial sector, providing an alternative form of payment or asset class that is not linked to traditional banking systems or fiat currencies. This could have implications for cryptocurrencies, as people may opt for the more stable option provided by governments backed by a central bank rather than a decentralised currency that still needs to be fully regulated.

When introducing CBDCs into retail payments, it is essential to consider the potential adjustments to the public’s asset portfolios, such as an increase in money velocity and deposit disintermediation. Despite this competition, cryptocurrencies still have a place in the market as viable investment options due to their longevity and finite supply caps on tokens like Bitcoin. Therefore, CBDCs and cryptocurrencies can coexist in the long run.

Uncertainty and debate surround the future of cryptocurrencies and Central Bank Digital Currencies (CBDCs). Governments and regulators worldwide are weighing the pros and cons of both forms of digital money, with some countries choosing to embrace cryptocurrencies. In contrast, others look to clamp down on their usage with stringent regulations. Many are left wondering: will CBDCs reign supreme, or will their overbearing controls prove to be too much for businesses and global populations?

In the next LinkedIn article, we will discuss the worrying control elements of CBDCs and provide some examples of their early role in other countries. We will also discuss the potential implications for businesses and citizens alike and provide insight into how these changes could shape the future of digital money.

We invite your thoughts on the matters discussed and encourage you to share ideas on further material you would like to hear about in the future.

Co-authored by Ryan Babbage and Lachlan Mee.

Disclaimer: Please note that the information provided in this article is not to be considered as financial advice. Please seek advice for your personal or business matters from a qualified professional or make contact with myself or one of the team at Strategy Hubb to tailor custom solutions to accommodate your circumstances.