The cryptocurrency frenzy

2020 has turned out to be a tumultuous year for the world’s economy and societies. Conversely, against that backdrop, cryptocurrency as an asset class has grown exponentially mainly bolstered by investors searching for new safe-haven assets, to hedge against the increased market volatility. Consequently, blockchain technology and cryptocurrencies took the stage due to their decentralized property that allows them to be unaffected by government policies, their immutability, privacy and transparency. Bitcoin, being at the forefront of this exponential growth, earned the name of “valuable form of digital gold”.

Bitcoin: the “Bullish” leader 

During the last months of 2020, a sharp soar in Bitcoin’s trade volume and market price could be witnessed, mainly led by the perceived inflation-hedging qualities, the quick gain potential, and the possibility to be used as a mainstream payment method. 

Graph 1: Bitcoin Price: Nov. 2020-Jan 2021

The roots of such a bullish trend may be traced back to the Fed‘s attempt of alleviating the lockdowns’ effect on the US economy, by printing US dollars in huge quantities, thereby causing concerns about a possible currency devaluation for many investors. Hence, despite its volatile nature, Bitcoin has been attracting large sums of money from worried investors. Therefore, some argue cryptos might eventually reaffirm as a strong contender to the US dollar, representing a more decentralized and democratic alternative. However, already now the cryptocurrency seems to have established itself as more than a Millennials’ hype. This becomes obvious when considering that the price rally of the last months of 2020, was further pushed up by the injection of institutional money into the asset. For instance, the UK-based asset manager Ruffer poured 2.7% of the firm’s asset-under-management in Bitcoins, amounting to an investment of more than 500-million dollars. This move can be viewed as at the beginning of a wave of diversification of portfolios towards cryptocurrencies, assets that institutional money can’t avoid anymore. 

Despite that, skepticism around the appellative “digital gold” is still spread due to the volatility of the asset: the last bitcoin bubble popped less than three years ago and daily price-swings are still four times larger than those of actual gold. Doubts about Bitcoin seem to be more prevalent with people who did not grow up with digital technologies. While only 3% of baby boomers said they invested in cryptocurrencies in a recent survey, it was 27% of the asked millennials. 

Bitcoin and cryptocurrencies, often considered as an investment, are also progressing as a means of exchange. Smaller businesses are starting to utilize bitcoin in international trade, especially in those countries where dollars are difficult to get or where the local currency is unstable.  Additionally, many start-ups such as Coinbase, Revolut, and Square’s Cash are starting to allow cryptocurrencies as a payment method. Furthermore, the recent news about Paypal entering the virtual coins’ market, by announcing the possibility to trade virtual currencies through Paypal accounts, represents a breakthrough for this asset class. 

Owning a network of 26 million merchants, Paypal is the largest multinational to make this move, leading to a potential wider acceptance of digital currencies globally and a further improvement of its status as a form of investment. The American-based company aims at strengthening consumers’ understanding and adoption of cryptocurrencies, hence providing account holders with educational content related to the topic.

Stablecoin: a definitive shield against volatility?

However, the volatile nature of virtual currencies has, so far, translated into unsuccessful attempts to radically amend the financial system as a whole. 

This resulted in the diffusion of Stablecoin, a less flimsy variant to the most commonly known cryptos. It is pegged to assets, such as US Dollars or gold, and it could potentially represent a mean, allowing faster and cheaper payments. Also, as a variant of the crypto asset, it provides the same level of privacy and fraud protection because the underlying algorithm has the same structure.

This asset class is becoming constantly more popular and a lot of big private banks and tech companies are working towards achieving a first mover’s advantage. For instance, IBM is in the process of building a support network of Stablecoin issuing banks, while Visa is working on ways to enable B2B payments using this more stable crypto. In addition, JPMorgan launched JPM Coin last year, with the objective of easing cross-border payments for its institutional clients, and recently opened a blockchain unit called ‘ONYX’. Finally, Facebook is also trying to come aboard through its global Stablecoin, Libra, backed by other companies such as Spotify and Uber, but harshly criticised in 2019 for its strong association with the social network, and it‘s potential of becoming a hotbed for money laundering. Despite the remonstrances, it will likely be relaunched in January 2021 under the new name of “Diem”. 

Although the already-repleted above-mentioned list is not exhaustive, the finance domain still lacks an official and definitive Stablecoin, while its value grew from $10 billion to $ 18 billion in just four months in 2020.

The Central Banks’ response

These private initiatives have resulted in Central Banks acknowledging the existence of a solid threat represented by wild deregulation and mounting decentralization. In the foreseeable future, individuals and businesses will be able to make large money transactions in the economy without involving bank transactions, consequently disrupting the traditional banking system. 

People’s Bank of China is leading the way in finding a credible response to face the perils, through several trials for its prototype digital currency, the “Renminbi”.

To worsen the scenario for Central Banks, the Covid-19 pandemic has accelerated the awareness and growth of digital currencies around the world, increasing the pressure on regulatory authorities that will need to tread carefully through the latest financial developments. 

Recent statements made by the Office of the Comptroller of the Currency, allowed US National banks to trade crypto assets, in a move that could finally create a circuit of supply and demand of this asset class. By attracting issuers and clients, and establishing new payment networks, Central Banks can possibly create new lending and financing services: a godsend for a hard-hit sector with deteriorating revenues caused by low-interest rates and rising customers’ defaults.

Can all these clues suggest that cryptocurrencies can finally replace fiat money?

This is extremely hard to say at this point, but the most likely answer is “not yet”. This is because even with the less volatile cryptocurrency in the market, the Stablecoin, some drawbacks can still be found.

First of all, as it will become a major part of the financial system, it will attract more regulatory interest, wiping out the actual advantage the currency has over the traditional bank sector. The Federal Reserve, together with other central banks, in fact, see the development of a financial system outside the boundaries of the regulatory institutions as a threat. Secondly, given the confirmed trend and need for decentralization by financial services’ customers, the banking sector will surely further respond by introducing FinTech innovations. For instance, it could introduce electronic reserve currencies through which transferring electronically-based dollars within the accounting system of the central bank, achieving a non-intermediated transfer without involving cryptos’ use. 

Cryptocurrencies advocates will need to wait some more years to see their dream of decentralized and deregulated payment methods finally come true. 

Authors: Ugo Zaccaria, Surbhi Khurana

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