Chatper 4: Cryptocurrency as Universal Money – The Future?

In just over a decade, cryptocurrencies have grown from digital novelties to trillion-dollar technologies. They have the potential to change the global financial system. Now, more people hold Bitcoin and other cryptocurrencies as assets. They use them to buy many goods and services.

Supporters see cryptocurrencies as a way to give power back to people. They think it takes control away from central banks and big financial institutions. But, critics say cryptocurrencies help criminals, terrorists, and rogue states. They also say these digital currencies can make things more unequal, have big ups and downs in value, and use a lot of electricity.

As of January 2024, 130 countries, including the United States, are looking into their own central bank digital currencies (CBDCs). They want to compete with the cryptocurrency boom.

Key Takeaways

Cryptocurrencies have grown rapidly, with Bitcoin’s market capitalization reaching over $1 trillion.
Many countries are exploring central bank digital currencies (CBDCs) to compete with the rise of cryptocurrencies.
Cryptocurrencies are viewed as a democratizing force, but also face criticism for enabling illicit activities and environmental concerns.
Cryptocurrencies have the potential to improve financial inclusion and cross-border payments, but face challenges in mainstream adoption.
The collapse of stablecoins like TerraUSD highlights the crypto sector’s reliance on the credibility of central bank-issued currencies.

Introduction to Cryptocurrencies and Their Rise

Cryptocurrencies are a digital money type that use cryptography to keep transactions safe and control new unit creation. They are traded on decentralized networks and have public, secure ledgers called blockchains. This system doesn’t need a bank to check transactions.

What Are Cryptocurrencies?

Bitcoin, made in 2009 by Satoshi Nakamoto, is the top cryptocurrency, with a value over $1 trillion. Many other cryptocurrencies, like Ethereum, have come out since then. Now, there are over 25,000 cryptocurrencies, with more than 40 having a value over $1 billion.

How Do Cryptocurrencies Work?

Users send money to each other using digital wallets. These transactions get added to a “block” and checked by the network. Miners earn coins by solving math problems to organize these blocks, proving transactions are valid. This is called “proof of work.”

Some cryptocurrencies, like Ethereum, use “proof of stake” instead. Cryptocurrencies have seen ups and downs, including big crashes in 2011, 2013-2015, 2017-2018, and 2021-2023. They are expected to get better in use, size, and how they fit into different areas, like supply chain and healthcare.

A digital world with glowing lines and circuits, showcasing the decentralized and secure nature of cryptocurrencies.

“Cryptocurrencies offer a low-cost, accessible, and borderless option for individuals excluded from traditional financial institutions, especially in developing nations.”

The Popularity and Appeal of Cryptocurrencies

Cryptocurrencies, especially Bitcoin, have grown from a niche interest to a major hit, valued in the trillions. Their decentralized nature makes them appealing for quick, anonymous transactions across borders without a bank. They’re also seen as investment tools, offering a hedge against inflation. This is because their supply is fixed, unlike fiat currencies that can be increased by central banks.

Why Are Cryptocurrencies Gaining Mainstream Adoption?

Several reasons explain why cryptocurrencies are becoming more popular:

Investment Opportunities: Many see cryptocurrencies as a way to make money, hoping their value will go up over time.
Inflation Hedge: Some believe Bitcoin can protect against inflation because its supply doesn’t change, unlike fiat currencies that can be printed more.
Financial Inclusion: In places with weak currencies, cryptocurrencies like Bitcoin are seen as a way to improve financial access.
Stablecoins: Stablecoins, tied to real assets like the US dollar, could be better for payments because they don’t swing wildly in value.

In 2021, El Salvador made headlines by becoming the first country to accept Bitcoin as legal money. This move boosted the use of cryptocurrencies even more.

“Cryptocurrencies have the potential to change how we think about and use money. They offer new chances for investment, financial access, and making payments across borders.”

Cryptocurrency as Universal Money

Cryptocurrencies and blockchain technology have created a new financial world called DeFi. DeFi offers services like borrowing, lending, and trading without banks and brokerages. It uses smart contracts to make transactions happen automatically when certain conditions are met.

Cryptocurrencies could become a global payment system and universal money. They can help people without bank accounts join the economy. This could make more people around the world part of the financial system.

Smart contracts make it easy to create new financial tools for all kinds of needs. This decentralized finance (DeFi) can change traditional finance. It offers easy, clear, and quick financial services to people and businesses everywhere.

“You can imagine a new kind of financial system being constructed out of blockchain-based tokens that have advantages over the old, centralized kinds of money. You trust the code, and you trust the blockchain and the decentralized ledger, and it’s a new way of organizing finance.”

– CFR’s Mallaby

The move towards cryptocurrency as universal money is still happening. But, DeFi’s progress shows how big this change could be. As more people use cryptocurrencies, we might see a financial system that’s more open and easy to get into.

A world map with countries represented by cryptocurrency symbols, all interconnected through a network of digital lines and nodes.

Challenges and Drawbacks of Cryptocurrencies

Cryptocurrencies have gained a lot of attention and use. But, they also have challenges and drawbacks. Policymakers and regulators are dealing with these issues. One big worry is that cryptocurrencies might be used for illicit activities, like ransomware, money laundering, and terrorism financing.

Illicit Activities and Cryptocurrencies

Cybercriminals often use cryptocurrencies to get paid for their illegal work. The U.S. Drug Enforcement Agency says drug cartels and money launderers are using virtual currency more and more. They want to avoid being caught and followed by rules. Terrorist groups like the Islamic State, al-Qaeda, and Hamas use cryptocurrencies to move money around without being traced.

Environmental Concerns with Cryptocurrencies

Bitcoin mining is very energy-intensive. The Bitcoin network uses more electricity than many countries. This raises big concerns about its environmental impact and how it affects climate change. As more people use cryptocurrencies, the energy use and carbon emissions will grow. This will be a big issue for policymakers and those who care about the environment.

Concern	Impact
Illicit Activities	Cryptocurrencies have been linked to ransomware attacks, money laundering, and terrorism financing, posing challenges for regulators and law enforcement.
Environmental Impact	Bitcoin mining is an energy-intensive process, with the network consuming more electricity than many countries, contributing to climate change.

As more people use cryptocurrencies, policymakers and regulators will have to tackle these issues. They need to make sure the good things about this technology don’t get lost because of the risks.

Conclusion

The future of digital currency is set to change how we handle money and financial systems. Bitcoin, Ethereum, and many other cryptocurrencies are making central banks look into central bank digital currencies (CBDCs). These could make payments faster, cheaper, and available all the time. They could also help those who don’t have bank accounts.

The U.S. hasn’t said it will start a CBDC yet, but the Federal Reserve is studying it. They want to understand the technical sides of it. Central bank-backed digital currencies and fast payment systems could be great for everyone. They let private companies innovate without the problems of regular cryptocurrencies.

The world of crypto has shown some big issues that stop it from being a good money system. As we move forward with digital finance, we should focus on using innovation wisely. We need to make sure the financial system is fair, stable, and good for everyone.

FAQ

What are cryptocurrencies?

Cryptocurrencies are digital assets that use cryptography to secure transactions. They work on decentralized networks without a central authority like a bank.

How do cryptocurrencies work?

They are exchanged on decentralized networks. Transactions are recorded on blockchains, which are tamper-proof ledgers. This prevents coins from being duplicated and validates transactions without a central authority.

Why are cryptocurrencies gaining mainstream popularity?

Their decentralized nature allows for quick and anonymous cross-border transfers. Some see them as a hedge against inflation. They’re popular in countries with weak currencies. Stablecoins are also seen as a reliable payment method.

How are cryptocurrencies being used as “universal money”?

Cryptocurrencies and blockchain tech have led to DeFi businesses. These offer financial services without traditional banks. Smart contracts can automatically execute transactions, challenging traditional finance.

What are the challenges and drawbacks of cryptocurrencies?

Cryptocurrencies are linked to illegal activities like ransomware attacks and money laundering. The mining process for some cryptocurrencies, like Bitcoin, is also harming the environment.

What is a central bank digital currency (CBDC)?

A CBDC is a digital currency from a country’s central bank, backed by the government. Over 100 countries are looking into CBDCs. They could make payments faster and cheaper, helping the unbanked and underbanked.