Cryptocurrency Investments: Mainstream Or Niche?

Cryptocurrencies are becoming increasingly popular as investments, but they have made very little progress as a currency. In 2020, interest in cryptocurrencies boomed, with more people investing in them than ever before. This was partly due to the coronavirus pandemic, which saw government payments to individuals and businesses alike weakening the US fiat system. Large banking institutions like JPMorgan Chase have also started to welcome digital currencies onto their platforms.

The value of one bitcoin hit $20,000 in December 2020, after a two-month climb that saw the cryptocurrency's value double. This was the first or second time in history that this had happened. While it is difficult to tell who is buying bitcoin, the number of new bitcoin addresses recently hit a record of 25,000 per hour for the first time since January 2018.

Some people remain sceptical about cryptocurrencies, arguing that they are not a stable store of value and that they are too volatile to be considered a legitimate investment. However, others argue that cryptocurrencies are becoming more mainstream and that they offer an alternative financial system that gives people more control over their wealth.

Cryptocurrency's legitimacy as an investment

Arguments for Legitimacy

Proponents of cryptocurrency as a legitimate investment highlight several key factors. Firstly, the involvement of large financial institutions and prominent individuals signals mainstream adoption. For example, JPMorgan Chase, PayPal, Venmo, Goldman Sachs, and Robinhood have all shown interest in cryptocurrencies. Additionally, high-profile individuals like Jack Dorsey and Elon Musk have also supported Bitcoin, contributing to its legitimacy.

Another factor is the increasing number of new bitcoin addresses, indicating growing adoption and real investment. The unique identifiers where assets are sent, known as bitcoin addresses, reached a record of 25,000 per hour in 2020, according to data intelligence firm Glassnode. This growth represents real adoption and is expected to persist even if the market experiences a downturn.

The weakening of traditional fiat currencies, such as the US dollar, due to government aid and stimulus measures during the coronavirus pandemic, has also driven interest in cryptocurrencies as a potential hedge against inflation. Cryptocurrencies, with their decentralised nature and public ledger system, offer a level of transparency that traditional financial systems may lack.

Furthermore, the performance of Bitcoin compared to traditional investments has been remarkable. Bitcoin was the best-performing asset of the last decade, outperforming Amazon, Apple, Microsoft, and real estate. This has caught the attention of prestigious university endowments, such as those affiliated with Harvard, Stanford, and MIT, which have invested in crypto funds.

Arguments Against Legitimacy

Despite these positive signs, there are still valid concerns about the legitimacy of cryptocurrencies as an investment. One of the primary concerns is the volatility and speculative nature of cryptocurrencies. Bitcoin, for example, experienced wild swings in value, dropping from $20,000 in December 2017 to as low as $5,500 in the following months. This volatility makes it challenging to view cryptocurrencies as stable, long-term investments.

Additionally, cryptocurrencies have been associated with illegal activities and money laundering. A 2019 study found that one-quarter of digital coin users were involved in illegal activities, and nearly half of all crypto-transactions were for drugs, prostitution, and other black-market goods and services. This association with criminal activities may deter more risk-averse investors.

Another critical factor is the lack of intrinsic value in cryptocurrencies. Unlike traditional investments, cryptocurrencies are not tied to tangible assets or contractual rights. The value of digital assets is disconnected from traditional economic forces, and there is a risk that their value could decline rapidly, even to zero. This uncertainty makes cryptocurrencies a risky investment, especially for those seeking stable, long-term returns.

In conclusion, while cryptocurrencies have made significant strides towards legitimacy as an investment, there are still valid concerns about their volatile nature, association with illegal activities, and lack of intrinsic value. However, with increasing mainstream adoption, improved transparency, and strong performance compared to traditional investments, cryptocurrencies are becoming harder to ignore as a potential investment option.

Cryptocurrency's mainstream adoption

Cryptocurrencies are becoming increasingly mainstream, with Bitcoin leading the way. The value of one bitcoin hit $20,000 in 2020, and large funds and even CEOs of publicly traded companies are fuelling its run. The crypto narrative about "scarce digital gold" is growing, and more mainstream companies are seeking approval to invest in crypto.

The COVID-19 pandemic has played a role in the rise of cryptocurrencies. With many events cancelled and people staying at home, there was a captive audience for financial change. The value of the US dollar dropped as Americans received financial assistance and businesses utilised government loans. This led to more people hedging their bets on currencies that act outside the confines of the dollar and investing in cryptocurrencies.

Another factor is the disconnect between the stock market's success and the financial reality of people's lives. Many Americans remain unemployed, and cryptocurrencies are seen as an alternative system where they can have more control over their wealth.

The mainstreaming of cryptocurrencies is also being driven by their adoption by mainstream financial platforms, such as PayPal and Robinhood. Additionally, large banking institutions like JPMorgan Chase are condoning and even welcoming digital currencies onto their platforms. This is giving cryptocurrencies more credibility.

However, it is important to note that cryptocurrencies are still highly volatile and speculative. They are not backed by any tangible commodity or contractual right and their value can drop rapidly. As such, they may not be suitable for everyone, and it is recommended that people do their research before investing.

Cryptocurrency's volatility

Cryptocurrency is a rapidly growing market that has made millionaires and paupers. However, it is a highly volatile market, and its value is based on speculation.

Volatility in Cryptocurrency

Volatility is a measure of how much the price of an asset has moved up or down over time. Generally, the more volatile an asset is, the riskier it is considered to be as an investment. Cryptocurrency is widely considered to be volatile, with the potential for significant upward and downward movements over shorter time periods.

Factors Affecting Crypto Volatility

• Speculation and News Events: Speculation and news events such as COVID-19 drive price swings in crypto and mainstream markets. However, the effects of these events are often exaggerated in crypto due to its unique features, such as the ability to trade 24/7, and the lack of regulatory intervention.
• Market Maturity: Crypto is still a relatively new asset class, and the market is still in its early and high-growth phase. As a result, prices will continue to fluctuate as new participants enter the market and try to establish a consensus on the fair value of digital assets.
• Supply and Demand Dynamics: The limited supply of certain crypto assets, such as Bitcoin, which has a supply cap of 21 million coins, can lead to increased volatility. When demand increases, it can put upward pressure on prices, and vice versa.
• Investor Sentiment: The crypto market is heavily influenced by investor sentiment, and the immaturity of the market means that positive or negative views can spread like a contagion. For example, when Tesla bought Bitcoin in January 2021, the markets reacted with exuberance, driving up prices.
• Regulation: The lack of comprehensive and clear regulation in the crypto market also contributes to volatility. Unlike traditional financial markets, which have circuit breakers to dampen volatility caused by panic selling or destructive events, the crypto market has no such safeguards in place.

Managing Crypto Volatility

For some investors, the high volatility of crypto is part of its appeal, as it creates the possibility for high returns. However, for less risk-tolerant investors, there are strategies to limit the downside impact of volatility, such as dollar-cost averaging and investing in stablecoins, which are cryptocurrencies designed to have low volatility.

Cryptocurrency's regulatory environment

The regulatory environment for cryptocurrencies is complex and rapidly evolving. Cryptocurrencies do not fit neatly into existing regulatory categories, and the collapse of major players such as FTX in 2022 has highlighted the need for smarter regulations. National governments want to exert regulatory control over cryptocurrencies as a means of managing their economies, but the very appeal of cryptocurrencies for some investors is that they can operate beyond government control. This tension has resulted in varying approaches to regulation across different countries.

In the United States, for example, there has been a hot-and-cold approach to regulating crypto. While some in Congress seek to implement a comprehensive new framework to allow the industry to thrive, financial market regulators are cracking down on concerns over money laundering, scams, and cybercrime. The Biden administration has called on federal regulators to assess the risks and benefits of cryptocurrencies and has released a roadmap to mitigate crypto risks, encouraging regulators to "ramp up enforcement". The U.S. treats crypto as a security, attempting to regulate crypto platforms rather than the cryptocurrencies themselves.

Other countries have taken different approaches. Brazil, for instance, has been a frontrunner in crypto policy, with its central bank launching a pilot project to create a digital real. The U.K., on the other hand, has crypto regulations in flux due to broader changes in national leadership. Germany has been praised for providing more clarity in its regulatory environment, with its regulator BaFin publishing a set of medium-term goals, including increased regulation of DeFi and consumer protection.

The regulatory landscape in Canada is often viewed as stricter than in the U.S., with exchanges being regulated similarly to conventional money services businesses. India previously refused to regulate cryptocurrency, opting for a ban, but this has since been overturned, although regulators remain sceptical. South Korea is also working on comprehensive legislation to reduce crypto crime and bring clarity to the industry.

At the international level, there have been efforts to address the use of cryptocurrencies in money laundering and other illegal transactions. The Financial Action Task Force has provided a global framework for virtual asset service providers, and the International Organization of Securities Commissions (IOSCO) has issued regulatory guidance on crypto exchanges.

Overall, the regulatory environment for cryptocurrencies is still evolving, with varying approaches taken by different countries and ongoing efforts to address cross-border issues and ensure a level playing field.

Cryptocurrency's association with illegal activity

The rise of cryptocurrencies has brought about a new avenue for illegal activities, such as money laundering, drug trafficking, and terrorist financing. Cryptocurrencies are attractive to criminals due to the anonymity they offer, the ease of cross-border transactions, and the lack of regulation by traditional financial institutions. This has led to an increase in illegal activities such as dark marketplace trading, where illegal goods and services are traded using cryptocurrencies. The decentralised nature of cryptocurrencies makes it challenging for law enforcement agencies to trace transactions and identify the individuals involved.

Cryptocurrencies have also been linked to other illegal activities such as ransomware, Ponzi schemes, scams, hacks, thefts, illegal pornography, and even murder-for-hire. The use of cryptocurrencies in these activities provides a digital and anonymous payment mechanism, making it difficult for authorities to track the flow of funds. The rapid growth in the value and popularity of cryptocurrencies has further fuelled their use in illegal activities, with an estimated $14 billion in digital currencies received by illegal addresses in 2021, a 79% increase from 2020.

While the volume of illegal transactions remains a small proportion of total cryptocurrency transactions, typically less than 1%, the impact of these activities is significant. The ease and speed of cryptocurrency transactions, combined with the difficulty in tracing and prosecuting individuals involved, has made it a preferred method for criminal and terrorist organisations to move and store funds. The challenge for law enforcement and regulatory agencies is to detect and prevent the use of cryptocurrencies for illegal purposes while also promoting their legitimate use.

Frequently asked questions