Cryptocurrencies: blossoming future or merely a tulip bulb?

Bitcoin, Ether, Ripple – these are only three of the more than 1,000 cryptocurrencies in existence around the globe. At the latest since the meteoric price rises during the second half of last year and the introduction of Bitcoin futures, barely a day goes by without media reports on the „new money“. While many proponents of cryptocurrencies see the status quo merely as the beginning of something much bigger, there are arguably just as many detractors who compare Bitcoin et al. with the Dotcom bubble at the turn of the millennium or the Dutch tulip mania of the 17th century.

That said, all cryptocurrencies are not created equal. While they are all largely based on blockchain technology, there are important differences, for example in the way new money is created and the existence of an upper limit for the monetary aggregate of a cryptocurrency. However, they vary in their objectives: from merely supplementing the existing payment system to replacing the traditional world of finance and its mainstays of central banks and financial institutions.

Disregarding any sideshows and ideological differences, it should be noted that the underlying technology makes it possible to transfer money quickly and cost-effectively, while at the same time quite easily and safely, also across the borders of currency areas. At least compared to the established payment systems, this is a distinct advantage. As a consequence, Bitcoin et al. should be particularly interesting for users whose countries lack a sophisticated payment infrastructure (e.g. some African nations) or whose currencies are not deemed reliable (Venezuela).

However, this assessment cannot belie the fact that cryptocurrencies lack some important features of money and are not as safe as many of their proponents would have us believe. More importantly, there is no central institution that could intervene to stabilise the situation in the event of a major confidence crisis. What’s more, it is highly unlikely that private cryptocurrencies will, in the foreseeable future, completely replace the established monetary and financial system. After all, no major country would be prepared to forego its monopoly on a legal tender. As a consequence, going forward, no merchant and no private individual will be under any obligation to accept Bitcoin or any other cryptocurrencies. Similarly, it cannot be ruled out that cryptocurrencies will become subject to stricter regulation or even prohibitions; likewise, there is always the risk of hacker attacks on trading platforms.

That said, it is, as yet, impossible to make a well-founded forecast for the further development of any cryptocurrency, be it price rises or losses. For the avoidance of doubt: anyone who purports to know that the prices of Bitcoin or any other cryptocurrency will rise sooner or later, cannot base this prediction on anything other than gut feeling. There are no historic empirical data nor reliable fundamental indicators for a „fair value or exchange rate“. And even if there is a future place for cryptocurrencies within the financial world, which cannot be ruled out, no-one can predict which cryptocurrencies will be able to establish themselves for the long haul. For instance, with a view to the enormous energy consumption of mining, numerous observers doubt that Bitcoin has a future. They ignore, however, the fact that the underlying systematics could change.

And yet, there are two potential investor groups that do not need to shy away from cryptocurrencies if they have familiarised themselves thoroughly with the parameters. First of all, these are people who, because of their ideological stance, are looking for alternatives to the established financial system and have no trust in central banks or financial institutions anyway. Secondly, financial market players who see cryptocurrencies as the future of the financial world and expect further price rises, may consider adding cryptocurrencies to their portfolio mix. However, these investors should also be cautioned that they risk no less than the total loss of their invested capital. Investors who feel that this risk is too great for their liking should, at present, stay clear of cryptocurrencies.

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