This article is part 1 of a 2 part series on cryptocurrencies and their potential effect on retail. In part 1 is an exploration of the phenomenon of cryptocurrencies such as Bitcoin and the factors that have led to both their growth in popularity and value. In part 2 of the series I will explore how cryptocurrencies work, the reasons why cryptocurrencies haven’t been adopted by retailers en masse and whether or not they ever will be.
Bitcoin this, ethereum that it seems everywhere you go one can’t go a day without hearing about cryptocurrencies and their ever increasing values. In the past most financial advisors, top business analysts and business radio personalities have derided the value of cryptocurrencies, such as bitcoin, and relegated their existence to merely a fad or a financial bubble waiting to pop. Mark Cuban, famed billionaire and tech investor, once tweeted out the following:
“I think it's in a bubble. I just don't know when or how much it corrects. When everyone is bragging about how easy they are making $=bubble"
In recent months Bitcoin’s value has surged to unprecedented levels and usurped the value of gold in the process. Bitcoins increase in value has been remarkable. Take for instance the fact that in June 2013 one bitcoin would have cost you R1377.13 and compare that to the fact, at time of writing, that the same bitcoin is now worth R61 362 in 2017. This is the equivalent of a 4356% increase in value. The early investors of this new technology have become very wealthy to say the least.
This increase in value has subsequently attracted the interest of numerous parties such as bankers, institutional investor’s, government regulators and a host of other parties involved in the global financial industry. It even forced Mark Cuban to reconsider his position on the technology he once lambasted as being a “bubble”. In a recent email addressed to CNBC he confirmed that he is looking to invest in the technology. “I want to learn more about them," he said. I "haven't signed the paperwork yet. But it's likely it will happen," he added.
Like Mark Cuban many people, have realised that Bitcoin and other cryptocurrencies like it have become too valuable to ignore.
Before we can look at the potential effects of cryptocurrency in retail and the broader economy, we need to understand what it is and why it’s such a game changer for the financial industry.
In its simplest form a cryptocurrency is a digital asset designed to work as a medium of exchange. Seems simple enough, so what’s the difference between that and other currencies such as the American dollar, UK pound or South African Rand you may ask. What separates it from other currencies is that it uses cryptography and block chain technology to secure its transactions and to control the creation of additional units of the currency. This essentially means that it is a currency that is decentralized. To understand why this is so special we need to understand traditional currency types and how they operate.
Fiat VS Commodity
The UK pound, South African rand and American dollar are all examples of fiat currencies. A fiat currency is a legal tender whose value is backed by the government that issued it. The opposite of a fiat currency would be a commodity currency. A commodity currency is a currency which has its value underpinned by some physical good i.e. gold. Meaning that one could potentially exchange a commodity currency for the physical good from which the commodity currency derives its value. The United States Dollar used to be a commodity currency as far back as the 19th and early 20th century.
So a commodity currency derives its value from the physical good that underpins it and in contrast a fiat currency’s value is underpinned by the strength of the government that issues it.
But why have global governments switched from commodity currencies which have a real and intrinsic value to fiat currencies which don’t really have any intrinsic value except for the paper that they are printed on you may ask?
Well the answer is simple. Fiat currencies allow governments and central banks to protect their economies from the volatile effects of booms and busts of the natural business cycle. Confused? Let me explain.
Central banks have a dual mandate which is to ensure a country’s economic growth is as high as possible while also keeping inflation as low as possible. This job is made near impossible with the use of commodity currencies due to the simple fact that in times of economic uncertainty people have a tendency to limit spending. I know what you’re saying “but the same thing happens with fiat money”. True the same patterns are seen with both currency types but the response and level of interventions available to central banks are not.
In the case of commodity currencies central banks have little to no methods to stimulate economic growth as they can’t create gold/ any other precious metal out of thin air and therefore can’t print more money to circulate in the economy. This is in stark contrast to fiat currencies where governments and central banks can increase the money supply in the economy through a variety of methods ie dropping interest rates as fiat money is not tied to any intrinsic value.
So the key benefit fiat money has over commodity money is that it can be controlled and therefore stabilised during times of economic uncertainty and thus make sure that economic downturns do not persist for decades. Therefore its strength and the reason for its pervasive use in the global financial industry lies in its stability.
Drawbacks Of Fiat Money
The main strength of fiat money may well also be its main weakness. One of the major risks of fiat currency is that it relies on the confidence people have in the currency and in the nation backing it. As its value lies in a system and the faith that a currencies government is doing a good job it is open to manipulation in a variety of ways some of which include, but are not limited to:
Poor Monetary Policy
Since the government controls the printing press, some governments mistakenly think they can simply print their way out of money problems such as low economic growth or foreign debt payments. However time and time again we have seen this not to be true and result in disastrous consequences for the citizenry of those governments with poor monetary policy. There have been many instances of poor monetary policy leading to hyperinflation and literally destroying the faith and credit of a national currency and subsequently the value of its citizenry’s wealth.
Currency Manipulation
Currency manipulation involves a country artificially reducing its currency price in the foreign exchange market in an effort to lower the price of its exports in an effort to flood other economies with those exported products. Currency manipulation has a few benefits for the consumers in the import economies and the working class of the offending economy in the short term but can result in a lose-lose situation for both economies in the long term.
Short term
•Consumers in the import economies enjoy cheaper goods.
•The offending economy enjoys a steady inflow of foreign money which leads to an increase in the supply of jobs, higher work hours which could possibly lead to higher wages.
It raises standards of living in for everyone in the short term, which feels like a win-win.However lets take a look at the potential effects of this manipulation in the long term.
Long Term
•Currency manipulation impoverishes the working class of the offending economy more so than exporting at fair market value as export prices remain depressed and this reduces the ability to increase manufacturing quality which would further increase fair market values the end result being that workers can’t earn a fair wage
•For the consumers in the import economies, they may be enjoying low prices now but they are shackled by the low prices due to the fact that their import economy would find it impossible to manufacture exports and charge fair market value.
Are Cryptocurrencies The Future?
Cryptocurrencies allows those who are disaffected by their country’s monetary policies, exchange controls and other seemingly prohibitive systems in the finance industry to use a viable alternative to store value and trade goods. The benefits of using cryptocurrencies include, but are not limited to, the following
•Its value is not controlled by a central bank therefore the currency is decentralized. A global network of computers use blockchain technology to jointly manage the database that records cryptocurrency transactions. That is, Cryptocurrencies are managed by its network, and not any one central authority. This means that cryptocurrencies run on a pure system of demand and supply and are not vulnerable to any government/central banks machinations.
•It allows one to pay for goods and services anywhere in the world. Since cryptocurrencies are not bound by exchange rates, interest rates, transactions charges or other charges of any country they can be used at an international level without experiencing any problems.
•The transfer of cryptocurrency funds is a quick and easy process and is usually done in a few minutes as opposed to using traditional banks and waiting days for transfers to clear(This does appear to be changing due to the high volume of trades going on)
•Buying goods with cryptocurrencies carries no to very low transaction (Unfortunately this is also changing for reasons I will expand on in a later article)
• Cryptocurrency funds are very secure. The currency is secured using a public key cryptography system. Only the owner of the private key can send cryptocurrency.
•No permission is needed from anyone to use cryptocurrency.
•While it’s possible to analyse the transaction flow of cryptocurrency funds, it is not necessarily possible to connect the real world identity of users with those addresses as neither transactions nor accounts are connected to real-world identities.
Due to the above factors and more, many have predicted the fall of fiat currencies in favour of cryptocurrencies. While I don’t exactly share this sentiment one can agree that cryptocurrencies and their continual development and evolution will fundamentally change the finance industry and by extension the retail industry as it will change the way the world buys and sells goods as well as exchanges money.
The views and opinions expressed in this article are solely my own and do not express the views or opinions of my employer