Digital currencies have celebrated an impressive comeback in 2019. The importance of digital currencies in trade will likely increase over the next years.
Bitcoin is soaring again. The world’s leading digital currency measured by market capitalization has already gained more than 120 percent year-to-date in 2019. Alone in May, the price of Bitcoin increased by more than 65% compared to April and is now trading around the $10,000 mark.
What a comeback! Throughout most of 2018, cryptocurrency markets were bearish, having had temporary losses of more than 80% compared to their peak in late 2017. The so-called “Crypto Winter” has wiped out many digital currencies and somewhat separated the wheat from the chaff in blockchain markets.
Now prices are picking up again. Not only Bitcoin but altcoins as well. The CCi30 tracks the 30 largest digital currencies by market capitalization. The index has appreciated by more than 80% in the last six months.
With Crypto Winter ending and “Crypto Spring” starting, what is the future of digital currencies? Are we on track to create a fully digital monetary system in which central bank issued fiat currencies will become redundant?
Decentralized worldwide peer-to-peer system with low transaction costs
Digital currencies like Bitcoin are based on a public blockchain, a self-governing network that does not rely on a central entity. That comes with several advantages. Network participants supervise themselves, meaning no single person or entity can manipulate the system.
Traditional fiat currencies, like the U.S. Dollar, the Euro, or the British Pound, are subject to central bank manipulation. Central banks impact the value of fiat currencies by manipulating the money supply. They change interest rates and buy and sell securities to increase or decrease the amount of money in circulation. Cryptocurrencies are decentralized and thus free of such government intervention.
Moreover, cryptocurrencies make it relatively easy to trade anywhere in the world. They are not limited to national borders and don’t use the banking system. Users can execute transactions quickly by sending money directly to another user’s digital wallet. As there are no banks or other middlemen involved, transaction costs are significantly lower.
Technology still early-stage; currencies like Bitcoin are volatile
Despite the advantages, it’s too early to declare the end of the fiat currency system. The technology is still early in its development cycle. Market prices are highly volatile, making it almost impossible to use any of the major cryptocurrencies as a means of payment.
As networks grow larger in size, there are scalability issues and environmental costs, as cryptocurrency networks consume large amounts of energy. Regulations are almost non-existent, creating legal uncertainty.
Nevertheless, cryptocurrencies and especially the underlying blockchain technology, have the potential to disrupt the way we trade and use money. Therefore, the importance of digital currencies as a means of payment will increase over the next few years.
In some years from now, we will likely be using two types of currencies: a central-bank issued fiat currency, and a digital stablecoin, meaning a digital currency that is backed by a basket of real-world assets or fiat currencies to guarantee its price stability.
Will a digital currency one day be more important for trade than fiat currencies? That’s possible. But due to lack of stability, it’s unlikely that it will be Bitcoin.
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