By Gille Ann Rabbin, Esq., CIPP/US
A cryptocurrency is a virtual currency intended to function the way a traditional currency like the U.S. dollar does: as a medium of exchange. But unlike traditional currencies, a cryptocurrency isn’t under the governance of a bank or government.
The most popular cyptocurrency is Bitcoin, which records transactions anonymously in a public blockchain database that includes all transactions that occur, and which is maintained by a decentralized network of computers. These computers, called “miners” or “validators,” use cryptography to verify and add new transactions. The cryptography used makes the blockchain database extraordinarily difficult (although not impossible) to tamper with or modify.
Cryptocurrencies have their problems, significantly, volatility. In January 2017, the price of a bitcoin was around $900; in December 2017, it spiked to over $16,000; in February of 2019, it was around $3,400; in August 2019, almost $13,000. In contrast, the value of the dollar rises or falls dependent upon inflation, which has been relatively tame over the past ten years.
Furthermore, transacting in cryptocurrency is relatively slow. A major credit card company can complete 24,000 transactions per second; bitcoin miners, only three to seven transactions.
Additionally, cryptocurrencies are not regulated (generally with the exception of some states’ registration or licensing requirements), making them potentially useful for money laundering or other criminality. (Bitcoin was the official currency of the Silk Road.) Regulation could tackle these issues, thereby encouraging good conduct by industry players, consumer trust, and price stability.
Furthermore, given their volatility, cryptocurrencies present liquidity problems because investors can’t easily convert them into cash without exposure to drops in value.
Recently the media reported that Facebook plans to launch a cryptocurrency called Libra. Libra is different than other cryptocurrencies. To introduce greater price stability than is inherent in Bitcoin, Libra is designed to be a “stablecoin,” a digital currency backed by fiat currencies and securities. Also, unlike Bitcoin, Libra will be reserved, meaning that every Libra will be backed by an asset, similar to the old gold standard idea.
Additionally, Libra will use a nonpublic, “permissioned” blockchain managed by a group of “trusted parties,” a consortium called the Libra Association. This means that not everybody will be able to transact in Libra. In contrast, Bitcoin’s public blockchain ledger can be accessed by anyone with special hardware and internet access. The Libra Association will provide management and the initial funding to back Libra and maintain its blockchain infrastructure.
Some experts have opined that, given that true cryptocurrencies “are defined by their lack of reliance on trusted intermediaries… Libra is not a cryptocurrency because of its use of a permissioned ledger and its reliance on a trusted issuer to hold and manage a fund of assets that back the currency.”
Bitcoin was designed as a peer-to-peer payment system, enabling the exchange of money without using banks. Today it is generally used as an investment.
Unlike the more volatile Bitcoin, Libra was designed to allow Facebook users to send and receive money through its messaging services for ordinary transactions like paying utility bills, tuition, rent.
Cryptocurrencies are still nascent. It will be fascinating to watch their development. Consumers interested in becoming investors should proceed with caution.