The introduction of Bitcoin in 2009 made a strong case against modern fiat currencies: that it is possible to introduce digital currencies free from the constraints of a central authority such as a central bank and the government, intermediation from traditional financial institutions, and limitations due to legal and geopolitical boundaries.
Bitcoin is a cryptocurrency and the first of its kind. Its introduction marked the beginning of a new era in the history of money. But what exactly is a cryptocurrency? For starters, cryptocurrencies are decentralized digital currencies based on the distributed ledger concept and implemented and maintained using blockchain technology.
Numerous crypto-coins and crypto-tokens have emerged since 2009. These include the Ether native cryptocurrency of the Ethereum blockchain, Litecoin, and Ada native cryptocurrency of the Cardano blockchain, and Dogecoin, among others, as well as crypto-tokens such as SLP, AXS, Binapet, Rare Antiques Token or RAT, and Vabble, among others.
A blockchain is fundamentally a type of database used as a ledger of transactions and maintained by a peer-to-peer network of computers. Each block contains data about a particular transaction and is linked or chained with the previous block of a previous transaction. The ownership of a cryptocurrency is essentially recorded in this ledger using cryptography.
Note that most people would think fiat currencies are represented by physical objects such as coins and papers. However, in modern economics, more than 90 percent of these currencies exist as records in digital databases. The same is true for cryptocurrencies. They do not exist in physical form because they are essentially binary data.
The peer-to-peer network that maintains the ledger and the underlying blockchain technology is the reason why a particular cryptocurrency is a type of a decentralized digital currency. It also equips it with notable features and advantages to include faster and borderless transactions, e-commerce suitability, and easier implementation, among others.
Disadvantages: A Look Into the Criticisms of Cryptocurrencies
Despite the promises of a decentralized digital currency, the aforesaid advantages of introducing and using currencies based on blockchain technology, as well as the potential to make money from the cryptocurrency market, critics of cryptocurrencies have grown since the introduction of Bitcoin and further with the introduction of new alternative crypto-coins or altcoins and crypto-tokens.
Negative Environmental Impacts of Blockchain
One of the disadvantages of blockchain technology is its high energy requirement. Of course, energy-intensive applications have environmental drawbacks. This is also one of the major criticisms of cryptocurrencies by extension, particularly those that use the cryptographic zero-knowledge proof-of-work algorithm to achieve consensus.
Blockchains based on a proof-of-work algorithm require powerful computer processors. These processors are inherently energy-intensive. Furthermore, to avoid overheating and specific hardware damages, computers used in blockchain mining require efficient heat management, thus resulting in additional energy input.
A 2019 analysis using an online tool from the University of Cambridge revealed that Bitcoin mining had an estimated energy consumption that is equivalent to the annual energy consumption of Switzerland or a total of 58 terawatt-hours of electricity per year. This accounts for 0.21 percent of the total energy consumption in the world.
Furthermore, a 2021 follow-up analysis showed that the energy consumption of Bitcoin mining had increased to 121.36 terawatt-hours per year due to the expanding application of this cryptocurrency. Hence, the researchers concluded that Bitcoin consumes more electricity in a year than the whole of Argentina and The Netherlands.
Observers and critics have raised concerns over the possible environmental impact of cryptocurrencies. Microsoft founder and philanthropist Bill Gates explained that the environmental impacts of cryptocurrencies can be offset if the underlying blockchain technology uses clean energy, as well as if it does not crowd out other consumers of energy.
It is important to note that burning fossil fuels remain the most cost-efficient method for generating electricity. However, the consumption of these fuels has been linked by experts to global warming and the ongoing climate emergency. The high energy demand of blockchain also makes it an impractical and inefficient way to process digital transactions.
Risks in Trading and Investing in Cryptocurrencies
Then there are the risks associated with attempting to earn money through cryptocurrency trading or investing. Of course, a lot of people, even those who are experts in finance and economics, have considered crypto-coins and crypto-tokens as digital assets. Hence, they have become financial instruments.
It is important to note that the value of Bitcoin and Ether have considerably appreciated since their introduction. For example, from February to April 2011, 1 BTC was equal to USD 1. The value of 1 BTC significantly grew to USD 33400 by January 2021. This capital appreciation has benefitted those who bought and held Bitcoins in the early years.
However, the cryptocurrency market remains extremely volatile in general. 1 BTC in December 2017 was around USD 19000 and it plunged to USD 3300 in December 2018. Altcoins such as Litecoin and Dogecoin have experienced drastic highs and significant lows within a short period. Trading or investing in cryptocurrencies are reserved for aggressive traders and investors.
Some critics have noted that these digital assets have no actual use other than in trading. In his opinion article for Foreign Policy, David Gerard explained that pump-and-dump schemes have been rampant in cryptocurrency trading in which traders partake in speculations to manipulate market prices. For him, there is no practical use case for these currencies.
It is also important to highlight the apparent sensitivity of these assets to speculation-related occurrences. Take Dogecoin as an example. After it garnered public support from Elon Musk and Mark Cuban, more people bought this altcoin, thus creating an increase in demand and affecting its market price. Herding was the primary driver of its value.
A study by F. A. Enoksen et al. and published in 2020 noted that higher volatility, trading volume, and transactions were positively associated with the presence of bubbles across eight popular cryptocurrencies from 2017 to early 2018. A Fortune article by D. Z Morris also noted several instances of bubbles in Bitcoin.
Note that an economic bubble is a phenomenon characterized by rapid increases in the price of a particular asset and followed by contraction or deflation. Some of its causes include displacement, boom, euphoria, profit-taking, and panic. Regardless of factors at play, historical price data have shown that cryptocurrencies are prone to bubble events.
As a Medium of Exchange and Store of Value
Fiat currencies have no intrinsic value, unlike currencies backed up by precious metals. They still function as a medium of exchange, a store of value, and a unit of account because of their divisibility, utility, transportability, authenticity, and acceptability. Modern economics also consider utility and scarcity as two of the essential characteristics of a commodity.
Cryptocurrencies also do not have an intrinsic value. However, one of their major advantages is that they demonstrate the characteristics or attributes mentioned above. It is also important to highlight the fact that the advantages of blockchain technology as a public or distributed ledger fundamentally equip cryptocurrencies with the same functions as fiat currencies.
However, despite having a strong theoretical basis as an alternative or replacement to fiat currencies, a key criticism of cryptocurrencies centers on acceptability. The fact remains that they are not universally accepted as a medium of exchange. Furthermore, a number of jurisdictions have not legalized their use as a legal tender.
Their role as a store of value is also a matter of debate due to their extreme volatility. Drastic changes in their value or market price within a short period definitely affect their purchasing power. In addition, because of the absence of universal acceptability, they still do not have a stable demand, unlike other stores of value.
It is also worth mentioning that not all cryptocurrencies are scarce. For example, unlike Bitcoin and Litecoin, which are deflationary by nature, there is no cap to the supply of Ether and Dogecoin. Their supply is fundamentally limitless. Note that there is a limited number of fiat currencies in circulation. Precious gems and metals have value because they are rare.
Limited Accessibility Due to Technological Barriers
One of the strongest arguments for promoting cryptocurrencies is decentralization. They adhere to the principles of decentralized movements. For their supporters, centralized control produces negative outcomes to include sensitivity to bank failures, the shortcomings of a central authority, and the collapse of the financial system, as well as from stringent policies and fees.
A decentralized currency is fundamentally more accessible. One of the visions of cryptocurrency developers and supporters is to make the use of currencies more accessible to a lot of people. Without a doubt, because it is borderless and not bound to a jurisdiction or central authority, anyone can virtually use cryptocurrencies.
But the fact remains that they are a form of digital currency and digital asset. They exist in a digital realm. They are only accessible and usable to individuals and institutions that have access to digital communication technologies such as computers, smartphones or other mobile communication devices, and an internet connection.
Online-enabled products and services have technological barriers, which limit their accessibility. These barriers defeat one of the purposes of cryptocurrencies, which is to make financial services accessible to underserved communities. Hence, because they take place in the digital realm, one of their biggest drawbacks is that they are not really accessible.
A large portion of the global population still does not have access to digital communication tools and technologies, as well as basic utilities such as power or electricity. Some of these communities also prefer following a barter system because they are more accessible and less complicated than the modern monetary system.
Cryptocurrencies are also too complex to understand for some people, especially for those who are not deeply acquainted with modern technology. Their adoption is dependent on socioeconomic development. Owning and holding a cryptocurrency is not as straightforward as owning and holding a physical coin or paper money.
FURTHER READINGS AND REFERENCES
- Baraniuk, C. 2019. “Bitcoin’s Energy Consumption ‘Equals that of Switzerland.” BBC. Available online
- 2021. “Andrew Ross Sorkin Interviews Bill Gates in Clubhouse.” YouTube. Available online
- Criddle, C. 2021. “Bitcoin Consumes ‘More Electricity than Argentina.” BBC. Available online
- Enoksen, F. A., Landsnes, Ch. J., Lučivjanská, K., and Molnár, P. 2020. “Understanding Risk of Bubbles in Cryptocurrencies.” Journal of Economic Behavior & Organization. 176: 129-144. DOI: 1016/j.jebo.2020.05.005
- Gerard, D. 2021. “Confused About Dogecoin? Here’s How It (Doesn’t) Work.” Foreign Policy. Available online
- Morriz, David Z. 2021. “A Brief History of Bitcoin Bubbles.” Fortune. Available online
