May 19, 2023
By Anjali Kochhar
With the advent of digital transactions and financially engineered products, the modern-day banking and finance industry have witnessed the growth of financially engineered products like cryptocurrency, bitcoins, etc., globally.
A cryptocurrency, not to be confused with virtual currency, is a digital currency and works as a medium of exchange similar to a physical currency in a respective jurisdiction or country. Bitcoin is the first decentralized cryptocurrency.
Many investors also look at cryptocurrencies from a trading perspective. Many cryptocurrency enthusiasts opine that if added to their portfolio, cryptocurrency as an alternative asset would give a better diversification benefit and a higher return than traditional asset classes like stocks, bonds, and mutual funds. However, cryptocurrencies are still in its nascent stage.
Despite the hype created around decentralized finance and digital currency, cryptocurrency is yet to fulfill its merit of being a ‘safe heaven’ or even combat the ill effects of inflation and market volatility.
Bitcoin “is a highly volatile, highly risky investment”, James Ledbetter, editor of FIN, a fintech newsletter.
Nouriel Roubini, an economist, commented, “Cryptocrazies are also criminal Cyber-Terrorists”.
As per the latest report published by World Economic Forum, the market capitalization of cryptocurrencies stood at $1.7 trillion, with over 18,142 cryptocurrencies managed by 460 cryptocurrency exchanges. Nearly $91 billion in cryptocurrencies in Bitcoin or Ethereum are traded each hour.
The growing dimensions and magnitude of cryptocurrencies, and digital transactions worldwide, can have spillover effects if not managed and accounted for properly.
On that note, let us look at some of the challenges of cryptocurrency before cryptocurrency enthusiasts think of venturing into this space
- Increasing volatility and uncertainty: Cryptocurrencies like Ethereum and Bitcoin are subjected to increased volatility and inherent uncertainty, making investing risky and challenging. The large movement and swings in prices of cryptocurrencies make price prediction and forecasting a major challenge, posing a question mark on generating a profit from such transactions.
- Lack of transparency and understanding of cryptocurrency mechanisms: Although there is widespread adoption and acceptance of cryptocurrencies as alternative asset classes in modern-day investments, the lack of investor awareness and education on how cryptocurrencies work makes it even worse. Moreover, the lack of liquidity and transparency tends to quadruple the challenge of investing in cryptocurrencies.
- Lack of regulations: As opposed to the traditional financial system, which is regulated and tightly controlled, cryptocurrencies lack regulations across countries and jurisdictions. As the world of cryptocurrencies is at its nascent or embryonic stage, many countries are contemplating introducing rules and regulations. The lack of regulations exposes investors to fraud, crimes, and scams. There can also be market manipulation and price distortion due to a lack of stringent rules and regulations.
- Lack of risk management framework: The ill effects of financial risks like frauds, scams, disruption of internal or exchange servers, money laundering activities, and terrorism activities are some of the inherent risks faced by cryptocurrencies. The lack of a risk management system makes it even more difficult to detect and combat these risks. It is important to have security and risk management frameworks in place, ensuring periodic audits, thereby safeguarding and restoring investor confidence.
- Lack of taxation and accounting: Although blockchain and cryptocurrency can bring about the next wave of revolution in the digital economy, some countries are ignorant of its widespread opportunities in paving their way into mainstream finance. The lack of proper accounting and taxation of cryptocurrencies is still a probing challenge for government and governmental institutions to make cryptocurrency transactions a part of regular investment activities. For better governance and market stability, implementing transparent accounting and taxation laws is essential, thereby boosting investor confidence.
Cryptocurrency is still a widely discussed topic worldwide in terms of its impact and ramification on society. However, many countries believe in the merit of a decentralized financial system. Henceforth it is imperative to look at some of the legal status of cryptocurrencies prevalent in some countries.
China: The People’s Bank of China, the central bank of the country, in its latest resolution, passed on September 2021, banned all cryptocurrency transactions, including bitcoins and Tether making it illegal in the country.
India: India has neither regulated cryptocurrency nor legalized it so far. However, a tax rate of 30 per cent is imposed on investors and a 1 per cent TDS is levied on crypto transactions. The Cryptocurrency and Regulation of Official Digital Currency Bill is yet to be passed, which shall prohibit private transactions, but certain exceptions will be applicable.
European Union: The policymakers in the European Union are tightening cryptocurrency rules in lieu of money laundering. It neither made cryptocurrency legal nor illegal. However, they consider bitcoins as ‘crypto-assets’.
The possibilities of a decentralized and digital currency are explored widely. However, cryptocurrency’s potential risks and threats can prove to be catastrophic if these risks are not properly identified and mitigated. Policymakers must consider the lack of education, investor awareness, and regulatory uncertainties to implement an effective and transparent cryptocurrency ecosystem.
About the author
Anjali Kochhar covers cryptocurrency stories in India as well as globally. Having been in the field of media and journalism for over three years now, she has developed a sharp news sense and works hard to present information that goes beyond the obvious. She is an avid reader and loves writing on a wide range of subjects.