Cryptocurrencies

‘Cryptocurrencies’ are often talked about but they’re not well-understood. In 2019, 73% of the UK population said they didn’t understand the idea.

What are cryptocurrencies?

‘Cryptocurrencies’ are a digital means of financial exchange. This briefing focuses on the ‘decentralised’ model used by Bitcoin, which is still dominant. In traditional currencies, governments and central banks guarantee to maintain confidence. Bitcoin replaces this with a public algorithm and technology. But being ‘decentralised’ means that there is nobody to take responsibility when things go wrong.

Most cryptocurrencies are very volatile in value and not suitable for everyday financial transactions. They are often used for speculative investment, and the overall market is comparatively small. It may be better to call them ‘crypto-assets’, ‘exchange tokens’ or ‘unregulated tokens’.

How do they work?

Users of cryptocurrencies receive public and private cryptographic keys and a ‘public address’. These enable them to make and accept transfers and to withdraw funds. Accounts are usually anonymous.

All cryptocurrencies use distributed ledger technology (DLT) to verify transactions. This involves multiple confirmations of transactions that are than added to a permanent record – the blockchain in the case of Bitcoin. Multiple checking is meant to make fraud next to impossible.

Benefits and challenges

• Cryptocurrencies may have been over-hyped. They may be a solution looking for a problem. But many financial services and authorities are interested in DLT.

• Most cryptocurrencies are extremely volatile. They may be more attractive in countries in economic chaos. More regulation and uptake may help to reduce this volatility.

• Approving transactions may be slow and open to premium charges. This undermines some of the improvements to traditional systems that they were meant to offer.

• Running Bitcoin relies on vast amounts computer processing power. This is unlikely to be sustainable for continued expansion. By January 2020, Bitcoin processing was using as much electricity as Austria.

• The decentralised nature of most cryptocurrencies has made them attractive to organised crime and tax evasion. But the public ledger can enable audit and tracing of criminal transactions.

• Cryptocurrencies can present major risks to consumers. There is little or no guarantee for protecting investment. There is a wide range of scams that take advantage of the mystique of the cryptocurrency.

Political and regulatory responses

The Bank of England and other authorities have strongly highlighted the consumer risks of cryptocurrencies. They have tended to play down their threat to established systems.

The Financial Conduct Authority (FCA) regulates some types of crypto-assets that function like shares or investments. Cryptocurrency exchanges must register with the FCA and follow anti money laundering regulations. The FCA can offer little further consumer protection.

Facebook and the Libra

In June 2019, Facebook announced the proposed launch of a new cryptocurrency, the Libra. They aimed to overcome some of the drawbacks described above. But the political and regulatory response has been very critical. Many partners have since withdrawn from the project.