Cryptocurrencies are unregulated in the UK. Capital Gains Tax or other taxes may apply. The value of investments is variable and can go down as well as up.
By the end of this article you will understand:
1. The benefits of cryptocurrencies
2. The limitations of cryptocurrencies
3. Why there are so many different types of cryptocurrencies and why they have different values
What are the benefits of cryptocurrency?
Communicating the benefit of any new technology comes down to demonstrating that it solves a problem. In this article, we look at some of the ways cryptocurrency tackles issues with our existing money.
But solutions aren’t enough unless they are scalable and feasible. So, we’ll look at the limitations of cryptocurrency before bringing the pros and cons together to think about how to attach a value to crypto.
Let’s start by looking at the problems crypto solves with existing money and the potential use cases:
Anyone with an internet connection can use Bitcoin, Ethereum or any other cryptocurrency; there is no application process or restriction – they simply need a crypto wallet.
Use case: The millions of unbanked (people without access to a bank account) worldwide
Alice can send Bob cryptocurrency wherever he is in the world, and the transaction will generally be faster and cheaper than traditional payment options. For example, there are no foreign exchange charges.
Use case: Foreign workers sending funds home (remittance)
Cryptocurrencies are designed so that rule changes are democratic, protecting against censorship or the exclusion of specific user groups or uses.
Use case: Anyone suffering financial repression
Anyone with an internet connection can see the entire Bitcoin transaction history without revealing the identity of Alice or Bob.
Use case: Minimises transaction disputes
Some cryptocurrencies have a fixed limit on the number of coins that will ever exist. For example, there will only ever be 21 million bitcoin.
Scarce commodities provide good stores of value (they maintain purchasing power), which is why Bitcoin is described as digital gold.
Use case: An alternative store of value
Though it's great that Alice and Bob can quickly send money or data to each other regardless of where they are and without knowing each other, there are limits to cryptocurrency transactions.
Speed of transaction
Each cryptocurrency processes transactions at different speeds. Some are near instant, but the Bitcoin Protocol dictates that batches of transactions can take up to ten minutes, which is impractical for time-sensitive purchases, like buying a cup of coffee.
Number of transactions
Each cryptocurrency has different capabilities regarding the number of transactions that can be processed in a block; few if any, can rival Visa or Mastercard throughput right now.
Bitcoin sacrifices speed and scale to prioritise security by ensuring the system remains decentralised. Other blockchains are faster and with greater transaction throughput but less decentralised.
This problem of balancing security, scalability and decentralisation is known as the blockchain trilemma, and is one of the main limitations of cryptocurrency, but not the only one.
The downside to a permissionless money network is that it inevitably includes bad actors. These bad actors are individuals or groups that mean to cause harm to the network, for example, with hacks or scams.
Even if illicit activity accounts for a tiny proportion of transactions, the amounts are significant and have prompted calls for greater regulation.
Another negative perception of cryptocurrency is the environmental impact of the mining process used by Bitcoin and other proof-of-work blockchains because it’s so energy intensive.
There is no clear agreement on how to measure the environmental impact of blockchains or comprehensive data on the proportion of mining that uses sustainable energy. The issue was, however, considered important enough for Ethereum to switch to proof-of-stake in 2022, which they claim reduced their carbon footprint by approximately 99.992%.
The disruptive potential of cryptocurrencies has made them a popular form of investment, but no one knows if they will fulfil that potential. That uncertainty and irrational trader behaviour can create price volatility, which makes many cryptocurrencies less suitable as money for everyday usage.
There are now thousands of cryptocurrencies sharing common basic characteristics but offering different solutions to the blockchain trilemma, the issue of volatility (stablecoins), or just disruptive branding (meme coins).
The latest cryptocurrency prices and market caps can be seen on our live rates page, which shows how different cryptocurrencies are performing in real-time.
What are cryptocurrencies worth?
When Alice sends Bob £20, they both trust that the banking settlement layer is reliable and the issuer of the money (the Bank of England) is trustworthy. This trust ensures that pounds retain value and are happily accepted by businesses and consumers.
The value of British pounds (GBP) does fluctuate relative to other currencies (Euros, Dollars etc) as perceptions of its reliability vary, but those fluctuations are minor in the short term.
Without that stability, Alice and Bob would want to use a different currency, as is happening in Venezuela or Zimbabwe.
Blockchains represent alternative issuers to the Bank of England (or any other central bank), and their cryptocurrencies not only function as different types of value units but also as a means of valuing the underlying system and network, a bit like a share in a company.
Right now, more people are buying cryptocurrencies to speculate on their value as an investment rather than using them as money or to pay for using digital applications (dApps).
And the perception of that investment value varies because there are so many factors influencing it, such as regulation, adoption, the economics of the system that decides how many units of the cryptocurrency will ever exist (scarcity) and how they are distributed.
This uncertainty translates into short-term price volatility and longer-term periods of prolonged positive sentiment (Bull Cycles) and negative sentiment (Bear Cycles).
What are the benefits of cryptocurrency? A recap
Cryptocurrency has five main benefits. It is:
- Digitally scarce
But cryptocurrency also has limitations, which include:
- The blockchain trilemma, the balance of speed, scalability and security
- Environmental concerns
- Illicit transactions
Cryptocurrencies are a popular form of investment and speculation but assessing their fundamental value is challenging. It requires:
- Measuring their benefits over existing money and the size of the market
- Understanding existing limitations such as whether adoption can scale
- Knowing the impact of external factors like regulation and political resistance