Cryptocurrency 101: The Pros and Cons of It as a Currency and an Investment Target
Introduction to Cryptocurrency
Bitcoin topped $100,000 for the first time, dramatically increasing from its initial value of just $0.0009 in October 2009. Back in September 2021, El Salvador made history as the first country to adopt Bitcoin as legal tender, requiring all businesses to accept the cryptocurrency. More recently, the introduction of Bitcoin Exchange-Traded Funds (ETFs) has further integrated cryptocurrency into traditional finance, opening new investment avenues for mainstream investors and solidifying its role in the modern financial landscape. But there are still many people who don’t know a lot about cryptocurrency and wonder how they should approach it. So, this article serves as an introduction to cryptocurrency as a currency and an investment.
At its core, cryptocurrency relies on a technology called blockchain, a type of digital ledger that records transactions across a distributed network of computers that removes the need for intermediaries like banks and enables transparent, secure peer-to-peer (P2P) transactions. This structure of blockchain and other designs of cryptocurrency create their unique attributes from traditional money: decentralization, anonymity, and scarcity. All attributes have their pros and cons.
Cryptocurrency: Currency of the Future or Fraught with Risks?
Decentralization in cryptocurrencies empowers individuals by reducing reliance on central banks but also introduces risks like scams and fraud in unregulated markets. The popularity of crypto attracts malicious actors, posing security threats (Navamani, 2023). Despite these risks, crypto's autonomy appeals to risk-tolerant individuals, privacy-conscious users, and those in restrictive financial regions. However, transaction delays and variable costs, especially during peak demand, remain concerns.
The anonymity provided by cryptocurrencies ensures user privacy but also facilitates money laundering and regulatory evasion (Dyntu & Dykyi, 2018). This has prompted governments to tighten regulations or even ban crypto use. Critics like Jamie Dimon, CEO of JP Morgan, have labeled cryptocurrencies as fraudulent or akin to Ponzi schemes due to their lack of intrinsic value and central authority backing (Taskinsoy, 2021).
The limited supply of cryptocurrencies, such as Bitcoin, underpins their appeal as inflation-resistant assets, especially during periods of economic instability and government mistrust. However, this scarcity can hinder economic growth, as governments and central banks cannot enact expansionary policies to stimulate the economy. A mismatch between currency supply and economic growth could trigger a deflationary cycle. In a deflationary cycle, consumers delay spending as they expect their money's purchasing power to increase while the price level falls. This postponement of purchases leads to declining demand for goods and services, which indeed drives prices lower. As demand weakens, producers respond by reducing output and cutting costs—primarily through wage reductions and workforce layoffs. These measures increase unemployment, further suppressing demand as households face reduced income and potential debt defaults. The resulting downward spiral of decreased consumption, investment, and production creates a self-reinforcing cycle that progressively dampens economic activity, deepening the recession. Avoiding a deflationary cycle is one of the reasons why many governments and central banks, like the U.S., set a mild annual inflation rate target, and they are deeply concerned about using a currency with a fixed amount like Bitcoin as the major currency.
Analysis of Cryptocurrency as an Investment Target
As an investment, cryptocurrency continues to spark debate among financial leaders. JP Morgan Chase’s Jamie Dimon remains a vocal critic, dismissing it outright, while Elon Musk sees value in its ability to counter centralized control (Bambrough, 2024). BlackRock, the world’s largest asset manager, has taken a more cautious approach, introducing Bitcoin ETFs and signaling institutional recognition of crypto as an asset class. These differing viewpoints shape cryptocurrency’s market supply and demand dynamics.
Cryptocurrency supply is relatively stable, with new coins created through mining—a slow process. Environmental concerns around mining’s Proof-of-Work (PoW) system led to regulations, slowing supply growth. This issue is being addressed by transitioning to Proof-of-Stake (PoS) (Wendl, 2023).
Demand for cryptocurrencies is more complex, driven by support and opposition. Support stems from their appeal as a hedge against fiat currencies in high-inflation regions and times of geopolitical tension like now. Speculative interest and high-return potential also fuel demand, where market sentiment drives value beyond fundamentals. Many speculators hope to achieve rapid wealth through leveraged trading, similar to gambling. Unlike traditional markets, cryptocurrency markets show extreme daily price swings, making valuations challenging and sentiment-driven (Wątorek et al., 2021). Tech enthusiasts also support cryptocurrencies for their blockchain and decentralization potential.
Conversely, crypto’s volatility deters risk-averse investors and institutions. Some still view it as a portfolio diversifier due to its low correlation with traditional assets. Regulatory scrutiny further hampers adoption, as governments are wary of decentralized assets bypassing their control. A major economy banning crypto could trigger a market crash. The limited population acceptance as a payment medium also restricts cryptocurrency’s practical utility in everyday transactions, contrasting with fiat currencies and adding complexity to its valuation.
Conclusion
Cryptocurrency represents a multifaceted asset class that blends financial technology with speculative investment. Its blockchain-based foundation enables secure, decentralized transactions, appealing to users seeking autonomy from traditional institutions. However, the high volatility and speculative behavior associated with cryptocurrencies necessitate a balanced view, recognizing both the innovation it brings and the risks it entails. As regulations evolve and technology advances, cryptocurrency may continue to bridge the gap between traditional finance and digital assets, becoming a more established element in global finance.
Edited by Jeffrey Wu
References
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Dyntu, V., & Dykyi, O. (2018). Cryptocurrency in the system of money laundering. Baltic Journal of Economic Studies, 4(5), 75-81. https://doi.org/10.30525/2256-0742/2018-4-5-75-81
Navamani, T. M. (2023). A review on cryptocurrencies security. Journal of Applied Security Research, 18(1), 49-69. https://doi.org/10.1080/19361610.2021.1933322
Taskinsoy, J. (2021). Bitcoin: A New Digital Gold Standard in the 21st Century?. Available at SSRN 3941857.
Wątorek, M., Drożdż, S., Kwapień, J., Minati, L., Oświęcimka, P., & Stanuszek, M. (2021). Multiscale characteristics of the emerging global cryptocurrency market. Physics Reports, 901, 1-82. https://doi.org/10.1016/j.physrep.2020.10.005
Wendl, M., Doan, M. H., & Sassen, R. (2023). The environmental impact of cryptocurrencies using proof of work and proof of stake consensus algorithms: A systematic review. Journal of Environmental Management, 326, 116530. https://doi.org/10.13140/RG.2.2.15875.07201
Zidar, D. (n.d.). The prices of Bitcoin and other cryptocurrencies have collapsed this year [Illustration]. Dreamstime. https://www.barrons.com/articles/bitcoin-ethereum-dogecoin-price-crypto-today-51656408305
