Cryptocurrency – Innovation?
Fear of missing out, or “bandwagon” consumer behaviour, seem to be recurring themes in current digital marketing. Buzzwords like “AI”, “smart” “blockchain”, and “the cloud” are pervasive in many advertisements, implying that the use of these technologies is synonymous with innovation, no matter what the context. Cryptocurrency (crypto) has been one of the most discussed recent developments, beginning in the early 2010s and surging to mainstream attention around 2017.
Crypto: A Brief Introduction
Blockchain is a digital ledger (a record of financial transactions). A database stores transactions as blocks and links each block to the next. This chain is immutable, which means that the blockchain can only be changed with consensus from the system. No single person or entity has control over the entire blockchain – additions, changes, deletions must be approved by all the computers in the network (called nodes). The nodes use cryptography to verify transactions from users, hence the “crypto” in cryptocurrency. In short, blockchain is a transparent, decentralised way to maintain transaction records. Unlike fiat currency (currency that has value because governments say it does), cryptocurrencies have no intrinsic value as they are currently not regulated or managed by central governments.
Transactions are entered on the blockchain through “mining”, a process that uses computational power to “solve complex mathematical problems that generate coins” (Kaspersky 2018). The first miner whose computer determines the correct number set by the difficulty algorithm (an algorithm set by the cryptocurrency’s network) will be rewarded in Bitcoin (a type of cryptocurrency). Successful, competitive mining requires specific hardware, a considerable amount of electricity, and low latency (latency is the time it takes for data to travel from the local computer to the server).
Figure 1: Cryptocurrency Explained (Source: Reserve Bank of Australia)
Cryptocurrency’s appeal to the public largely stems from the potential for financial transparency, decentralisation, perceived optimism and “anonymity”. Although this rhetoric is very alluring, we must pose the question: are all the innovative promises true?
Debunking no. 1: Perceived Accessibility and Usability
“Banking the Unbanked” is a heavily used phrase in the crypto space that refers to the idea that those that do not have access to the required resources for traditional banking could use cryptocurrency instead. This virtuous notion makes sense in theory: cryptocurrency has decreased remittance fees and no requirements for home addresses or ID documents; the only requirement would be an internet connection and a digital device.
Conversely 2022 article “Debunking the narratives about cryptocurrency and financial inclusion” (Carmona) thoroughly refutes cryptocurrency’s financial inclusion power, utilising research to highlight the differences in what “banking the unbanked” aims for and what can actually be achieved:
“Many crypto platforms... require a bank account to use cryptocurrencies, so this defeats the purpose of serving the unbanked” (Carmona 2022, pp. 11)
“... what unbanked populations really need are simple, safe, and inexpensive ways to save their money” (Carmona 2022, pp. 12)
Crypto’s lack of scalability due to network volume can cause slow transactions, and low-income Americans need fast, reliable payment systems
Hidden fees and volatility make crypto unsuitable and unreliable9
“Crypto would need to address barriers to asset-building activities and products in order to serve the needs of historically excluded groups and account for the fact that people will enter the crypto ecosystem at different wealth levels” (Carmona 2022, pp. 25)
Debunking no. 2: Average Use Case
While transparency and immutability are important selling points for blockchain technology, when it comes to utility, it is important to examine if those qualities truly work for the specified context. What if an accidental transaction was made? What if the user wants more standardised security measures, like anti-money laundering, or ID verification in place? Realistically, for the average person, crypto is expensive to use; for example, with Ethereum (a blockchain), the fees are substantial for a single transaction unless it is a high value transaction. This begs the question, what value does cryptocurrency provide that traditional banking systems do not?
Cryptocurrency, because it is (or should be) decentralised, is not subject to exchange rates, geographical limits, or third-party intermediaries. This is beneficial for individuals that desire privacy and government censorship; however, it is important not to conflate privacy with usability.
Debunking no. 3: Risk to Reward Ratio
The fall of FTX, the Silvergate Bank failure, the LUNA crash, and many alleged influencer scams like the Save the Kids token are just a few examples of the unstable cryptocurrency landscape. It is estimated that $24.2 billion dollars have been stolen in crypto currency hacks in 2023 and 54% of ERC-20 (Ethereum Request for Comments 20) tokens listed on decentralised exchanges in 2023 displayed patterns that may be suggestive of pump and dump schemes.11 Pump and dump schemes usually involve “pumping” up the price of a coin or a stock by using false information and/or publicity, and then selling when it hits peak price. The others are then typically left with a loss, and a coin or stock that has little to no monetary value.
Market speculation, lack of clear and consistent regulations and technological developments like forks can make cryptocurrencies extremely volatile. Although cryptocurrency is often marketed as a high-yield financial investment tool, the risk to reward ratio is extremely unbalanced due to high-volatility, scams and hacks.
Debunking no. 3: Pseudonymity and Anonymity Are Not the Same
Due to the fact that users are identified by their unique wallet address, which is not directly associated with their identity, many infer that this makes their activity anonymous. Cryptocurrency is actually pseudonymous (under a fake name), therefore, with sufficient data analysis and effort, it can be possible to trace transactions and identify individuals (it is important to mention that many platforms such as Tornado Cash can achieve the anonymous result some users want). A well-known example of this was how police used blockchain analysis to trace stolen Bitcoins from the 2016 Bitfinex hack. It is important to mention that supplementary platforms such as Tornado Cash, a “tumbler” that mixed individual’s cryptocurrencies (“dirty” money is often mixed with “clean” money) can preserve anonymity, however majority of these platforms operate in a legal grey area or are simply illegal.
Debunking no. 4: The Flipside of Censorship and Proof of Work
It is no question that cryptocurrency’s relatively anonymous transactions can enable illegal activity such as money laundering, dark web transactions, or evading sanctions, and that the lack of policy governing cryptocurrency leaves regulatory gaps. There is also significant environmental impact due to the computation-heavy proof-of-work system used by some cryptocurrencies, as mining consumes a vast amount of electricity and requires specific hardware, increasing the amount of e-waste generated. Environmental impact, lack of regulation, and anonymity should be carefully investigated before cryptocurrency is accepted as an innovative technology.
Conclusion
Ultimately, all new technologies should be examined objectively to determine if there is value provided in their respective environments. In the case of cryptocurrency, factors such as accessibility, usability, censorship resistance, and ethical implications should be carefully considered before there is widespread adoption and integration into financial systems. Perhaps what is accepted as innovative is not as revolutionary as it purports to be.