Crypto’s uncertain future has been reinforced by the crash in 2022 of the cryptocurrency markets, while many investors continue to be interested in digital assets. If you are considering making an investment in this space, make sure that you have solid knowledge of both the challenges and opportunities in crypto.
Over the years, hype, bubble-mentality, and fraud has periodically inflated digital currency values. The sector still lacks fiduciary responsibility and regulation. The environmental impact of the crypto industry’s high energy demands on computers is alarming for both consumers and government.
Even though there are concerns about the future, enthusiasts remain optimistic. As of May 20, 2023, the global market capitalization for cryptocurrency exceeded $1 trillion. The blockchain technology that underpins the coin has many applications outside of cryptography, including in healthcare, media, and supply chain.
This article outlines some of the crises and controversies that have marked the cryptomarket in the past few years. In this article, I provide an overview of what crypto is, how it’s regulated and treated in accounting, and the things potential investors should know when they look at investing in such a volatile market.
Cryptocurrency Market Issues
According to the 2023 Pew Research Foundation survey, most Americans do not trust cryptocurrencies for their safety or reliability. Crypto enthusiasts may be worried by a number of factors.
Crypto Crash and Volatility
Crypto tokens can be volatile, vulnerable to frauds and even those that are advertised to have a stable value and to be backed up by real assets for their security collapsed.
The digital stablecoin TerraUSD, and its algorithmic stablecoin LUNA crashed in May 2022. This caused the cryptomarket to crash and investors to lose over $400 billion. Then, in November of the same year, crypto exchange FTX crashed due to insufficient liquidity, mismanagement of funds, and excessive withdrawals from unnerved investors–depressing the value of its token, FTT, as well as those of numerous other cryptocurrencies, including Bitcoin and Ethereum.
The fall of FTX has also affected other major exchanges: BlockFi, Gemini’s partner in third-party lending, Genesis Global Capital, froze all withdrawals. Crypto.com also frozen withdrawals for the USDC stablecoin and the Tether (USDT) whose values are based upon the US dollar. Coinbase has laid off nearly 1,000 staff in response to the aftermath of the crash.
Crypto crash brought the NFT down as well. In August 2022, the prices of popular NFTs like Bored Ape Yacht Club or CryptoPunks were slashed more than 50%. The collapse coincided with a drop in the price of cryptocurrency, but other factors such as high-profile scams or market saturation also played an important role.
Before these recent nosedives the cryptomarket had crashed multiple times. This was mainly due to media hype and investor speculation. This shows the instability of crypto but also that technology and currencies can withstand it.
Crime and deception
Some of the players who are most responsible for the functioning of digital currencies have already been accused of crimes, such as fraud, in 2022. These include Sam Bankman Fried of FTX, Do Kwon of Terraform Labs (the parent company of TerraUSD, LUNA, and Su Zhu of Three Arrows Capital).
Criminals also generated 117,000 fake tokens in 2022 to rob investors out of billions. Initial coin offerings are often suspect. This is especially true for cryptocurrencies that have speculative models. They’ve also been criticized by many as scams.
When transactions are disputed, the unregulated and pseudonymous nature of Bitcoin and blockchain transactions raises additional concerns. If the product or service provided is not up to standard, it can be cancelled and the funds refunded. There is currently no central authority in the crypto ecosystem that facilitates recourse.
Safety and privacy concerns
The blockchain is very difficult to hack. However, this is not true for exchanges that trade cryptocurrency. Since nearly a century, computer hacking has been a major problem. In 2015, hackers stole up to 850,000 Bitcoins from Tokyo’s Mt. Gox. Criminals hacked FTX in November 2022 when it declared bankruptcy and stole $600,000,000. Hackers stole $570 Million from Binance the month before. In 2021, 2022 and 2023 there were other attacks with combined funds of more than $1 billion.
Hackers can hack the code behind smart contracts. Hackers stole 613 million dollars from Poly Network, in one of the largest digital heists ever. The DeFi platform allowed peer-to-peer transactions, i.e. direct token exchanges between blockchains. A vulnerability in the contract which automated token transfers made the theft possible. The hacker claimed he only wanted to expose the “vulnerability” and returned the money within a couple of days. However, the incident exposed the serious risks these platforms face.
Ransomware is also common. Hackers infiltrate user accounts and then encrypt personal data to render it unreadable. They demand payment by crypto.
Bitcoin and other coins that use proof-ofwork to verify their consensus, like Ethereum, consume enormous energy. Ethereum’s tokens after 2022 will consume less energy than proof-of-stake. Ethereum claims to use 99.9% less power than it did before. However, the Centre for Alternative Finance at Cambridge University says that this is equivalent to comparing an observation wheel with a raspberry.
A US government factsheet states that by August 2022 crypto will consume 120 to 240 billion Kilowatt Hours annually, which is more than some countries’ annual electricity consumption. It’s not the top contributor to climate change, but it is one.
Crypto mining also caused significant power outages in Iran and Kosovo.
Responsibility, regulation, and oversight
National regulators have limited influence because cryptocurrency technology is not bound by political borders. Financial Stability Board (FSB) and International Monetary Fund (IMF) have combined forces in order to develop a global regulatory framework. New rules are expected by September 20, 2023.
Nevertheless, many countries decided to move forward immediately. A few countries, including China, Egypt and Iraq, Morocco and Algeria and Tunisia, have banned the issuing or holding of tokens due to environmental and/or criminal concerns. 42 other nations, however, have implemented regulations that restrict crypto exchanges and limit how banks are able to interact with these currencies. Other countries, however, have attempted to encourage companies to develop markets for the assets.
Japan, Switzerland and the United Arab Emirates all changed or added new laws between September 2022 to January 2023. PwC called the Swiss framework as one of the maturest to date, and the UAE created the world’s first virtual currency authority. Canada, Australia and the UK are all still working on legislation. The EU is close to adopting regulations.
Congress in the US has been monitoring cryptocurrency closely for the past few years. Events like the collapse of FTX are likely to trigger more scrutiny.
It’s not clear whether regulations will succeed, however, because cryptocurrencies were created to circumvent governmental control.
Why do investors choose cryptocurrency?
Although there are a variety of concerns about cryptocurrency, certain investors still find it appealing for several reasons. Investors are drawn to crypto because of the fluctuating prices and speculative nature.
Investors also like cryptocurrency because of the unique features they provide, including decentralization and security. Crypto enthusiasts, however, believe that these perceived benefits are mostly theoretical for the time being. They expect to see more widespread adoption of cryptocurrencies in the future, including faster transactions and lower prices, as well as improved privacy and security.
Protection Against Political Crises
Many people invest in cryptocurrency as a hedge against geopolitical risks. Prices of cryptocurrencies tend to rise during times of political unrest. In 2015, as political and economic unrest in Brazil increased, Bitcoin trade grew by 322%, while wallet usage grew by 461%. In response to Brexit and other destabilizing events, Bitcoin prices also rose.
Pseudonymity (Near Anonymity)
Cryptocurrencies are often viewed as a way to guarantee anonymous transactions. It’s not true. They offer pseudonymity instead, which is a state of near anonymity that allows consumers to make purchases without giving personal information to the merchant. These transactions are still subject to AML regulations, and trading platforms may ask customers for proof of identification such as an official ID. AML/KYC data could be used to track transactions to an individual or company by the law enforcement.
Programmable “Smart” Capabilities
Smart capabilities provide a certain level of programming or advanced functionality in a cryptocurrency or blockchain protocol. Some cryptocurrencies offer other advantages to their holders. These include limited ownership rights and voting rights for “stockholders” in the software code.
Non-fungible Tokens (NFTs) are a well-known, but not the only example. The digital assets are used to represent the ownership of an item, piece, or digital content such as art, collectibles or virtual property. Blockchain technology is used for authentication and provenance. These digital tokens can also represent fractional interests in assets such as art and real estate.
Other mechanisms can be used to block a transaction until the predetermined period of time or a condition has been met. Some cryptocurrency implement “smart privacy” features such as stealth addresses or ring signatures. Users can transact in a private manner by hiding transaction information, including the recipient and sender.
Smart contracts are the most common application of smart contract technology. These self-executing, coded agreements include the terms in the agreement. The contract terms are written into the code of these contracts, which automatically enforces the agreed conditions.
Consider supply chain management, as an example. Imagine a cotton-supplier contract between a company and a supplier of clothing. The smart contract specifies quality, quantity, delivery date, price, etc. The smart contract releases payment automatically to the provider once the conditions are met. No manual intervention is required or any third party verification. The smart contract then records that the cotton has been received by the factory. The smart contract records each stage of production, including dyeing, weaving and cutting, as manufacturing commences. The smart contract provides a tamperproof and accurate record of each stage in the manufacturing process. This ensures traceability and high quality.
The fact that cryptocurrencies allow for P2P transactions is one of their greatest benefits. P2P transactions are less susceptible to hacking and regulatory closures, which can affect trades made on central exchanges. This is because P2P doesn’t require the user or transactional information of the users or that they store their cryptocurrency within the exchange’s wallet. P2P transactions are more private, offer lower fees and allow for a greater variety of payment options as long as users protect their personal information.
Cryptocurrency: What you need to know before investing
It’s difficult to grasp cryptocurrency because it isn’t just digital currency. Investors are exposed to many risks. Many NFT holders learned this the hard way when, in 2021, they realized how little control over their art was left. It’s vital to understand exactly what you are buying to avoid costly surprises in the future.
What is Cryptocurrency?
Cryptocurrency is a type of digital asset which uses encryption techniques, such as cryptography. Some cryptocurrencies have smart features that allow them to be used for more than just buying and selling goods. The majority of cryptocurrencies do not have a backing such as gold and they are generally not considered legal tender. They are generally also issued by private organisations.
This isn’t always the case. In recent years, stablecoins — coins pegged to an asset like gold or the dollar — as well as digital currencies issued by the central banks in a few nations, including Nigeria and Bahamas, have been developed.
ICOs are used by some companies to raise money for the development of new Blockchain and Crypto technologies. They offer digital tokens instead of shares. The early access that investors receive to the cryptocurrency, and its associated capabilities is a benefit. Blockchain projects raised billions via ICOs.
Estimates indicate that 420 millions people will own cryptocurrency by 2023.
Different types of cryptocurrencies
Tokens such as Ethereum are a type of cryptocurrency that is used to purchase goods and services. Tokens can also be used to support digital records such as NFTs or smart contracts.
Bitcoin, released in 2009 under an alias Satoshi Nakamoto, is the world’s most popular cryptocurrency. It has a roughly 45% market share. Both the seller and buyer use mobile wallets in a payment transaction. In recent years the list of businesses accepting Bitcoin has grown, but some have stopped temporarily taking it due to its volatility, such as Microsoft and Twitch.
Bitcoin is not without its flaws. It can only process seven transactions per second, while Visa processes thousands. Its functionality is limited as well: Because it was designed primarily to be a tradeable currency, smart contracts and other decentralized apps are not supported. Bitcoin has experienced dramatic price fluctuations over the past few years. It crashed in 2018 due to developments such as tougher regulations from China and India. The SEC announced a crackdown against crypto exchanges. And the Binance exchange was reportedly hacked. Bitcoin boomed in 2021, as institutional investors started to take cryptocurrency seriously. Then it crashed again in 2022 after the FTX case.
Ethereum is a Blockchain that makes it relatively simple to create smart contracts. Ether, on the other hand, is the token you use when entering into Ethereum transactions. Ether, and other digital currencies that are based on Ethereum’s blockchain, have grown in popularity. Ethereum’s capitalization stood at $218 billion in May 2023. It has been volatile in recent years due partly to problems with the technology. However, its current market share is higher than two years ago.
Bitcoin and Ethereum still account for the majority of the market, but in the past decade, many other digital tokens and coins have emerged and grown rapidly, such as Litecoin Zcash Dash and Dogecoin. Nearly 23,000 different cryptocurrency exist in the world today.
What is Cryptocurrency?
Bitcoin, and the majority of other crypto currencies, are based on blockchain technology. The system relies on constantly updated ledgers, either public or private, that keep track of all transactions. It is decentralized and processes transactions without the involvement of a central authority such as a government or payment company. This is called an untrustworthy system.
The blockchain uses consensus mechanisms instead to validate transactions. These are recorded by multiple nodes. Nodes are computers that connect to the network of blockchains and download a copy automatically when they join the network. All nodes have to agree for a transaction be valid.
Both buyer and seller must approve and confirm any transaction before it can be added to the blockchain. The chain is secured by a third party, also known as a “miner”, “validator” depending on how the verification method was used. All parties must agree to alter the transaction data. The process for consensus is different depending on the blockchain. There are basically two methods of verification: proof-of work and proof-of stake.
Proof-of-work is used by many cryptocurrencies including Bitcoin. Mining is the process that confirms transactions and creates new currency units for proof-ofwork systems. To verify a transaction, miners have to solve a very difficult cryptographic problem. The first person to solve it is awarded cryptocurrency.
A proof-ofwork system allows anyone with enough computing power to mine, however, the overhead is high, since an individual computer cannot mine cryptocurrency profitably. Miners use several computers to boost their collective computing power. They also join mining pools in order to compete with each other to confirm pending transactions.
But profits are falling. Profitability of Bitcoin mining plummeted by 70% between October 2021 and May 2023 as overhead costs for Bitcoin miners grew. In the same time period, Bitcoin’s price fell by 63%. Due to strains on electricity grids, many countries have prohibited mining. Some cryptocurrencies, such as Ethereum, have completely stopped allowing anyone to mine.
Ethereum will switch to proof-of stake, a consensus method that is less energy intensive in September 2022. Users stake their coins in a proof of stake system to validate a transaction. To get back their staked coin, validators have to confirm that the transaction is accurate. A transaction fee is paid to the validator for his or her work. Proof-of-stake eliminates a race among multiple mining farms or miners to validate the transaction first, as only one validator will be chosen at random by an algorithm. The amount of electricity needed to validate transactions is reduced dramatically, lowering costs and emissions.
What is Cryptocurrency?
Most cryptocurrency transactions are done online, through wallets and exchanges.
Websites that allow individuals to buy, trade, and sell cryptocurrencies in exchange for traditional or digital currencies are cryptocurrency exchanges. These sites allow you to convert your coins into government-backed money or crypto tokens into other currencies. Binance, Coinbase Exchange Kraken and KuCoin are some of the biggest exchanges. They can trade over $10 billion per day. The majority of legally-operating exchanges adhere to government AML/KYC regulations. There are some decentralized exchanges which do not ask users for KYC data. Users who are interested in trading should be cautious as increased anonymity can increase risk.
To reduce risk, it is best to store crypto-assets in a wallet rather than an exchange. By generating and storing public and private keys, crypto wallets allow users to communicate with blockchain networks. Public keys are used to receive funds and private keys for signing and authorizing transactions. The wallet does not hold the user’s actual coins but the keys to them, which are held on the public blockchain network. A crypto wallet will not make your funds immune from price drops, but it can protect them against lock-ups, suspension of withdrawals and cyberattacks. Hardware or software wallets are available, but hardware is considered to be more secure. Ledger, for instance, is a wallet that looks like a USB and can be connected to a PC.
Virtual software wallets, while more risky because they are hosted online and therefore accessible to hackers, are also cheaper, easier to install on multiple devices, as well as being generally user-friendly.
The Price of Cryptocurrency: Factors that affect it
The difference in the interest rate, inflation, money supply, and capital flows between countries determines typically how much traditional currencies are worth. The value of crypto coin is affected by different factors:
Demand and Supply
Experts predict that the blockchain code will limit the total supply of Bitcoins to 21 million. With more than 19,000,000 Bitcoin already mined by miners, they should reach the 21 million mark in the year 2140. The price will likely increase if adoption rates are higher. Not all cryptos work in this manner. Some cryptocurrencies have unique tokenomics that define the total supply of their cryptocurrencies and their issuance model.
As a medium of exchange, cryptocurrency has value. The appeal of cryptocurrencies can be increased by improving the Bitcoin model, or by adding other features, like smart contracts that add value, to Ether.
Changes to the Regulatory Framework
The value of crypto currencies is heavily influenced by the future expectation, so increasing regulations will have a significant impact. Japan, unlike much of the rest of the globe, already has an established and expanding regulatory system, largely influenced by Mt. The Mt. Europe is expected to implement new rules as soon as July 2024. The US has not yet decided how it will regulate digital assets, although US President Joe Biden issued an executive order authorizing greater oversight and regulation in 2022 in response to the “dramatic” growth of cryptocurrency.
Prices of cryptocurrency often respond to technological changes. Bitcoin’s value, for example, dropped during the 2017 controversy over changing technology in order to speed up transactions. Two weeks later, however, after the technology change, Bitcoin’s price soared to $1,600, a new record. The price of Ethereum also dropped by more than 20 percent when it switched to a proof-of stake system from proof-of work. Reports about hacks of crypto exchanges often result in price drops.
Misbehavior of Investors
Bubble mentalities can inflate crypto values. The people in charge of crypto currencies can drive the value up by increasing hype, increasing speculation and limiting token supply for trading. Fraud is another significant factor in the inflated price. The con artists take advantage of the crypto-hype by using tactics such as grift and pump-and dump schemes. They also use exit scams in order to increase their wealth.
What is the taxation of cryptocurrency?
According to current accounting standards, cryptocurrency is not considered cash because it lacks the liquidity of cash and its stable value. The accounting treatment of cryptocurrency is uncertain, as the International Finance Reporting Standards and the American Institute of CPAs have not yet issued official guidance.
The IRS in the US instructs digital asset holders to consider them personal property, and to be subject to the exact same tax obligations that apply to property transactions. The value of crypto holdings on a balance is the same as the fair value when acquired.
Accounting treatment outside the US varies. The European Court of Justice decided in 2015 that cryptocurrency should be treated as government-backed currency, with holders not being taxed for purchases and sales. A new proposal by the European Parliament includes taxes on capital gains and transactions for investors, as well as mining.
In Japan, cryptocurrencies in 2017 were also reclassified and reduced to a 8% tax on consumption.
Cryptocurrency: The Ultimate Challenge
Bill Miller and other experts remain optimistic about cryptocurrency five years after its peak in 2017.
Cryptocurrency is, in the most basic terms, a phenomenon of fintech. On a deeper level, however, it represents a technology that challenges the economic, political and social foundations of our society.
The blockchain technology, which emerged out of cryptocurrency, has the potential to change the way businesses are conducted. CB Insights, a technology consulting company, has identified the ways in which blockchains can transform processes such as voting, supply chain management, banking and cybersecurity. By 2030, financial analysts expect the global blockchain technology market to generate revenues of around $1.24 trillion. This is up from just $5.85 billion dollars in 2021.
Crypto-enthusiasts face a challenge in advancing technology to the fullest potential, while building public confidence enough to reach mainstream adoption.
The article was recently updated to include the most recent and accurate information. The comments below could predate the changes.