How we (should) behave around crypto
As the world is slowly gearing towards digital economies, the likes of cryptocurrencies and altcoins are transforming our financial infrastructure. Governments still seem puzzled whether to embrace, support or reject the initiatives as the industry is on a fast train of innovation. While use cases are proven and digital currencies are trending to become mainstream, how to ensure our population is well prepared and its underlying technology will harvest greater financial inclusion?
Everyone has heard of them: cryptocurrencies. A new medium of exchange — i.e. digital currency and asset — enabling consumers to purchase goods and services typically via a decentralized ledger — i.e. outside of a centralized banking system — .
With some of them (Bitcoin, Ethereum, XRP…) showing signs of extreme value increase (some would call it volatility), their mainstream adoption over the past ten years has also become a source of worry for many policymakers.
But complimentary currencies are not new. They’ve actually been around for decades and have found a whiff of sympathy since the financial crisis of 2007.
As a response to a so-called broken system, initiatives around the world such as in France, Switzerland or Korea introduced local and regional currencies to encourage spending with local communities and businesses, and functions as an ethical and ideological response to exchanging goods and services.
In a similar fashion, the digital versions have soon developed. Since the launch of Bitcoin, more than 6,000 altcoins — alternative variants of crypto’s — have been created and are being traded. And while the global cryptocurrency market was estimated at $754 million in 2019, and is expected to grow to over $1.7 billion by 2027, the current total market capitalization of all these currencies stand at over $200 billion.
That’s a lot of money. And a headache for many governments and policymakers.
Crypto’s libertarian philosophy is about freedom from markets, institutions, regulation, or anything else overseeing one’s willingness to transact.
Dollarization 2.0.
In its original manifesto the mysterious and supposedly founder of Bitcoin, Satoshi Nakamoto, introduces the cryptocurrency as a way to replace trusted third parties by a peer-to-peer network enabling a more transparent financial system.
This manifesto, predated by years of free software movement, is at the very core of crypto’s libertarian philosophy: freedom. Freedom from markets, institutions, regulation, or anything else overseeing one’s willingness to transact.
In some cases, this search of freedom is well-understood and underpins some of the many opportunities these new currencies offer:
· Alternative to weak institutions and/or unstable national currencies — framed as dollarization 2.0., instead of adopting the currency of another country — such as the U.S. dollar — some of these economies might see a growing use of virtual currencies.
· Limiting the risk of data ownership or alteration — because of the underlying technology on which crypto’s are based — the so-called blockchain — many argue its public nature protects the integrity of whatever is being transacted since no entity owns the database.
· Reducing friction and cost — by taking out intermediates transaction fees are significantly reduced and bank charges absent unless your digital wallet is hosted by an online broker. This can have great opportunities for oversea money transfers, where blockchain-based technology is disrupting migrants’ remittances.
But equally challenging are some of the looming risks and worries:
· Government- or corporate-ownership — not all cryptocurrencies are used outside existing banking and governmental institutions, as evidenced by Putin’s CryptoRuble, Maduro’s Petro or China’s mass-launch of a digital Yuan. Some raise questions by their corporate intentions, such as Facebook’s Libra.
· Opacity & illegal activities — because of its anonymized nature, cryptocurrencies also serve the world’s black market from ransomware, to tax evasion and money laundering. Though illicit activities only account for 1% of Bitcoin transaction, they more than doubled in last year.
· Energy consumption — the environmental factor of crypto mining is also put to the test as huge amounts of electricity are required to maintain the network and validate payments. According to the Cambridge Bitcoin Electricity Consumption Index, Bitcoin accounts for roughly 0.25% of the world’s entire electricity consumption.
However, the main concerns market commentators raise are around the volatility and limited understanding of crypto’s, leading consumers to take on larger risks in absence of clear regulatory frameworks.
Just recently, the U.K. watchdog banned the sale of unregulated crypto-based products for retail investors specifically because they feared ‘unexpected losses, no reliable basis for valuation, volatility in price movements and a lack of understanding’.
So, what do we know about cryptocurrencies and how does our behavior influence our crypto decision-making process?
Sluggish economic growth combined with ultra-low interest rates can push people to look for places other than central-bank-regulated currencies for yield.
Decrypting the crypto
It is undeniable that in certain circumstances where the existing frameworks do not allow for proper participation in the financial system, the crypto alternative can come as a factor of inclusion. More widely, as a new asset class, it can help diversify investment strategies, and venture into alternate means of payments and trading with low(er) barriers to entry.
That said, because of the relative ease of accessing the crypto market, the ill-equipped are usually at a severe disadvantage without being entitled to compensation schemes in case of losses.
A Bank of Canada report found that those with less financial knowledge may be twice as likely to invest in crypto.
The main reason why investors are shying away from crypto seems to be their lack of literacy on the subject. An U.S. study found that investors would be more likely to invest in Bitcoin if there were more available educational resources and were more knowledgeable about the asset.
Without patronizing, this poses serious questions as to the knowledge of fundamental financial concepts of those engaging in the crypto sphere and whether these occasional investors should own cryptocurrencies.
A 2018 global survey found that about 43% of people worldwide do not own and do not intend to own cryptocurrencies, while the remaining 35% had never heard of cryptocurrencies before.
Academic researchers found an interesting correlation between financial literacy and cryptocurrency ownership: the more financially literate are less likely to own cryptocurrencies now or in the future.
In other words, financial literacy is positively associated with the awareness of cryptocurrencies but negatively associated with ownership.
That is, if investors are sufficiently financially literate to start off with.
As a result of the low barriers to entry, inexperienced investors without a financial background venture into the crypto space in expectation of instant returns.
Combine the sluggish economic growth stemming from the COVID-19 pandemic with the ultra-low interest rate environment, and you can see why people looking at places other than just central-bank-regulated currencies for yield can be an explosive cocktail.
Influencers promoting financial products is alarming considering their customer base is young people.
#cryptocoolness
Beyond the rapid development and adoption of altcoins, what has been most interesting to see is the way some have marketed themselves to the masses.
From boxer Floyd Mayweather, to actor Jamie Foxx or hotel heiress Paris Hilton, celebrity endorsement of crypto’s, crypto marketplaces and initial coin offerings greatly contributed for this asset class to easily break beyond its usual — and somehow experienced — financial community.
Consumers show greater recall of products that have been endorsed by celebrities — regardless of whether they are actual fans or not. It’s therefore unsurprising that with the growing importance of social media, companies are leveraging the endorsement game across different channels.
However, when you know that celebrity endorsements resonate more strongly with Generation Z (ages 15–20) and Millennial (ages 21–34) audiences, you can see why this can disproportionately expose ill-equipped investors.
Because of the regulatory unclarity, providers have — initially — treated the crypto space as another type of consumer good. Others found a self-serving loophole in the vacuum left by policymakers and bet on the low crypto literacy of clients by selling these currencies as a regular product.
Despite some actions by the American regulator, guidelines by England’s advertising watchdog, or even bans by private sector social media platforms themselves, the use of influencers to promote financial products is somewhat alarming considering the vast majority of their customer base is young people.
But the adoption of altcoins, crypto assets and blockchain technology by traditional financial providers and new fintech players sheds a brighter light on the industry’s disquietude.
Central banks’ change of narrative is helping to approach the crypto industry with more potential.
‘A brave new world’
In her speech as former Managing Director of the IMF, Christine Lagarde sketched a world where virtual currencies and decentralized technologies could operate alongside existing traditional financial infrastructure, allowing much-needed innovation in central banking and finance.
This change of narrative has pushed other institutions to approach the crypto industry with more potential. After an initial working group started early 2020 with various central banks from Canada, England, Switzerland, Europe, Japan and Sweden to assess potential cases for digital currencies, the group just recently published its first guiding principles and requirements.
Among the reasons for this push is the progress China has made with its central bank digital currency, but also concerns of falling behind virtual money issued by foreign private players. Would citizens wholeheartedly adopt virtual currencies operating outside a central bank’s oversight, it could impact monetary policy measures and/or market stability.
Next to governments, existing financial players also massively invest in this field. Research showed that about a third of large institutional investors across the U.S. and Europe own digital assets. High street banks are on the verge of launching virtual coins to make trading less risky and cheaper, as well as revamping their trade finance and syndicated loans through blockchain integrations.
Finally, the private sector also continues to innovate and adapt to the development of the crypto space.
Supermarkets, coffee shops and other consumer brands have started to accept digital currencies as regular payments methods — normalizing even further its use among the general public. This leads fintech providers to developing new tools for easily making cryptocurrencies and exchanges available to a large number of people, and making up a large chunk of Forbes’ latest fintech 50 list.
Policy should focus on acknowledging the crypto industry as an integral part of our (future) financial system, enabling a healthy and transparent societal debate.
A policy conundrum
So where does this leave policy interventions, and what balance should governments strike to avoid stifling innovation but ensure sufficient oversight to include and protect the vulnerable.
Use cases are showing that digital currencies and blockchain have potential for empowering financial inclusion by facilitating small money transfers overseas for migrants, providing decentralized bank account for financially excluded individuals, and set the basis for a more diversified set of financial services.
Some skepticism remains however as to whether cryptocurrency will advance financial inclusion and literacy altogether. Given the (over)complexity and volatility of digital currencies, vulnerable groups do not yet seem sufficiently prepared for it to go mainstream.
Through history, characteristics of financial bubbles — from the Dutch Tulip Mania of 1637 to the subprime crisis of 2007 — have usually shown to be similar, namely: (technological) innovation, asset scarcity, available liquidity, and a good narrative.
Does this mean cryptocurrencies — and the industry that was created around them — are a bubble? Not necessarily. Does it mean it should be approached with a degree of caution? Most probably.
If the cryptocurrency market remains dominated by unsophisticated users, then regulators are right to keep a close eye and pay attention to the financial well-being of its users.
To prepare individuals for its general adoption alongside existing financial services, the best place to start is to openly acknowledge the crypto industry as an integral part of our (future) financial system. In turn, enabling a healthy and transparent debate with proven educational results.
