What are cryptocurrencies?
Cryptocurrencies are digital currencies that are secured using cryptography. They are not tangible assets and are not legal tender in the UK. However, they can be legally purchased, sold and are accepted as payment by some businesses.
Cryptocurrencies are not issued by the government or the Bank of England. They rely on a public database, which is essentially a large spreadsheet that is not controlled by any individual or group, to record transactions.
Those transactions are irreversible, cannot be deleted and can be viewed by anyone in the world.
Blockchain is the most common database used for cryptocurrencies. Blockchain itself is not a cryptocurrency. The most well-known cryptocurrency is bitcoin. Other examples include ether and litecoin.
How did they start?
Bitcoin is widely viewed as the first established cryptocurrency. However, there were several attempts to create cryptocurrencies prior to its invention in 2008, with b-money and bit gold among its predecessors in the early 2000s.
Bitcoin’s creation is shrouded in mystery. An individual called Satoshi Nakamoto is credited as the ‘inventor’ of bitcoin, but their real identity remains unknown.
The cryptocurrency’s software entered the public domain in 2009, which allowed it to be ‘mined’ by individuals using computers. Mining is the virtual process by which new bitcoins are created and recorded on the blockchain.
The first recorded transaction using bitcoin was in 2010, when it was apparently used to purchase a pizza. Since then, over 4,000 cryptocurrencies have come into existence.
How do they work from a buying and selling perspective?
Cryptocurrencies can be bought and sold through an account at a cryptocurrency exchange. Investors will also need a cryptocurrency wallet if they wish to withdraw their bitcoin,
ether or other cryptocurrency from their account at an exchange.
The wallet has a private ‘key’ that, if forgotten, will mean they are unable to access their cryptocurrency.
It is also possible to trade cryptocurrencies via financial brokers. In this instance, an individual would not own any cryptocurrency, but would instead make gains or losses based on its future price movements. They can be extremely volatile.
As ever, investors need to be very careful that any cryptocurrency exchange or financial broker they use is regulated.
Who buys and sells cryptocurrencies?
Judging by the hype that surrounds cryptocurrencies, it may feel as though everyone is regularly buying and selling them. However, it is estimated that only 2.3 million UK adults, about 4%, own cryptocurrencies.
By contrast, around one-third of UK adults hold shares. In the US, the figure for cryptocurrency holding among adults is significantly higher than in the UK at 46 million, or 17%.
Cryptocurrencies are bought and sold by a wide range of individuals, from experienced investors to people who have never previously bought traditional assets. There are also dedicated funds that hold a range of cryptocurrencies, while some funds may hold cryptocurrencies alongside other assets.
Meanwhile, some businesses have started to accept cryptocurrencies as payment for a range of goods and services due to their increasing popularity over recent years.
Can anyone launch a cryptocurrency?
In short, yes. Anyone with an idea for a new cryptocurrency can put it into practice.
Clearly, they will require technological know-how to create the required systems. They may also need to conduct an initial coin offering (ICO), where people send money or existing cryptocurrencies in return for the new cryptocurrency, to fund their venture.
Note, an ICO is very different from initial public offering in the stock market. An ICO does not provide investors with shares in the company that created the cryptocurrency in question. Indeed, there are absolutely no guarantees a new cryptocurrency will catch on as bitcoin has done in recent years. This can mean new cryptocurrencies end up being worthless.
Why do central banks and governments worry about cryptocurrencies?
The prices of cryptocurrencies are wholly dependent on supply and demand. Therefore, in contrast to assets such as property and shares, cryptocurrencies have no underlying value. This could lead to significant losses for investors, which is a key concern for governments and regulators across the world.
In addition, cryptocurrencies have been subject to cybercrime that has led to holders losing their assets. Cryptocurrencies are also apparently used for criminal activities, since they are not controlled by governments or central banks.
This lack of control also means central banks would have less capacity to influence economic activity, such as via the printing of money to boost economic growth, should cryptocurrencies continue to become increasingly popular.
Why are central banks and governments trying to launch their own cryptocurrencies?
Many central banks and governments are now considering the launch of their own digital currencies. These would operate in a similar fashion to cryptocurrencies in that they would be intangible, but would function more like a traditional currency in terms of being governed by the Bank of England and having wide acceptance.
Although their release is likely to be many years away, the trend towards a cashless society is gaining momentum and could further persuade central banks and governments to release digital currencies.
Since 2017, the use of cash by UK consumers has fallen by 15% per annum, as online purchases during the pandemic and the prevalence of contactless payment technology have increased.
The release of government or central bank-controlled digital currencies may also dissuade consumers from using cryptocurrencies such as bitcoin for transactions. This may allow them to retain greater control over the financial system.
Are cryptocurrencies the same as Apple Pay or PayPal?
Apple Pay and PayPal are very different from cryptocurrencies.
Apple Pay aims to replace consumers’ physical wallets. It stores an individual’s credit/debit card details and can be used to quickly pay for products online with a single click or in-person by tapping a smartphone against a card reader.
PayPal allows an individual to pay for products, as well as send and receive money. Although it is possible to hold cryptocurrencies within a PayPal account, normally an individual’s PayPal balance contains traditional currency.
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