Cryptocurrencies, such as Bitcoins, cannot be touched, because they are only available in digital form. Often they are based on the so-called blockchain technology. In payment transactions, they still do not play a role of their own but have so far tended to serve as high-risk speculative objects. What do speculators have to consider?
What are cryptocurrencies?
The idea of cryptocurrencies or cryptocurrency is based on the desire to create an electronic payment system without the participation of banks and states. These non-governmental, virtual currencies work with limited amounts of money, which are digitally formed with the help of computer networks in mathematical procedures. Whether these are actually currencies or money is controversial because a central bank will not issue them. In common parlance, however, these terms have prevailed, which is why they are also used here.
Bitcoin (BTC) is the most well-known cryptocurrency. But there are other virtual currencies such as Ethereum (ETH), Ripple (XRP) and Litecoin (LTC), etc. Their exchange rate development can be tracked online.
Excursus Bitcoin
Bitcoin was the first cryptocurrency. It was developed in 2008 by unknown programmers under the pseudonym “Satoshi Nakamoto” and published in a white paper. The aim was to create a system for electronic payment that does not require banks or other intermediaries. Instead, it relied on self-management by users by combining the computing power of a large number of computers (peer-to-peer network) in order to publicly record and verify each transaction in a complex calculation procedure (mining).
Anyone who has an internet connection can theoretically buy, sell, mine, or simply pay for Bitcoins. Bitcoins can be bought on certain exchanges at the then current price or purchased on online trading platforms by other users.
Unlike in the past, this payment system is no longer based on trust in credit institutions as payment service providers but is based exclusively on mathematical rules. Payers and payees verify their transactions using so-called public and private keys, their respective identities do not play a role. Due to its pseudonymization, Bitcoin came under criticism early on. Criminals use it for illegal transactions. Nevertheless, the value of a Bitcoin has developed since its introduction in 2009 from 0.08 cents (dollars) to over 60,000 dollars in the meantime and to about 23,000 dollars by August 2022. Extreme fluctuations in value will continue to affect Bitcoin in the future.
What is the significance of blockchain?
The blockchain is a decentralized, public database. With blockchain technology, different data sets are linked together in chronological order. Using the example of cryptocurrency, you can imagine it like this:
A transaction with a virtual currency is summarized in a record. An algorithm (hash function) is used to shorten this complex data set to a smaller string. Hash stands for “chopping”. The result of this calculation is mapped in a checksum, the so-called hash value, and linked to hash values from other transactions in large data blocks. Thus, a blockchain is ultimately a long chain of data blocks. Any modification of a data block would change the logical relationship to the subsequent data blocks, which the system does not allow. Once transactions have been made, they are therefore irreversible. In this respect, it can be said that the blockchain cannot be manipulated.
However, this does not apply to the interfaces, the so-called wallets. If you want to use crypto money, you need this digital wallet to store the virtual money. If such a wallet is lost or hacked, crypto money can be lost (total loss). If you use wallets, you should inform yourself about the different security options.
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Trading cryptocurrencies
With your wallet, you can then start trading on crypto exchanges yourself. Since you can easily do something wrong, you should inform yourself well. Some crypto exchanges also offer integrated wallets for trading and custody, which can be convenient. To do this, you have to register there and be prepared to transfer money to foreign accounts.
Crypto trading via the smartphone app is also possible. These are designed to be user-friendly and provide access to the largest crypto assets.
The neobrokers also make it comfortable. Similar to the app solution, you only have to open a depot there and you can get started immediately. Crypto ETPs (Exchange Traded Products) are also increasingly being offered there. Here you do not invest directly, but via bonds that replicate the performance of the respective crypto asset. This entails higher costs but is very easy for investors to handle.
Opportunities and risks using the example of Bitcoin from the consumer’s point of view
- Flexible but slow: A transfer of Bitcoins takes between 10 minutes worldwide. This is many times slower than in classic digital payment transactions. Cryptocurrency works independently of national currencies. Exchange rates are eliminated, and anywhere in the world can theoretically be paid with Bitcoin. In fact, however, the payment options both on the Internet and even more so in stationary retail in Germany are still limited.
- The secure procedure through transparency and irreversible payments: Blockchain-based cryptocurrencies have so far scored with their non-manipulation and the fact that all transactions take place publicly. However, this also means that payments once made can no longer be reversed.
- No value stability: Even if Bitcoins are sometimes touted as a store of value (digital gold), crypto money is subject to very strong fluctuations in value and has not yet proven to be a safe haven in times of crisis. As an investment, cryptocurrencies are therefore to be classified as highly speculative. They are not at all suitable for retirement provisions.
- No cost stability: Fluctuations are also common in transaction costs. For example, a Bitcoin transfer in March 2021 cost only 0.30 USD, while in December 2017 you still had to pay over 55 USD for it. In addition, transaction costs can rise permanently the faster the energy demand for global cryptocurrency mining develops. Currently, the energy consumption for Bitcoin mining alone is comparable to that of the Netherlands, and the trend is rising.
- High energy consumption/Low sustainability: Calculating Bitcoins is energy-intensive. In 2021, the energy consumption for this was as high as that of Ukraine. And the trend is rising. This can certainly be seen as a legitimate price for the benefits, say the proponents. Thus, many people, especially in poorer countries, benefit from crypto money’s payment and value storage possibilities. However, the energy used up comes mainly from dirty power generation and hardly from sustainable sources, the critics reply.
- Uncertain market: Which provider, which currency, which system will prevail? These questions cannot be answered at this time.
- Technical challenges: What if something goes wrong when dealing with cryptocurrency? For example, the loss of the private key or the wallet leads to the fact that you can no longer get to your Bitcoins. Then there is no bank, complaints office, or public institution to turn to. The use of cryptocurrency makes it necessary to familiarize oneself with the rules of the game that this technology entails.
- There are also dubious trading platforms on the Internet that try to lure investors with lucrative investment transactions, e.g. in cryptocurrencies. You can read more about this in the article “How to recognize dubious online trading platforms”.
Regulation of cryptocurrencies
The German Financial Supervisory Authority (BaFin) classifies crypto money as a so-called “unit of account” within the meaning of the German Banking Act (KWG). In other words, as a unit of value that is not denominated in legal tender and is comparable to foreign currency.
Do you need permission from the financial supervisory authority for the business with cryptocurrencies? It depends. Possession, use, purchase, sale, and mining of cryptocurrencies are basically not subject to permission. Crypto money is used exclusively as a substitute for cash or cashless payment. As long as users comply with this, they are no case for financial supervision. But this is a fine line. Anyone who publicly advertises that he buys or sells cryptocurrencies is engaged in proprietary trading subject to authorization. Accordingly, crypto money trading platforms and mining pools typically require a BaFin license.
