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Cryptocurrency: Can it replace real money? Why does its value fluctuate?

The notion of completing trans-continental monetary transactions in a matter of minutes is still one we categorize as nonsensical and Hollywood-esque, but may very soon become the prevailing norm.

With the gradual advent of cryptocurrency, instant and anonymous money transfer may not belong in only in action movies. However, there’s still quite a way to go and before we discuss the path ahead, let’s take a quick look back.

Why is cryptocurrency so appealing?

As the name suggests, cryptocurrency is digital money that is secured by cryptography. They are essentially decentralized systems based on blockchain technology.

Part of the appeal of cryptocurrency is the relative anonymity it provides. ‘Digital signatures’ distinguish the users from one another without revealing any identifying information.

Another defining feature of cryptocurrency is that it eliminates the middlemen such as banks, governments, and other central authorities. Not only is the system autonomous, but it also does not adhere to the working hours and costs associated with banks.

Moreover, as data is decentralized and stored across a network of computers, it becomes increasingly difficult to tamper with data.

Also read: 15 important cryptocurrency terms that you should know

How does it work?

Can cryptocurrency replace fiat currency? Why does its value change?

As mentioned earlier, cryptocurrency relies heavily on blockchain technology for its functioning. Blocks are basically stacks of information regarding your monetary transactions. They record details like the date, time, value of cash transferred, and the parties involved.

One block can store information about thousands of transactions.

Details of a transaction are stored in a block with a unique code called ‘hash’ once it is verified by other computers on the same network. This is how data is decentralized and stored at multiple locations.

After several failed attempts to digitize currency in the late 90’s, Bitcoin emerged in 2008 with a revolutionary form of money transfer. It was the pioneer of the contemporary decentralized system of cryptocurrency.

Anyone can view the details of a block, but it is mostly resistant to hacking and data tampering.

Also read: What is cryptojacking? How to detect and prevent it

Can cryptocurrency replace fiat currency?

Can cryptocurrency replace fiat currency? Why does its value change?

Fiat money, in essence, is a currency that has buying and selling power because the government declared it to be as such, but has no value of its own.

What this means is that a ten-dollar note allows the holder to purchase goods but the note itself is only a piece of paper. Hence, it is fiat currency.

In contrast, gold coins would not be fiat currency because gold, unlike paper, has value all by itself.

Cryptocurrency is not fiat money as it is not legal tender and is not backed by a government.

Whether or not cryptocurrency can eventually replace all forms of fiat money is still up for debate, though most believe that it can.

Futurists such as Thomas Frey and Tim Draper believe that cryptocurrency will replace around 25% of national fiat currencies by 2030.

It is not hard to imagine why one might prefer cryptocurrency. As data is harder to manipulate, cryptocurrency is free of the manipulation experienced by current money. It would effectively be a global currency, independent of interest and exchange rates.

Challenges

Theoretically, it is possible for cryptocurrency to entirely replace fiat money but it would be a difficult transition. Some of the challenges that the world would face if and when this shift occurs are listed below.

  • Need for brand-new infrastructure: New protocols and systems would have to be developed and implemented after accepting cryptocurrency as a standard, but before the existing system becomes incompatible. It is unclear whether established organizations can change tracks in such a short period of time.
  • Administrative crises: Governments will no longer have the same amount of control over the nation’s currency. Consequently, they cannot simply print new money as a response to financial turmoil, as they have done in the past.
  • Unstable nature of cryptocurrency: Fiat money has become a well-established, well-understood system over the past 3000 years. Cryptocurrency, however, is still in its infancy and hasn’t yet set trustworthy trends.

UBS, a Swiss investment bank, says that Bitcoin can replace mainstream money supply in the US only when its value hits nearly $213,000. As of March 4, 2019, the value of one Bitcoin is approximately USD 3710.

Also read: 5 risks you should know when investing in cryptocurrency

Why does cryptocurrency’s value fluctuate?

Can cryptocurrency replace fiat currency? Why does its value change?

The international value of fiat money depends upon many variables such as inflation, interest rates, government debt, and terms of trade, but cryptocurrency is independent of those factors.

Regardless, it is not a law unto itself and is still influenced by certain changes in the status quo, a few of which have been explained below.

Government regulation

Though cryptocurrency largely works outside governmental jurisdiction, it can still be hit pretty hard by laws and regulations passed by established bodies.

For example, when Japan legalized Bitcoin in April 2017, the price hit $1130, rising nearly three times.

In contrast, when China repeatedly cracked down on cryptocurrency in early 2018, a market crash followed every announcement. The value of Bitcoin fell to an unprecedented low of $775.

Supply and Demand

Though it is a brand-new financial institution, cryptocurrency is still subject to the basic principles of economics.

Due to most governments’ reticence regarding cryptocurrency and bad media coverage, average citizens do not trust it. As a result, a large portion of the public is sheltered and demand for cryptocurrency tends to remain well below its potential.

As the demand doesn’t meet the supply consistently, the value of cryptocurrency tends to rise and fall.

Unconducive to large holders of currency

Here, large holders of currency can be thought of as investors holding $10 million or more in cryptocurrency. These traders are colloquially known as ‘whales.’

They have limited options to liquidate their holdings into fiat money, should the need arise. Liquidating such large sums of cash can severely move the market.

In addition, speculative traders may buy and sell quickly, hoping to earn profits. As they deal with large amounts of money, such trades can cause sporadic dips and spikes in the value of cryptocurrency.

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