Cryptographic forms of money have entered the standard discussion as advanced monetary forms, for example, Bitcoin and Ethereum have soar in esteem, effectively outperforming the additions of numerous different resources. Rocker financial backers have gotten enchanted with Bitcoin, making it quite possibly the most looked-through themes in 2017. This public free for all has the monetary business scrambling to serve the developing interest to access and exchange digital money. Like the land bubble that prompted the monetary emergency of 2008, financial backers and the business don't completely comprehend the resources they are seeking after.
Not at all like the housing market, digital forms of money are new to the point that most conventional monetary administrations organizations don't yet give admittance to the cryptographic money market. All things being equal, this market is to a great extent adjusted by fintech organizations that offer helpful client encounters for opening records or exchanging. Nonetheless, these organizations are as yet figuring out how to help less-refined customers deal with the novel dangers in regards to cryptographic forms of money. Cryptographic money firms are additionally as yet figuring out how to perform essential errands expected of the monetary administrations industry, for example, care or legacy move.
This article looks to bestow a significant level comprehension of digital money and the remarkable dangers that this new resource class postures to conventional monetary administrations organizations that partake in this market.
WHAT IS A CRYPTOCURRENCY?
Cryptocurrency is tradable digital money created from a combination of cryptography, distributed computing software, a worldwide network of computers, economic incentives, and consensus algorithms, to make digital information scarce. Digital scarcity is a fundamental characteristic of cryptocurrency, otherwise the data representing the currency could be copied an unlimited number of times and the unlimited number of copies would make the digital currency worthless. For the purposes of this article, digital scarcity only works within a network, and only works when the participants within that network can come to a consensus around the validity of cryptocurrency transactions. The consensus method used must ensure that digital money cannot be double spent, which prevents the cryptocurrency version of counterfeit money. Most cryptocurrencies use a technology commonly referred to as a “blockchain” to track ownership, create digital scarcity, and prevent double spend.
IS CRYPTOCURRENCY A FORM OF MONEY?
The Federal Reserve characterizes cash collectively of safe resources that families and organizations can use to make installments or to hold as momentary investments. Bitcoin and other digital currencies meet that fundamental definition. In a new article, the St. Louis Federal Reserve expressed that Bitcoin is more similar to unmistakable money than a record passage identified with a checking account.[3] Like cash, Bitcoin has no natural worth, it has a restricted inventory, and doesn't need a delegate to trade with different members on the Bitcoin organization. In any case, the U.S. Interior Revenue Service (IRS) regards digital forms of money as property and gathers material capital additions charges.
WHY ARE CRYPTOCURRENCIES IMPORTANT?
Bitcoin was the first cryptocurrency and remains the most heavily traded cryptocurrency. Bitcoin started as an esoteric way for a small group of tech-savvy crypto-explorers to circumvent using traditional fiat currency. Bitcoin and other cryptocurrencies have grown into a massive market worth tens of billions of U.S. dollars. This creation of value has created significant public interest in owning and trading cryptocurrencies. Traditional financial services firms have largely not been intermediaries for the cryptocurrency market, but recent trends indicate that many traditional firms are exploring the possibility of accessing cryptocurrency markets.
WHAT ARE THE CATEGORIES OF CRYPTOCURRENCY RISKS?
Cryptocurrencies are an inseparable combination of financial instruments, supporting technology, and a Web-enabled network. Therefore, when it comes to cryptocurrencies, the financial risks cannot easily be separated from technology risks. The cryptocurrency market requires financial risk management to avoid cryptocurrencies that are not a going concern, to properly diversify portfolios, to avoid asset bubbles, and to manage liquidity. The cryptocurrency market requires technology risk management to properly protect private keys and to sustain cybersecurity. Cryptocurrency markets also require managing the risks associated with emerging financial markets such as uncertain legal status, undefined protocols for estate planning, and custody best practices.
MANAGING CRYPTOCURRENCY FINANCIAL RISK
If Bitcoin and other cryptocurrencies were considered a form of foreign currency, then the exchange rate relative to the U.S. dollar would be extremely volatile. During the three-month period from December of 2017 to February of 2018, Bitcoin fell over 50%. Moreover, the website Bitcoin.com reported that 46% of the cryptocurrencies that held initial offerings in 2017 have already failed.[5] This means that financial services companies will have to exercise prudent fiduciary responsibility through educating investors, providing appropriate disclosures, and carefully supervising portfolio recommendations that involve cryptocurrencies.
The cryptocurrency market also has a high amount of liquidity risk. According to the crypto-media company CoinDesk, the total cost of making a $1 million bitcoin transaction can run between $10,000 to $100,000 more than the listed spread on an exchange. Centralized cryptocurrency exchanges, such as Coinbase or Kraken, have been unprepared to handle the growing demand of cryptocurrency, resulting in bottlenecks and liquidity issues. Liquidity concerns are confounded as investors cashing out of cryptocurrencies may find it hard to deposit their proceeds due to safeguards related to money laundering and fraud prevention.
MANAGING CRYPTOCURRENCY TECHNOLOGY RISK
Investors and financial institutions cannot separate the enabling technology and the related technological risks from the cryptocurrency. The popularity and relevance of the underlying blockchain technologies supporting each cryptocurrency will inevitably impact the value of the cryptocurrency. If the underlying blockchain technology becomes obsolete, then the related cryptocurrency may lose all value. The risk of obsolete technology is a new risk consideration for financial assets and has traditionally been associated with hardware or software.
Moreover, the use of blockchain creates unique risks in managing custody because proof-of-ownership is a function of a private key, a precise string of characters which may be long and cryptic. If an investor loses a private key then the cryptocurrency cannot be exchanged or used. Losing a private key causes the value of the related cryptocurrency to be lost forever. With a blockchain, there is no central authority; no one with the superuser password; no one who can overwrite changes that were made. Whoever has the private key has total control of the assets. This elevates the stakes of cybersecurity and there is no FDIC backstop for cryptocurrency deposits lost due to cyber breaches.
MANAGING CRYPTOCURRENCY EMERGING MARKET RISK
Cryptocurrencies are an “emerging market” in the sense that they are new, and as such, not all of the normal functions of mature financial markets have been established. For example, it is difficult to establish who legally owns an amount of cryptocurrency because private keys can be compromised. Financial institutions may solve this problem by creating a central digital-vault for storing private keys and tracking ownership through traditional bank ledgers off of the blockchain. However, this solution creates additional complexity around cryptocurrencies as well as a single point of failure that could lead to large losses. Furthermore, a central digital-vault would make cryptocurrencies become dependent upon services provided by custody banks, therefore the cryptocurrency would lose the advantage of being a decentralized peer-to-peer medium of exchange.
Another risk related to the maturity of the cryptocurrency market lies in the legal frameworks of various jurisdictions across the world. Cryptocurrencies are geographically everywhere, which means any large country can introduce political and regulatory risk into a cryptocurrency network. This has led to wild swings in value as countries like China cause legal uncertainty in the crypto markets. Countries that outlaw cryptocurrencies may also seek to block access through their routers, while other countries may have a poor technological infrastructure, making transactions difficult. Moreover, legal issues such as the protocol for inheritance-related transfers of cryptocurrency have not been firmly established and could present problems if estate disputes require adjudication.
