Cryptocurrencies such as bitcoin have the mesmerising lure of a lottery or a gold rush. Set up in 2008, bitcoin uses cryptography to secure transactions. However, since these are also hidden, they remove the currency from the purview of a traditional safeguard, financial regulation. Bitcoin opened this year around US$1,000, surged past US$10,000 for the first time last month, and soared to US$16,777 before retreating. This kind of volatility feeds infectious euphoria, which must meet sobering reality at some point. None the less,the digital currency's debut on a major exchange was a milestone for it. Once associated with drug-dealing and other illicit activities, bitcoin is on the way to being legitimised as an alternative currency through the trade in futures.
Some might take the view that there is nothing inherently fraudulent about cryptocurrencies. They are the financial face of an Information Age embodied by the Internet. According to one author, these currencies break with a protocol whereby commerce on the Internet relies almost completely on financial institutions which act as trusted third parties to process electronic payments. What is required, the author argues, is an electronic payment system based on cryptographic proof instead of trust. So long as cryptocurrency transactions involve willing sellers and buyers, both of whom understand the mechanism which they are using, bypassing tradition is but just one more of the revolutionary possibilities created by the Internet.
This is true but, given the heady mix of possibility and risk inherent in the trade in cryptocurrencies, it falls on the individual to exercise caution when investing in them. Essentially, as a senior Federal Reserve banking oversight official has pointed out, decentralised virtual currencies operate as a payments system without a central bank. These currencies are not backed by other secure assets, possess no intrinsic value, are not the liability of a regulated banking institution, and in many cases are not the liability of any institution at all, he notes. The more widely they are used, the greater the chance that they will question the international financial system, whose stability depends on predictable exchange mechanisms. In worst-case scenarios, a single, sustained crisis could wipe cryptocurrencies off the global economic map, leaving investors literally with nowhere to turn. Singaporeans must weigh these pros and cons in deciding whether to take to cryptocurrencies and, if so, to what extent. Calculable risk is an integral part of any investment decision. Shares, property and real currencies all obey that cardinal rule. Virtual currencies follow the laws of cryptography. How far they reflect the workings of the real economy, and therefore how long they will be sustainable, is a question that each investor must answer for himself.