As the global financial system has become ever more reliant on and controlled by the world’s central banks, particularly so in the decade since the global financial crisis, alternative assets and mediums of exchange have been developed to bypass this centralised control.
A prominent example of such an asset is the category of cryptocurrencies.
What is a cryptocurrency?
A cryptocurrency is a form of digital currency created, operated and exchanged in a secure online environment through the use of cryptography.
Typical characteristics of these currencies include their limited supply, the anonymity between the counterparties exchanging them, and their decentralised nature.
The latter is often regarded as the assets’ strongest appeal, as it theoretically prevents interference and manipulation of their prices by governments and central banks.
The creation of Bitcoin, the original decentralised cryptocurrency, in 2009 has been followed by a large number of other cryptocurrencies, with the current tally standing at over 900 different variants today.
Many of these just use simple variations of the Bitcoin code, a fact which reduces their relative appeal and results in their value fluctuating in tandem with that of Bitcoin.
Critics of cryptocurrencies usually single out the anonymity of transactions in them as their biggest drawback, as this feature obviously attracts a set of illegal activities, such as money laundering and tax evasion.
Another potentially deterring aspect in their use is their high volatility; price fluctuations in even the most established cryptocurrencies can be truly nauseating for investors or dealers in them, due to the market’s relatively low liquidity and fledgling nature.
The first half of the year has seen a dramatic increase in the interest, demand, and consequently the price of cryptocurrencies.
Bitcoin, the market’s bellwether, has seen its price rise by 200% during that period, currently standing at $2,350. Ethereum, the second biggest currency, is up by a whopping 3,000%.
Inevitably, this sort of performance has led to a sharp division within the investment community as to the future prospects of the asset class.
Tom Lee, Head of Research at Fundstrat Global Advisors, recently penned a letter to investors predicting that Bitcoin could soar to anywhere between $20,000 and $55,000 over the next five years.
Others, such as renowned billionaire investor Mark Cuban, are way less optimistic and a lot more cautious with Bitcoin.
Cuban recently expressed a view that the cryptocurrency may already be showing signs of being in bubble territory.
Regardless of which view prevails, it’s worth noting that there are some strong factors in play, which could help explain the recent rise in the price of Bitcoin and cryptocurrencies in general.
The most interesting ones concern the asset’s appeal in two huge Asian markets.
China has traditionally been considered the biggest market for Bitcoin in terms of volumes traded.
Earlier this year, however, the government embarked on a far-reaching crackdown against Chinese-based digital currency exchanges and suspended all withdrawals.
Although this weighed heavily on the price of the cryptocurrency at the time, recent reports have indicated a new regulatory framework might be in the works, which will allow withdrawals again.
With China effectively taking itself out of the game earlier in the year, Japan jumped at the opportunity to fill the market gap.
Indeed, the country’s share of global bitcoin trading increased six-fold during that time and provided a new source of liquidity for the market.
This introduced a viable alternative to the continuously deflated Japanese Yen for local investors, further fuelling demand for the new asset.
Extra caution needed
So after all is said and done, is this violent upward trend likely to continue for Bitcoin and the other cryptocurrencies?
Only time will tell. Given the nature of the asset class, however, wild swings are very likely to persist.
Though theoretically immune to government intervention, as the Chinese case demonstrates, Bitcoin can still be influenced quite significantly by decisions and restrictions put in place by various authorities.
Before investing in it, make sure you do your homework.