How safe are cryptocurrencies?

Financial and public players are questioning how cryptocurrencies can fit in the existing regulatory framework. Still they are considered as new values with high potential. Here are some explanations.

Still a test on the world stage

Libra, Facebook's digital currency that is under development, is paving the way for a new era in the history of cryptocurrencies. If this currency-to-be has attracted much attention and raised many concerns, it is not only because of the number of existing users that it will reach. Its private consortium system exceeds the value of any other public currency. Both banks and governments are increasingly questioning the intrinsic value of these new currencies, as well as the way in which they can fit into the existing regulatory framework. Often criticized for diverting funds towards illicit activities, cryptocurrencies nonetheless remain a new stock with high potential.

Digital technologies are paving the way for an unprecedented transformation of the financial landscape. What are the opportunities and risks for large banks and financial institutions?

Libra, cryptocurrencies, bitcoin: unstable values

One can easily quote numerous cryptocurrencies, from Bitcoin to Monero passing by Ethereum. More recently Dune, the next ambitious new French cryptocurrency, has been under the spotlight. Cryptocurrencies are based on the blockchain system, which works as a tamperproof public digital register. This allows transfers to take place both anonymously and securely.

The problem with cryptocurrencies lies in their lack of regulation; this has allowed criminals to profit from illegal activities, thanks to the high degree of anonymity they afford. What's more, many cryptocurrencies are not based on any certified monetary value. A further impediment to their adoption lies in their volatility. This is born out by the speculation surrounding bitcoin: worth next to nothing at its launch in 2009, it went on to reach a peak value of 19,511 dollars in December 2017, before depreciating to its current value of around 9,000 dollars.

The Libra claims to guarantee its exchange rate and achieve stability by being linked to a currency basket. However, this is not accepted without question: banks, global regulators and the US Federal Reserve all want guarantees over Facebook's project, especially given the large number of potential active users – up to 2.41 billion. Nonetheless, according to analysts, such concerns will not slow the rise of cryptocurrencies.

What is the value of cryptocurrencies?

The value of digital currencies, which could be measured by its functional scope, needs to be subject to regulations, systematic checks and audits. This would help to integrate them into the global economy. For the time being, that is neither simple nor a given, because the value of each cryptocurrency varies from bank to bank, from users to speculators. The lack of digital currencies' fungibility makes them marginal financial products, as well.

This raises new questions, such as how to integrate thriving digital currencies when the existing regulatory framework is unable to embrace innovative financial products and systems.

Efforts are being made by several government in this direction. They have sought to provide an answer by regulating digital currencies and by including them officially in their economies. China, for instance, is preparing to launch its own sovereign cryptocurrency, which aims notably to improve the circulation and internationalization of the yuan. The nascent 'crypto-yuan' is also seen as a response to the advances of tech giants in the field of digital currencies.

Seeking a common ground

Although some countries and big companies are considering whether to launch their own cryptocurrencies, the involvement of financial institutions has thus far been more circumspect. A major limitation is imposed by the fact that the valuation of each cryptocurrency or "coin" varies from bank to bank. The volatility of cryptocurrencies is the single major barrier to their wider adoption, traditional players preferring instruments that are stable and avoid the risk of intrinsic credit.

The importance of international regulations and agreements for banks and financial institutions has often been touched on. It seems to be a prerequisite for the global development of cryptocurrencies. Salvation may come from an initiative to implement fully developed Central Bank Digital Currencies (CBDC), like the Fnality project (ex-Utility Settlement Coin), financed by a group of a dozen major banking players.

Just about foreseeable is a future in which individuals would be able to easily transfer money through their social and mobile applications, and to pay in cryptocurrencies without having to worry about currency exchanges or cash – anytime and anywhere.

However, before this futuristic scenario becomes a reality, the question of reliability remains fundamental. Faced with skepticism and significant unease, digital currencies still have a long way to go before they are fully integrated into the global financial system.

 

Natixis-Frédéric-Dalibard-Global-Blockchain-Coordinator-375x275"The Libra is the electric shock, the catalyst, which could trigger the appearance of digital central bank currencies. The major central banks – especially those in the G7 – have remained very cautious and discreet on this subject until now. Their reaction following the announcement of the Libra strongly suggests that they may catch up soon." Frédéric Dalibard, Head of Digital at Corporate & Investment Banking at Natixis

 

In a nutshell:

  • The Libra is controversial: both banks and American federations are asking for guarantees over Facebook's project.
  • China is preparing to launch its own sovereign cryptocurrency to help regulate the internalization of the yuan.
  • The volatility of cryptocurrencies is the single major barrier to their wider adoption by banks and financial institutions.
  • The full growth of digital currencies will require that they comply with current – and future - regulations and laws along with the implementation of control mechanisms to avoid any systemic risks.
  • The question of reliability is therefore at the heart of the matter. Faced with skepticism and unease, digital currencies still have a long way to go.