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While the 2008 financial crisis shook the global economy, a reclusive cryptographer going by the pseudonym Satoshi Nakamoto invented bitcoin. Dissatisfied with the conventional financial system, he created this electronic version of cash that allows people to transact without interference from banks and governments. The idea took off.
In the last few years, cryptocurrency has been making headlines, with thousands of kinds of digital coins attracting attention from speculators. Bitcoin, the first and still the most popular cryptocurrency, saw its price rise from US$900 in December 2016 to almost $20,000 a year later, before falling back to about $5,000 in April 2019. Is cryptocurrency the future of money, or just a risky bet? Associate Professor of Practice in Finance Chew Seen-meng weighs in.
Chips off the Block
Blockchain is the underlying technology of cryptocurrencies. While one may need a computer science degree to fully understand its workings, Professor Chew offered a simple analogy to it: ‘Just think of blockchain as an advanced database management system, like a giant Excel spreadsheet, which can manage, record and encrypt all transaction data efficiently and securely.’ In other words, cryptocurrency like bitcoin uses the blockchain technology as its transaction ledger.
Instead of having a trusted central authority, e.g., a central bank, that keeps track of financial transactions, the blockchain technology uses cryptography to remove the middleman and achieve peer-to-peer transactions. This is particularly useful in financial areas that require fast, accurate and secure records. In trade finance, for example, blockchain can simplify complex documentation and reduce the number of parties involved in cross-border selling and buying, streamlining payment processes and lowering transaction costs.
Blockchain technology is also immutable and verifiable. Transactions become permanent record and cannot be altered once written. Every record can be viewed by any participant, allowing everyone to verify the authenticity of each transaction. By inhibiting data tampering, the system facilitates audit processes and enhances the security of transactions.
The Other Sides of the Coin
Although the design of cryptocurrency is safe by default, drawbacks remain. Like gold, many cryptocurrencies are in limited supply. For bitcoin, the supply is capped at 21 million units, which can be problematic for the monetary system. ‘Money demand expands in tandem with economic growth, but if money supply is fixed, interest rates could be driven too high, resulting in structural deflation, similar to the gold standard,’ explained Professor Chew.
The anonymous nature of cryptocurrency transactions is another concern. The ability to conceal the origin and destination of fund transfers makes cryptocurrencies highly attractive for money launderers and terrorists to use for illegal transactions. Similarly, since users’ identities need not be disclosed in these virtual transactions, people could use them to make cross-border payments for the purpose of evading taxes.
In the course ‘Current Developments in FinTech’ he teaches at the Faculty of Business Administration, Professor Chew, who was an economist at J.P. Morgan and International Monetary Fund, uses case studies to show his students how cryptocurrency and blockchain have been used by companies to do business. He also shows them economic models that have been developed to predict the elusive value of bitcoin.
However, splashing out on the volatile e-currency is not something he encourages. ‘At this point it is still a highly speculative kind of investment, a playground for the rich. To ordinary people, I would say don’t burn away your savings investing in cryptocurrency unless you have a full understanding of what it is and what you are getting into.
‘Having said that, it’s good to learn about bitcoin, even if you are not going to invest in it, because digital currency could become an important part of our lives in 10 or 20 years’ time if the blockchain technology becomes more mature and gains a much wider user adoption,’ said Professor Chew.
Cryptocurrency is still in its infancy. Time will show whether it will cause a revolution in the financial system or turn out to be just another speculative mania like the dot-com bubble. The only thing we can tell for sure is that our reality will never be the same again.
This article was originally published in No. 537, Newsletter in May 2019.