Financial System and Cryptocurrency
Since the Financial Crisis of 2008, many Americans have held lingering doubts about the stability and creditworthiness of the current financial system. In response to the economic crisis, the first cryptocurrency, Bitcoin, emerged, intending to be a cash-like payment system unaffected by economic downturns. Unlike the traditional monetary institutions whose negligence caused the financial crisis, cryptocurrencies such as Bitcoin differ from the established infrastructure within the context of peer-to-peer networks and decentralized organization using open source software. The focus of this review paper is to review the economics of digital cryptocurrencies and discuss their impact on the financial system following the recent financial crisis, as well as explore future applications of digital currency. Going further, we will examine the supply and demand of digital money, the role of the blockchain, applications in FinTech, intermediation, innovation of payment systems, and cryptocurrencies as investment alternatives.
Despite the growing number of cryptocurrencies, our paper will focus primarily on Bitcoin for simplicity’s sake, as it is the most used cryptocurrency. Thesis Statement: Our research aims to examine the impact of digital cryptocurrencies on the financial system following the 2008 financial crisis, by analyzing the current uses of cryptocurrencies compared to their potential applications in other economic arenas. Body: As the world’s financial infrastructure was crumbling in late 2008, the domain bitcoin.org was registered, and a person or persons using the pseudonym Satoshi Nakamoto published a white paper on Bitcoin, outlining how the cryptocurrency would work. The foundation of Bitcoin is the use of a peer-to-peer network (P2P) and its open-source software, the blockchain, which stores all transactions made on the network. Today, most cryptocurrencies, including Bitcoin, operate independently and consist of issuance and circulation for exchange. We begin our review with one of the most significant aspects of cryptocurrency: blockchain. The relationship cryptocurrencies share with the current monetary system relies heavily on the technology on which they are built. To understand this relationship, we look at the core technology underlying these digital currencies: blockchain. Often referred to as the ledger, the blockchain records all past transactions and bitcoins produced (Dwyer, 2015). Simply put, blockchain is defined as a decentralized, shared ledger that uses chronological encryption and chained blocks to store data across a P2P network (Dumitrescu, 2017).
How it works
Broadly speaking, the decentralized nature of blockchain guarantees secure and private transactions, with cryptography and the distributed computing paradigm storing encrypted data forming a “blockchain” of self-executed scripts (Yuan & Wang, F2018). Additionally, cryptocurrency blockchain protocols intertwine seamlessly within the financial technology sector, where the innovation of digital currencies is highly disruptive. The “distributed-ledger” technology could be implemented within several areas of FinTech, such as capital marketing, corporate banking, insurance, and supply chain monitoring, to name a few. In the context of blockchain, the FinTech sector seeks to cultivate the “security and reliability of the underlying infrastructure and implement smart-contract functionality” (Eyal, 2017). Blockchain represents an ever-growing system that has attracted interest from tech firms, financial institutions, governments, and capital markets, as many consider it to be one of the biggest innovations in cloud computing (Yuan & Wang, F2018). In addition to the intrinsic applications of the blockchain, the regulatory constraints of intermediation limit the effectiveness of financial institutions in a way they do not for the protocols of cryptocurrencies.
However, even after the financial crisis of 2008, digital commerce relies almost exclusively on financial institutions acting as trusted third parties to process payments (Corbet et al., 2018). Cryptocurrencies and related technologies can reduce transaction costs and lower the costs associated with attaining and sharing information. However, some researchers believe it could amplify contagion and destabilize financial markets. For conventional business models, this would undermine the role of the banking system and put pressure on central banks to maintain financial stability (Harwick, 2016). In theory, a decentralized financial system utilizing digital cryptocurrencies would decrease the layers of intermediation, creating a simpler alternative. In such a system, more power is given to individuals as the middleman is removed from the equation. However, it is important to note that these implications are highly speculative given that little research exists to support such claims. A few years ago, cryptocurrencies were not considered a viable investment, and some people had never heard of them. With the development of society, Bitcoin, a type of cryptocurrency, has gained significant attention.
Bitcoin’s value suddenly rose from $1,000 to $10,000, reaching a high of $19,000 in December 2017 (Pasztor, J., 2018). Deciding to invest in Bitcoin is a significant decision and should only be made by pure speculators who understand the risks. Bitcoin has no revenue, earnings, or underlying asset value. Its price rise is driven by demand alone, which shows signs of a frenzy (Huang, 2018). Compared to the stock market, where stock prices are based on expectations of earnings or revenue, Bitcoin is not a stable market. Bitcoin not only has the necessary application needs and scenarios but also represents the core of securitization. This securitization core refers to an asset form that people can speculate on. Bitcoin, therefore, is much like a bubble in the market. It has usage requirements, application scenarios, value attributes, and a switching function. As a result, Bitcoin can be considered a broad currency and a viable investment.