What is cryptocurrency?
There is no one standard definition of cryptocurrency.1 At the most basic level cryptocurrency—or digital currency or virtual currency—is a medium of exchange that functions like money (in that it can be exchanged for goods and services) but, unlike traditional currency, is untethered to, and independent from, national borders, central banks, sovereigns, or fiats. In other words, it exists completely in the virtual world, traded on multiple global platforms. These currencies are designed to incorporate and exchange digital information through a process made possible by principles of cryptography, which makes transactions secure and verifiable. The most well-known cryptocurrency is bitcoin, which was created back in 2009 and which still dominates the virtual currency market today.2
Why do they matter?
Cryptocurrency is relevant to most businesses and financial firms. Over 100,000 merchants worldwide already accept bitcoin3—including Amazon.com, Target, PayPal, eBay, Dell, and Home Depot—with anywhere from 80,000 to 220,000 transactions occurring per day, representing over $50 million in estimated daily volume.4
Cryptocurrencies allow for increased market efficiencies and reduced transaction costs. At base, cryptocurrency transactions are:
- Private—no personal information is required to complete a transaction;5
- Fast—they are settled almost instantaneously, unlike credit card transactions or wire transfers that require days;
- Irrevocable—because transactions are settled almost immediately, there are no resulting chargebacks or possibility for disputes between buyer and seller;
- Inexpensive—transaction costs are generally less than 1% if an intermediary is used, rather than the customary credit card processing fee of roughly 2.5%; and
- Global—neither buyer nor seller requires a bank account, and there are no currency transaction fees.
How does it work?
The use and transfer of cryptocurrency is based upon a technology called “the blockchain protocol.” The blockchain protocol is the basis for a public decentralized ledger that records all bitcoin transactions and removes the financial middleman, allowing transactions to be settled within minutes. Each transaction is verified and validated, resulting in ledger (or log) of these transactions that is public and transparent.6 Further, the blockchain is secure and virtually impossible to hack because of its decentralized nature and the fact no entity controls it. The blockchain protocol is not limited to bitcoins.7 In fact, nine of the largest investment banks have announced plans to develop common standards to expand the use of the blockchain technology across the financial services markets. The implication is clear: transactions will become faster, cheaper, safer, and more efficient.
What should I think about?
Financial institutions, Fortune 100 companies, and well-funded startups are focused on cryptocurrency (specifically) and the underlying blockchain (generally) to capitalize on the economic utility of the technology. These applications include (but are in no way limited to):
- Using the distributed ledger blockchain technology to issue and transfer the shares of privately held companies without the need for paper stock certificates;9
- Revolutionizing foreign currency trading;10
- Increasing payment speed and decreasing transaction costs;11
- Rethinking how to trade complex assets like derivatives, syndicated loans and corporate bonds;
- Redefining collateral management and other back office operations.