Wild crypto-coaster ride: Digital currencies' fluctuating fortunes red-flagged

Cryptocurrency has been touted by financial gurus and economists as the currency of the future since its inception, and as more countries continue making strides toward becoming cashless societies, they may be right.

People have described cryptocurrency as digital gold and have even speculated that its independence from centralised governments and central banks would revolutionise banking.

Leading currencies such as Bitcoin, Etherium and others have created an outlet for digital financing for several people and has proven, for many, to be a lucrative investment.

But as cryptocurrencies experience roller-coaster-like volatility many central banks, including in TT, have expressed concerns with it.

Central banks have flagged such issues as a risk for fraud and illicit financial activities, making governments apprehensive about buying into cryptocurrency.

Despite its concerns, the TT Central Bank has made strides in developing fiscal policies for cryptocurrencies and other forms of fintech with the support of the Securities Exchange Commission (SEC) and the Financial Intelligence Unit. Central Bank has also approved e-money issuers in the past couple years, which shows its cautious interest in cryptocurrency.

Still, cryptocurrency's speculative value structure, the shortcomings in vendors' ability to adhere to anti-money laundering (AML) and counter-financing of terrorism (CFT) policies have proven that for the moment it is still risky business.

Volatility a main concern

Cryptocurrency is a decentralised digital currency in which transactions are verified and records are maintained using cryptography rather than a centralised authority. This differs from Fiat currency which is a legal tender that is connected to a country's economy.

In TT, the Central Bank developed fintech policies aimed at promoting an environment for financial innovations such as cryptocurrency. The SEC also developed its own policies, with the intention to guide its approach to fintech.

In September 2022, Pay Wise was registered as an approved e-money issuer. This year, in March, PESH Money Ltd was also registered as an e-money issuer. TSTT was also given a licence to issue e-money through it Paypr service.

The main difference between both currencies is that the issuance and governance of Fiat currency is regulated by governments through central banks, and cryptocurrencies are issued and governed by blockchain protocols, code and communities.

But, for central banks it continues to be very difficult to predict or determine its value.

Bitcoin, one of the first cryptocurrencies, began increasing in value from 2014, at about US$327 for one bitcoin. The value of that same bitcoin continued in an upward trajectory until it peaked in 2017 at US$19,650. It then fell again in to US$3,798 in 2019. In 2021 it sky-rocketed to more than US$60,000 for one bitcoin. In November 2021 it peaked at US$64,400. Then, one year later, in November 2022, it took a nosedive, reaching a low of US$16,452. Today, although the price of Bitcoin rebounded to US$29,974, it is still a 53 per cent decline from its peak in 2021.

Team leader for crypto asset management at the Royal Bank of Canada (RBC) Karim Hamasni, at a webinar on the potential impact of cryptocurrency on the Caribbean hosted by UWI on Thursday last, said the reason behind the unpredictable manner of cryptocurrency is how it is valued. He said the value of cryptocurrencies is affected by speculation which is affected by supply and demand and media and news reports.

“Really the price of cryptocurrency is determined by the market and how much people are willing to pay for it is what the price ends up landing on. There are all these different exchanges that have central order books where people can bid or ask for crypto and that is what sets the price,” he said. “It is tremendously volatile.”

Buying Bitcoin, for example, would be akin to buying a commodity, since it is not a corporation and it is not affected by measurement tools such as monetary policies, inflation rates and economic growth, which is what determines the value of Fiat currency.

“I wouldn’t go so far to say that it is a pyramid scheme, but the idea is that you go in quickly to invest and you hold on to it because you believe that at some point in time someone is going to ask for it at a higher price and you then sell and make your money and move on,” said Terrence Clarke, senior manager of macroeconomics and finance at the Central Bank.

“From a regulatory perspective the volatility does not provide a great deal of confidence in what many people perceive as a currency.”

“But imagine the regulator,” he added. “There are still issues that are still outstanding. Does this actually have value? Is it a commodity or is it money?”

He added that cryptocurrency also had the potential to fund a list of fraudulent activities, as transactions are not monitored or regulated by securities exchanges. He also mentioned the avoidance of sanctions and other infractions in AML and CFT policies.

The volatility also serves as danger to investors. Clarke warned that there is very little redress, particularly in TT, if one were to invest in crypto and lose his or her money.

“At the end of the day when you go into that type of speculative asset and you lose your funds it is your loss. At the end of the day it is your responsibility to ensure that you actually know what you are getting into.”

Volatility has led to the development of commodity-backed cryptocurrencies called stablecoins. Investopedia explains stablecoins "attempt to peg their market value to some external reference. Stablecoins are more useful than more-volatile cryptocurrencies as a medium of exchange. Stablecoins may be pegged to a currency like the US dollar or to the price of a commodity such as gold."

Clarke and Hamasni said cryptocurrency has its benefits. It is seen as an alternative to traditional banking, which could also help with financial inclusion.

“Banks basically categorise who they want as a customer and who they don’t really care about,” Clarke said. “That system would actually be shaken up by cryptocurrency. Banking fees would likely be smaller because the number of different entities involved in a transaction would be a lot less. It could also help with cross-border transactions and make it faster and cheaper.”

The crypto winter

Along with Bitcoin, other cryptocurrencies, such as Etherium experienced the same volatility last year. Clarke called the financial results “the Crypto winter” and said that several cryptocurrency companies, and even official banks fell by the wayside in the wake of the volatile wave.

Clarke said the Crypto winter started when the US Federal Reserve began raising rates in March 2022.

With the rise in rates, people began cashing out their cryptocurrencies from companies resulting in an effect similar to a bank run where the companies had to sell off assets in order to keep up with the high rate of withdrawals.

The first to be affected was Terra which was linked to the US dollar.

“Terra was tied to an aligned asset, so you would always have a value of US$1,” Clarke said. “But when a lot of these assets had to be sold in order to pay out deposits, you will find the value of these assets would begin to fall.”

Last May, Terra plummeted in value by US$45 million in a matter of 72 hours.

A month later, crypto lender Celsius had to suspend withdrawals due to “extreme market conditions.” Crypto-based hedge fund Three Arrows also defaulted on a loan of US$670 million in the same month.

In July, last year, Voyager Digital, another cryptocurrency company, filed for bankruptcy protection in relation to the Three Arrows’ defaulting on its loan.

Popular crypto trading company FTX also crashed in July, with its founder Sam Bankman-Fried now facing the courts in New York. Coinbase, a popular cryptocurrency trader as well as Binance, were also put in hot water because of suspicions of SEC breaches and violations.

The Crypto winter didn’t just affect the cryptocurrency industry alone. Clarke said it also affected the entire tech sector, as stock value for major tech companies also declined. The fallout also expanded to banks in the traditional banking sector that dabbled in bitcoin. The Silicon Valley Bank shut down, Clarke said, was also indirectly because of the Crypto winter as it dealt heavily with tech companies and cryptocurrency.

Clarke used the Crypto winter as one example of why regulators are still apprehensive about cryptocurrency.

“As regulators these are things you don’t like to hear about,” he said.

He added that there are still indirect impacts to the wider economy that are being felt since last year.

“When the fed started raising rates and customers had a run on some of these cryptocurrency-related companies, real assets for example treasury bills increased and the price went up. When the price goes up, the yield falls. That is what happened in March this year. That has implications for us that could affect foreign exchange.”

Cryptocurrency, still the future

Despite the volatility and other questions behind cryptocurrency, it still serves as an innovative disruptor – an innovation that transforms highly sophisticated and sometimes unattainable products into something that is accessible to a broader population.

Hamasni said that many societies could benefit from a native financial system that could enable payments, ensure safety and trust, and enhance the speed of current systems. He said cryptocurrency and blockchain networks are quickly developing to become that system.

Countries such as Ukraine, the Philippines, India and even the US, have adopted cryptocurrency and blockchain systems into their banking systems, with lower-middle income countries leading the charge.

“In these countries users rely on cryptocurrencies to make remittance payments; preserve savings in times of Fiat currency volatility and fulfil other economic needs. They tend to lean on bitcoin and stablecoin,” Hamasni said.

But he added that for cryptocurrencies to take its place as the currency of the future it has a lot more growing to do. He said it has to be faster, cheaper, more reliable, more private, safer, and more permitted for it to see its true potential.

“Crypto services the needs of those down market that banks largely ignore. As the technology improves with time it can become more of a substitute.”

For now, many see cryptocurrency investments as an investment in the future. When people buy bitcoin or other assets, they are usually betting on the value that it would have in the years to come.

“As the technology improves, cryptocurrency could be more of a disruptor but the technology. If crypto continues to follow the disruptive innovator model it could have more effect, but the technology needs to improve significantly before it does,” he said. “In the meantime, traditional institutions are looking at means to satisfy investor demand for crypto assets.”

In 2022, the Central Bank said it is hoping to make a decision on a possible pilot project for a digital currency – similar to cryptocurrency in many ways, but like Terra, will be pegged to TT's Fiat currency and may or may not use blockchain technology.