SPOTLIGHT INSIGHT The Complex World of Crypto
Deborah Beyer Assistant Professor of Finance
Siyuan Fan Assistant Professor of Finance
Cryptocurrency was introduced in a 2008 whitepaper by Satoshi Nakamoto. The person or people under this pseudonym are credited with inventing and developing Bitcoin, a secure, decentralized, digital currency that allows direct financial transactions between parties. Cryptocurrency is powered by blockchain technology, a digital ledger that adds blocks of data to a chain originally through the solving of complex hash puzzles. The process used in this blockchain technology is referred to as mining or “proof of work.” Blocks become permanent record once they are added to the chain and confirmed by the network of miners, making it extremely difficult to tamper with the stored information contained in each block. Although blockchain technology is generally secure, cryptocurrency wallets, exchanges, and other online platforms are still subject to hacking and scams. According to the FBI’s 2023 Cryptocurrency Fraud Report, Americans lost $5.6 billion last year alone because of these scams. Due to the decentralized nature of crypto and its value in promoting peer-to-peer and global transactions, alternative forms of cryptocurrency, or “altcoins,” emerged. Examples of these include Litecoin, introduced in 2011, and the more commonly known Ethereum, which became available in 2015. In response to concerns over the environmental impact of mining cryptocurrency, green cryptocurrencies appeared. These cryptocurrencies use a less energy-intensive “proof of stake” (PoS) consensus mechanism, allowing them to scale faster and more efficiently. Ethereum merged with the PoS model in September 2022. Innovations continue with the upcoming Ethereum 2.0, that will benefit from even greater efficiency, speed, and scalability through an enhanced process known as sharding.
A natural financial development stemming from the creation of earlier cryptocurrencies was the introduction of Initial Coin Offerings (ICOs) in 2013. ICOs are an unregulated way for companies to raise capital through crowdsales, crypto’s version of crowdfunding. In an ICO, companies issue tokens instead of equity in exchange for capital. Due to the lack of regulation in the ICO process, ICOs bear higher risk to investors. Consequently, countries such as China and South Korea have banned their use. In addition to ICOs, there have been other financial innovations involving cryptocurrency. In October 2021, U.S. bitcoin futures exchange-traded funds (ETFs) became the first investment instrument that permitted investors to trade cryptocurrency outside of the online crypto exchanges. Most recently, in January 2024, the U.S. Securities and Exchange Commission (SEC) approved the first spot bitcoin ETFs. Investing in crypto ETFs reduces some of the risks and costs associated with direct purchasing of Bitcoin. As with any investment, investing in Bitcoin carries both risks and rewards. Some of the higher risk factors include lack of regulation, consumer protection, and transparency, cybersecurity threats, and fraud. The infamous case involving the 2022 collapse of Samuel Bankman-Fried’s cryptocurrency exchange (FTX) cost investors billions of dollars. High price volatility, another potential risk, can be attributed to factors such as market immaturity, corporate investment, supply and demand, politics, investor sentiment, and speculation. At the time of writing, for example, Bitcoin is valued at over $89,000, up from $5,000 during the beginning of the pandemic, as depicted in the following graph.
Central Wisconsin Report - Fall 2024
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