Cryptocurrency- The buzzword of the digital age 19 Feb 2018

Cryptocurrency is the new buzzword for trading and investment in the digital age.

It's gained fame – and some notoriety – in recent years as a form of money that's designed to be secure and anonymous.

In this article, we look at the history of money and explain the basics of cryptocurrency. It's a complex subject, so we'll explain more in later articles.

For thousands of years, people have used objects of value to carry out transactions. The Chinese and Indians used cowry shells as an early medium of exchange. In other parts of the world, gold and silver became legal tender and coins were made from these precious metals. Later, paper money was produced. Anything of value, of course, has been used for trading, relying on trust to determine its worth.

Gold in the 19th century became a standard currency. The “gold standard” adopted by many countries held that “fiat currency” (paper money) could be converted to gold at a set rate.

Wealthy countries accumulated gold, but other countries lost it as they paid off debt.  The First World War created new political alliances and government finances deteriorated. A new, more flexible system was required. The British pound and US dollar became standard currencies and smaller countries began holding these currencies instead of gold.

At the end of World War Two, the Bretton Woods agreement meant the United States dollar became the international standard, itself being valued against gold valued at $35 an ounce. In 1971, the US dropped the gold standard and the world entered the flexible world of “fiat” money, the value of which is determined by governments.

Fiat money has held sway since, as the international means of exchange, but we're now entering the age of cryptocurrency.

As its name suggests, cryptocurrency uses web-based cryptography, which converts traditional data into code to track purchases and transfers. The same sort of code is widespread on the internet to protect private information.

Cryptocurrencies such as Bitcoin allow users to buy things of any value electronically and store money anonymously without going through a traditional bank. No money is ever printed, no coins minted.

There are no fees nor government control, making it an attractive proposition for people tired of bank fees and wary of market manipulation. It's the decentralised nature of cryptocurrency that sets it apart from traditional banking. No one controls the network on which it runs.

This lack of control worries many central banks, though most admit cryptocurrency won't go away soon and might well be the future of money. All are studying its implications for the global financial system. Some countries, such as South Korea, have banned bitcoin trading via exchanges in their nation. What are the implications for taxes, inflation, GDP, trading in illegal goods etc?

So how do you buy cryptocurrency? You can buy units or “coins” from brokers with traditional money or  cryptocurrency. Your coins are stored in a virtual wallet from which you can spend them. You can also earn cryptocurrency by “mining”, which involves solving complicated online maths problems. All transactions are updated and held on a public ledger called a blockchain.

Bitcoin was the first major cryptocurrency and is the best known. It was created in 2009 and last year rocketed in value before diving 30 percent by year end. Even so, it's a big player that financial authorities have to take seriously as the possible future for transactions of all kinds, including stocks and bonds.

Bitcoin's market capitalisation was more than NZ$300 billion at the end of 2017. About 17 million “bitcoins” are in circulation.

In New Zealand, Inland Revenue is considering whether profits from Bitcoin and other cryptocurrencies should be taxed just as it taxes trading in conventional currency.

More on cryptocurrency in the next issue.

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