Pros and Cons of Cryptocurrencies

What are Cryptocurrencies

Cryptocurrencies are digital assets that can be exchanged between trading counterparties directly in decentralized computer networks connected via the Internet. The encryption and decentralized record keeping mechanisms employed in these direct payment networks, which bypass financial intermediaries like banks, provides higher privacy and security for transactions. A major challenge for cryptocurrencies adoption is the higher variability of these digital assets which entails higher likelihood of big losses.

Cryptocurrencies, also known as crypto, are digital or virtual assets. Bitcoin and Etherium are the most popular cryptocurrencies. They do not exist in the form of physical tokens as coins or notes, but rather as digital tokens stored in digital “wallets”, which are software applications installed on user computers or mobile devices.

Cryptocurrencies are used for electronic payment transactions. Crypto payments are implemented in decentralized computer networks connected via the Internet. There are no banks involved in transactions and no paper notes. This entails many of advantages of cryptocurrencies as well as disadvantages of cryptocurrencies.

Let us consider Bitcoin transactions. All Bitcoin transactions are recorded in a virtual public ledger called the “block chain,” which is maintained by Bitcoin “miners” that can be anyone. Each Bitcoin digital wallet contains encrypted information in the form of files, called public and private keys, that are used to send and receive Bitcoins.

Advantages of Cryptocurrencies

1. Higher Security and Privacy

Crypto transactions are processed in groups called blocks by miners using encryption. The encryption action is called a hash: a hashing algorithm takes a unit of data and turns it into a random string of numbers and letters. Hashing ensures that data are extremely secure.

Crypto transactions are characterized by privacy not attainable for money payments since transactions are not carried out in central bank-controlled banking system but are implemented in decentralized networks. They are virtually anonymous.

2. Easy Transactions

Crypto transactions can be made easily: anyone can send and receive a variety of cryptocurrencies by using a simple smartphone app, hardware wallet, or exchange wallet. And a bank account isn’t always required to use crypto: some types of cryptocurrencies, including Bitcoin, Ethereum, and Litecoin, can be bought with cash at a Bitcoin ATM. They can then send those coins to their phone, hardware wallet, or exchange wallet.

3. 24/7 Transactions

Crypto payment transactions can be carried out any time: operation of exchanges like New York Stock Exchange or London Stock Exchange is not needed to execute the transactions. Cryptocurrency trading hours are the reflection of the fact that crypto transactions are being directly executed between counterparties in computer networks connected via the Internet.

4. Fast Settlement and Low Fees

Crypto payment transactions cost much less than making payments in conventional currency via banking system. They are also settled in much shorter time periods than payment transactions via banking system.

For comparison, cryptocurrencies like Litecoin, XRP and others can be sent for a few cents or less. Bitcoin and Ether transactions could cost anywhere from ten cents to several dollars or more.

And payments for most cryptos settle in seconds or minutes. Wire transfers at banks often take three to five business days to settle and can cost significantly more.

5. Inflation Hedge

Bitcoin has a limited supply: there will ever be only 21 million Bitcoins in existence. Cryptocurrencies with a limited supply cap like Bitcoin, Litecoin and others, are considered to be good hedges against inflation.

When central banks increase money supply by printing more money prices rise as more money is chasing the same number of goods. And the price of fixed-supply coins as measured in dollars has a higher chance of going up.

Disadvantages of Cryptocurrencies

1. Very Volatile Crypto Prices

A relatively stable price is a desirable feature of any means of payment – it makes holding it and storing wealth in it not risky.

Crypto prices though are much more volatile than other assets like currencies, bonds, stocks. And while fast price increases entail high rates of gain for crypto holders and crypto investors alike, steep crypto price declines entail steep losses for crypto investments.

Relatively small size of crypto markets (overall market capitalization of cryptocurrencies was $2 trillion in early March 2022) makes it more vulnerable to price fluctuations. To understand better market capitalization, it's better to start from learning about What is cryptocurrency market.

2. Scalability Challenges

There is no massive infrastructure yet in place that could enable crypto payments on the scale of money payment systems that operators like Visa, Mastercard and others provide. The same is true for the speed of a transaction – crypto technologies have to evolve so that they can be massively scaled as crypto adoption increases rapidly.

3. Cybersecurity Issues

The digital nature of crypto currencies makes them vulnerable to theft via hacker attacks. Hackers can potentially steal the contents of a digital wallet.

A major security feature for digital wallets is the usage of a public key and a private key - like a password or PIN. However, crypto networks allow users to remain relatively anonymous and there is no central data bank. If a hacker steals from a wallet there is little hope of recovering the assets.

4. Little Regulation

Cryptocurrencies are essentially not under supervision or control of governments and central banks. El Salvador is the only country that has adopt a cryptocurrency – the Bitcoin – as legal tender. A consequence of freedom from such oversight is the absence of regulatory mechanisms for investor protection in case crypto platforms fail or are hacked.

5. Technical Complexity

It is not easy to understand the principles and operational processes of crypto currencies. The procedures for interacting with crypto currency networks can be involved and complex to many people. As a result, users may send a transaction to an incorrect address, over-pay or not pay enough on transaction fees called ‘gas’ (and so lose the fee and transaction).

Bottom line on Pros and Cons of Cryptocurrencies

Cryptocurrencies markets are evolving rapidly. As the adoption of cryptocurrencies grows rapidly after their invention driven by need of higher privacy and security, digital assets trading provides the opportunity for higher profits thanks to higher volatility of their prices. At the same higher volatility entails the risk of higher losses.

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