Cryptocurrency values can fluctuate by as much as 20 percent. Bitcoin's value rose almost 40% in October, and Ethereum has followed close behind in November.
This volatility is what drives many towards cryptocurrency, but also deters more risk-averse individuals. However, with the markets trending upwards for many cryptocurrencies, the bigger question remains.
Will cryptocurrency replace money?
The markets are shifting and financial advisors are dealing with more clients asking about cryptocurrency investments. If you have an interest in all things crypto, then keep reading on for more information.
First of All,
What Is Cryptocurrency?
At its core - cryptocurrency is a digital currency. These digital currencies are a part of a decentralized network that uses blockchains. Since they operate in a decentralized format, cryptocurrency is not regulated by any government.
Arguably, the most prominent cryptocurrency is Bitcoin. It was the first blockchain digital currency that was announced in 2009. Since then, hundreds - if not thousands - of other digital currencies have tried mimicking Bitcoin's early structural setup.
Currently, the cryptocurrency market is worth trillions in Canadian dollars. It has spread around across multiple nations and affected global markets worldwide.
By understanding Bitcoin, you can have a better understanding of how most cryptocurrencies operate. Only 21 million coins were created with Bitcoin. Most digital currencies only have a set number of coins in circulation.
The initial goal of Bitcoin was for easier and faster money transactions. Since it is not regulated, this allows users the direct sale and trade of their cryptocurrencies without going through any middle man.
There are private and public keys used in crypto trades. The private key is where your currencies are stored - some people dub this the wallet. A public key uses cryptography.
Anyone can use this key for trading. When someone trades a digital currency, it gets marked in the blockchain. Essentially, this creates a chronology of the transaction of cryptocurrencies and deters hackers.
Let’s Talk Inflation
Steady inflation accounts for why prices for grocery items or fuel are not nearly as cheap as they were two or three decades ago. In developed nations, economists consider inflation healthy and natural for the growth of a country. Keep in mind - it can be challenging in knowing how much inflation is beneficial.
However, this can also mean that the fiat money you hold onto without investing loses its value over time due to inflation. While it might not be a tremendous amount within a few years, it can lead to more drastic values years down the road.
Cryptocurrency resists inflation in multiple ways. While there are many different components of cryptocurrency that affect inflation, there are two main points.
Heading back to the Bitcoin example, there are only 21 million digital coins made. Other types of currencies are printed on a regular basis and there is no limit. This means it won't fall victim to standard inflation rates.
Additionally, cryptocurrencies are not regulated by governments. These digital currencies aren't tied down to interest rates. Essentially, cryptocurrencies are going to rise and fall at their own pace.
Sometimes, digital currencies drop when the world markets shift. During the start of the COVID-19 pandemic, Bitcoin dropped with other stocks.
There are expectations that inflation decreases each year with Bitcoin. This is because the new amount of Bitcoin that is mined helps decrease inflation.
No Returns
Cryptocurrency transactions and trades are permanent. You cannot return digital currencies. Any transactions are recorded on blockchains.
Technically, this means that anyone else could see when you owned a cryptocurrency and how much you had. While that point might seem a bit intimidating, blockchains can deter hackers.
When you have a recorded chain of transactions and sales on a blockchain, it makes it harder for invalid transactions to occur. In some instances, a hacker must control more than 50% of a blockchain.
In the case of Bitcoin, this would entail quite a bit of money. This scenario in itself makes it less prone to hackers. However, typical insurance plans don't cover your assets.
In these scenarios, it still pays dividends in investing money for long-term benefits and looking at insurance plans that protect you.
On The Downlow
Anonymity comes at a price. The decentralized format of digital currencies ensures that any user can purchase, sell, or trade their crypto. In fact, many people claim the anonymous nature of cryptocurrency transactions is what makes it a great form of currency.
There are two main debates with this. The first one is that anonymity leads to increased illegal activity. In Canada, fraud has increased more than 400% from 2017 to 2020. Scams were one of the most popular frauds with cryptocurrency.
Unfortunately, scammers can operate from anywhere in the world since digital currencies don't require a physical platform. They can also hack into your account or wallet and gain access that way.
The second main point is that cryptocurrency is not completely anonymous. The public key or blockchain hides the user's name through a pseudonym.
For the average person, this becomes extremely difficult when deciphering. In return, this protects the user's identity. However, certain companies use algorithms in figuring out the identities and addresses of individuals making cryptocurrency transactions.
Reporting Your Capital Gains to The Government
In Canada, you can hold onto cryptocurrency without accruing taxes. There are four different scenarios that fall under tax consequences. These include:
- Selling or gifting cryptocurrency
- Trading or exchanging
- Converting cryptocurrency into Canadian dollars
- Buying with cryptocurrency
If you fall under one of those four categories, then it qualifies as income or capital gains. Even if you trade a coin for another, it qualifies as a disposition. In Canada, you have to report any dispositions on your tax return.
Reasons Why Crypto Is Not A Good Replacement for Cash Money
Banks and other investments with cash are still the go-to options. There are plenty of banks that can address your financial goals. These are safer and more reliable options.
In general, using cryptocurrency for purchases is not always wise. The volatile nature of the currency makes finding a good purchase difficult. For instance, if you pay for a service with Bitcoin today, but it plummets over the next few months, then you likely overpaid and lost money.
The stability of fiat currency still makes it a better choice for goods and services.
Vulnerable Third Parties
Typically, you need a third party for cryptocurrency transactions. Most people also store their currencies in a digital wallet through a third-party site. In fact, there have been many crypto hacks on third-party sites that have cost users millions.
These exchanges are usually not protected by insurance or other government entities. This has cost users significant amounts of money lost. Sometimes that money has been regained but not always.
This shines a light on carefully choosing which platform holds your cryptocurrencies.
Costly Transaction Fees
In conjunction with lack of security, most cryptocurrency exchanges have high transaction fees. These fees are typically higher than other market exchanges.
Each platform also operates under different fees for transactions. It can be difficult in knowing which one benefits your investments the most.
Volatility
As mentioned earlier, cryptocurrency remains largely unleashed in the world. This means you could fall subject to extreme losses or gains within just a few months. Ultimately, this is a high-risk, high-reward type of investment.
Additionally, it shows greater fluctuations in monetary worth, similar to Bitcoin and other digital currencies.
Some people have invested most of their savings into crypto while hoping they can strike rich. Ultimately, this should not be the end goal and you should also have investments in more secure locations.
Cryptocurrency Alternatives
There are several other cryptocurrencies out there that are less risky. Some users might find them better alternatives than investing in Bitcoin or other popular digital currencies. Like any form of investment, make sure you research and budget your money accordingly.
Additionally, there are still risks associated with investments in cryptocurrency alternatives.
Central Bank Digital Currencies (CBDC)
The CBDC represents fiat currency in a digital format. In basic terms - the standard currency in a nation could opt for a digital format. In Canada, households and individuals can only open up an account in a private bank versus the Bank of Canada.
A CBDC would aim in changing that. It would allow citizens accounts within the central bank. Currently, this is still at the beginning stages of discussion and has not been implemented.
Stable Coins
Stable coins are newer forms of cryptocurrency that try and eliminate volatility. Instead, they function by associating themselves with the nation's currency. In Canada, this has come in the form of VCAD. It is backed by VersaBank.
Additionally, it shows greater fluctuations in monetary worth, similar to Bitcoin and other digital currencies.
How Soon (and if) Crypto Will Take Over
Some people have compared cryptocurrency to credit cards. Not everyone uses cash when they are purchasing goods or services. Many people use credit cards associated with banks.
Cryptocurrency might function in a similar way in the future. It is likely it won't fully replace fiat currency but might offer another alternative just like credit cards do.
Conclusion
So - will cryptocurrency replace money? For now, it looks like fiat currency remains stable. However, with a rise in cryptocurrency in underdeveloped nations, you may start seeing the tides turn.
Since cryptocurrency isn't covered by insurance or government entities, make sure you are set up for any type of emergency. Contact us today for quotes on insurance and other services.
