Cryptocurrencies, innovative assets that trade on the blockchain, have drawn significant interest in the last few years.
A perfect example of this interest is the robust inflows these currencies have attracted over the last several months.
The total market capitalization of these digital currencies reached an all-time high of $117.2 billion in mid-June, a more than 500% year-to-date increase, according to CoinMarketCap.
Sharp Returns
These robust inflows have driven up the price of many cryptocurrencies, including bitcoin and other major digital currencies like ether, litecoin and monero.
Bitcoin has risen more than 200% this year, before falling back in recent weeks, while ether’s price enjoyed a year-to-date gain of more than 5,000% when its price reached roughly $415, according to CoinMarketCap.
Many other cryptocurrencies, including litecoin and monero, have experienced impressive gains in 2017. Earlier this year, the two rose to YTD returns of more than 1,000% and 350%.
Notable Volatility
While these sharp price increases have benefited investors, they have also made these currencies more volatile, provoking the concerns of some market observers.
A perfect example of this volatility is the price fluctuations bitcoin experienced in 2013. That year, the digital asset’s exchange rate relative to the US dollar fluctuated roughly 10 times as much as the exchange rate of major currencies including the Japanese yen and the euro, according to David Yermack, a New York University professor of finance.
While these gyrations may seem significant, other digital currencies are even more volatile, according to an analysis conducted by research provider Smith + Crown. Of the 100 cryptocurrencies analyzed, bitcoin was the most stable.
Volatility is certainly positive for some, as the price movements create opportunities for traders to generate returns.
However, some have taken a different view, pointing to bitcoin’s price volatility as a reason why the digital currency falls short as a medium of exchange. If bitcoin’s value relative to other currencies suffers wild price swings, it makes it more difficult for market participants to make transactions using the cryptocurrency.
Strong Foundation
While some market observers have emphasized the robust volatility of cryptocurrencies, these digital assets have strong fundamentals. The blockchain, the underlying distributed ledger system which records all their transactions, has enjoyed rising adoption.
Governments and financial institutions have been experimenting with the blockchain. Last year, almost every major financial institution was looking into the potential applications of this distributed ledger system, according to the PwC Financial Services Institute.
Blockchain’s Great Potential
The blockchain could potentially revolutionize the financial services industry, impacting everything from lending to securities trading, and some advocates have asserted this innovative technology could transform the sector.
Blythe Masters, a former J.P. Morgan Chase executive and CEO of New York technology startup Digital Asset, emphasized the blockchain’s vast potential during an investor conference in 2015.
“You should be taking this technology as seriously as you should have been taking the development of the Internet in the early 1990s,” she said. “It’s analogous to e-mail for money.”
Masters is not the only one who is optimistic about the potential implications of the blockchain, as the World Economic Forum stated in a 2015 whitepaper that “The blockchain protocol threatens to disintermediate almost every process in financial services.”
International Payments
One area where the blockchain may be able to provide a particularly notable benefit is international payments. Currently, most of these transactions take place through a system called SWIFT, which was designed in the 1970s.
While SWIFT has been in use for decades, it has some significant disadvantages when compared to blockchain. SWIFT provides little in the way of transparency, offering limited information to both transaction participants and outside parties.
If financial institutions opted to use a distributed ledger system instead, a permanent record of transactions would be available to senders, recipients, regulators and even the public.
Aside from this heightened transparency, there are several reasons why financial institutions might want to use the blockchain for international payments. While payments made through SWIFT generally take 1 to 3 working days to reach their destination, the blockchain processes transactions in a matter of minutes.
Another potential benefit of using the blockchain for international payments is cost reduction. The international payments space can be expensive, as consumers can end up paying fees as high as 15%. Businesses can frequently get better deals, paying fees as low as 1-2%.
In addition, SWIFT charges joining fees, annual support charges and additional fees for individual messages. These expenses can push even higher as transactions go through the network, where individual institutions can add fees. Blockchain, on the other hand, eliminates intermediaries and their associated expenses by using peer-to-peer technology.
Regardless of whether systems like SWIFT become more user-friendly and efficient, blockchain technology can potentially drive great change within financial institutions. By using this distributed ledger system, these companies can potentially cut costs, bolster transparency and expedite international payments.