Crypto Currency and What you need to know about Global Exchange Risk Management
With all the craze surrounding cryptocurrencies it becomes imperative to understand what they are, and how they can be utilized in today’s modern economy. What are their capabilities, and where are their weaknesses?
Although this post does not attempt to be comprehensive it does intend to provide a quick overview and some basic information regarding the new economy and industry of online currencies in the context of international business and draws mostly from two articles that the author found to be most helpful in understanding the cryptocurrency economy. Therefore, apology ahead of time for long quotes, but the articles explain it all well. So the following discuses quickly what a crypto currency is, what the benefits and uses are, and then some quick risks and red flags.
What is Cryptocurrency?
Some general characteristics of cryptocurrencies include: block chain technology for verification and record keeping, algorithmic scarcity creating value, online ease of trade, storage, and commerce, and storage on offline systems such as hard drives (online and offline storage mechanisms are known as “wallets”).
According to an article regarding the new currencies with a specific look at bitcoin,
Governments may create financial and credit troubles thereby causing major problems for their currencies, global investors are looking for something more firm than the promise of a central bank. Tyler and Cameron Winklevoss—Bitcoin entrepreneurs—touted the digital currency as a solution to the world's troubled currency markets. "It's Gold 2.0," Tyler Winklevoss said.
“Like gold or other precious metals used as specie, Bitcoins are scarce. But their scarcity is algorithmic, as opposed to natural or accidental.
New Bitcoins are added only by being "mined," in the high-tech equivalent of a land rush. Computers on the Bitcoin network race to solve increasingly complicated mathematical problems. The first to do so has its solution verified by the other nodes on the network. Once verified, the Bitcoin can be traded using Bitcoin's wallet software.
Bitcoin mining guarantees a fixed rate of inflation (relative to itself). It roots the value of Bitcoins in the work needed to solve the puzzle. And the decentralized proof-of-work consensus protocol guards against fraud and counterfeit” (Carmody, 2013).
Therefore, Bitcoin "commoditized the process of securing the network." All the work done by financial centers and payment systems to detect fraud or counterfeit for traditional currency and credit markets is done all along the network according to the peer-to-peer protocols for Bitcoin. And the costs of that work are likewise distributed throughout the system, paid for through Bitcoin mining. This is what lets Bitcoins be traded and exchanged without huge fees (Carmody, 2013).
Cryptocurrencies therefore, are an innovative way to exchange goods and value, while maintaining scarcity and value for themselves all while being held, verified, and constructed in the web.
The most prevalent is Bitcoin, and most goins that are not Bitcoin are an alternate form of Bitcoin and are known as Alt-coin.
So, now that we have a general working idea or definition of cryptocurrencies, let’s now look at some usages and risks.
According to Carmody, the area with the greatest potential for Bitcoin worldwide is probably international remittances: money sent home by workers living abroad. Although obviously the international business community can utilize these currencies in the same manner. Currently, this money has to be handled by several intermediaries: banks, wire services, and currency exchanges all take their cut. A report by Businessweek noted that the average fee for remittances was 9 percent of the money transferred, with conversion to cash often costing an extra 5 percent. Western Union's profit margins are enormous for an intermediary, nearly 16 percent, and most of its costs are devoted to the technologies moving money from one place to another, guaranteeing the legitimacy of the transfer. In short, Western Union spends and earns billions to do what Bitcoin does for free (Carmody, 2013).
"The vast majority of people on the planet don't even own a bank account," Bitcoin evangelist Jonathan Mohan tells PBS Newshour. "And it's my contention that—and a lot of people think this—that, just as in Africa, they didn't go to phones. They went directly to cell phones, that, in the same sort of adoption curve, in these developing nations, you're not going to see them start getting bank accounts. You're going to see them just going straight to Bitcoins, because if you own a Bitcoin address, you have a bank account on your phone that you can interact on the global stage with (Carmody, 2013)"
"Money has become data," Ben Milne, founder of Dwolla, a real-time payments company, said at emTech. "There needs to be an infrastructure that allows people to exchange whatever they have for whatever they want, that confirms who they are, and confirms that the transaction is legitimate (Carmody, 2013)"
Therefore, there is great potential for utilizing crypto currencies for reaching lower level markets that may use cryptocurrencies instead of their own currencies to buy international goods. As developing markets may not have the financial infrastructure to use credit cards and other such financial instruments, cryptocurrencies may become readily available and provide a very quick and cheap alternative.
However, it must be stated that cryptocurrency has a primary use of speculation, it is estimated in a 2016 joint report from Coinbase and ARK Invest that 54% of bitcoin users utilize bitcoin strictly as an investment (Hileman & Rauchs, 2017).
Other uses include payment. “Estimates of the use of cryptocurrency for payments has varied significantly across different sources. For example, a 2016 report from the Boston Federal Reserve has estimated that 75% of US consumers who own cryptocurrencies have used them for payments within a 12 month period, while the Coinbase/ARK Invest report indicates that 46% of Coinbase users use bitcoin as a ‘transactional medium’ (defined as making at least one payment per year)” (Hileman & Rauchs, 2017). “The use of payment in cryptocurrency and merchants who will accept it is increasing worldwide as a payment method, however, cryptocurrencies are not being used as primary payment method on a daily exchange or for everyday expenses. This is mostly due to cryptocurrency not being a “closed loop” system or economy in which businesses or individuals would be compensated in the same form of payment while also utilizing cryptocurrencies as a form of making payments” (Hileman & Rauchs, 2017). (in other words, payments are usually a one-time transaction from one institution or individual to another and the economy does not necessarily blend with other currencies)
There may be some clear advantages to corporations utilizing cryptocurrencies for cross border payments, as “a considerable number of companies have emerged that
use cryptocurrency networks primarily as a ‘payment rail’ to make fast and cheap cross-border payments. However, following the recent surge in bitcoin transaction fees, some are reconsidering this strategy and shifting transactions towards private blockchain-based solutions” (Hileman & Rauchs, 2017).
So now that we have a better understanding of some of the benefits of Cryptocurrencies, now we can take a look at some downfalls.
One potential major downfall is that cryptocurrencies tend to be very volatile. This can cause major issues for the payment or transferring funds through cryptocurrencies into other more stable currencies. For example, the manager who intends to move several hundred thousand dollars in Bitcoin to Europe to be exchanged for Euros will suffer great exchange risk if Bitcoin drops within seconds of making the transfer. In this sense, most major operations using cryptocurrencies are not actually used as currencies, but instead are used more in the speculation market to attempt to grow assets and wealth. As cryptocurrencies become more stable in the future this may change, but for now it causes an extreme risk for mangers to face.
Other risks include the future of regulation and government interventions, the potential for cryptocurrencies to not being widely adopted, and cyber-attacks in the form of theft.
Nevertheless, with Cryptocurrencies being a multibillion dollar industry, they cannot be ignored, and must be explored in management as possible utilities for the expansion of global growth of Multinational firms.
Resources: Carmody, T. (2013, Oct 15). Money 3.0: How Bitcoins May Change the Global Economy. Retrieved from National Geographic: https://news.nationalgeographic.com/news/2013/10/131014-bitcoins-silk-road-virtual-currencies-internet-money/
Hileman, G., & Rauchs, M. (2017). Global Cryptocurrency Benchmarking Study. University of Cambridge, Judge Business School. Center for Alternative Finance.