LWL | The rise of Crypto currencies and their potential to disrupt traditional financial systems

Thesis: The rise of Crypto currencies has had an adverse impact on our   current economic structures and the methods in which our economieswork

 

Abstract

This research aims to investigate the impacts of crypto currency in the traditional financial systems and how the introduction of crypto currency has shaped some of the policies in the modern day financial systems. This paper uses a qualitative analysis of all the bibliography published before, this paper analysis all of the previous works of research produced including historical crypto currency data, macroeconomic policy data and the inflationary and deflationary aspects of crypto currency. Additionally it also provides an overview of the impacts on central policies, impact on users and the overall cash flow in the economy. It summarises these findings and provides a deeper understanding of how cryptocurrencies impact our modern day financial systems.

1.Introduction

Crypto currencies have been on the uprise in recent years and have slowly found their way into the traditional financial systems in place originating from an anonymous untraceable currency system proposed by Chaum (1983) which kickstarted the earliest digital currency theory. Crypto currencies are only accessible on an electronic format and they are a type of digital currency which allow people to make payments to each other online, in contrast to national currencies crypto currencies have no legislated fixed value of sorts their value keeps on fluctuating, for example the price of bitcoin increased from about “30000USD in mid-2021 to almost 70000USD towards the end of 2021 before falling to 35000USD in early 2022”.Their rivals ether have also gone through the same dilemma. Some crypto currencies like bitcoin have very high inflation rates due to it scarcity as there will only be 21 million in existence, these high inflation rates make crypto currencies a risky investment for a lot of consumers. Cryptos main innovation lies within its peer-to-peer payment system which is independent of financial institutions and secondly the rules governing its supply are mechanical which is often met with argument to regulate it using the inflation policy of central banks. 

Crypto currency’s boom into the global market has impacted the shift of various existing government policies like the monetary policy used in the central banking systems and international policies, the cross-border transactions related with crypto currency has sparked a debate relating how these transactions could pose a major financial risk and how it could risk scams and cases of money laundering. Crypto currency’s use provides users with a quick and efficient landscape for transactions, however the uncertainty it proves to place has been a topic of global debate. 

Likewise, it is important to discuss the potential implications of Crypto currency in global economics as it could prove to be a deciding factor for future investments and could reshape the structure of the economy as we know it and change various existing policies in place, thus it is important dive deeper into the potential scale of impacts Crypto currency can pose to scale out the potential developments and negative impacts it can cause. The goal of this research paper is to investigate and discuss the potential impacts that Crypto currency has had on the current financial systems in place and how the introduction of these independent blockchain based systems have led to a major concern and advancements in the modern economy of various developed nations.

 

2.1 Literature review

 

Global policies and challenges faced

Crypto currencies have slowly entered the traditional financial systems but have faced various challenges with the traditional policies in place which is also displayed by a paper written by Jonathan Chiu and Thorsten Koeppl(2018) in which they highlight how crypto currencies volatility in the market reduces “investor confidence” the high volatility and changing rates of crypto currency makes it a risky source to invest in and goes against the standard conventions of banking and its decentralisation goes against the monetary policy tools like interest rate adjustments and open market operations. Crypto currency also has many regulatory challenges it faces according to Tekat Sukomardojo, Mutia Pamikatsih, Yulian Arpianto, Ani Nuraini, Endang Fatmawati (2023) Crypto could expand into a wide network if its not loosely regulated however its growth could lead into a stalemate if the government regulations are too strict, it also sheds light on how Crypto currency could be a potential cross border payment system. However they also point out how international policies could be ineffective in stopping money laundering and how cross border transactions could lead to other illegal activities. They also stated how crypto currency can affect the inflation “For example, if cryptocurrency prices suddenly spike, people may be more inclined to save them rather than spend them.” According to the study crypto currency could be used a mode of payment and lead to the spike in the price of goods and services, if crypto currencies experience deflation the economy could also experience deflation.

Another study led by Talis J. Putnins and Jonathan P. K. Wong(2020) discuss efforts put forward by the “government like anti money laundering and KYC regulations” which was a step forward to stop the drawback presented by crypto currency as it discourages money laundering and illegal activities, they reviewed previous case studies and real world examples to show the impacts crypto currency can have on various financial sectors in different ways. Crypto can also be a huge risk to consumers because of its technology in place a study by Philipp Hacker and Chris Thomale (2019) revealed that cases of scammers, fraud and violations to consumer protection were very common on a unregulated application of crypto currency systems and how there were also cases of taxation complexities in transaction and how it was hard to ensure a transparent market integrity. 

Advantages of crypto as a decentralised system

A decentralised system helps users create their own private accounts for transactions it can serve as an added asset to many of the users investing money. The book by authors Don Tapscott and Alex Tapscott(2016) points out that crypto currencies are added assets outside traditional financial norms and can effectively help an individual benefit from the investments. It points how the personalisation of crypto currency systems can increase the speed of transactions and how by reducing intermediaries it can reduce transaction fees it can make crypto currency a valuable resource for cross border transactions. According to the study users enjoy the benefits of a decentralised system as it reduces the control of central bank systems and government regulations. Crypto currency serves to provide the users with a more efficient, quicker and more profitable transaction service which attracts the users towards crypto currency which has led to the boom into the newer crypto financial world which separates itself from the traditional financial system.  

2. Method

This research uses a qualitative analysis of all the bibliography published before, this paper analysis all of the previous works of research produced including historical crypto currency data, macroeconomic policy data and the inflationary and deflationary aspects of crypto currency, the analysis of secondary works also accounts for the various security risks crypto currency poses on the financial market and financial stability. In its implementation the method could be subjected to limitations from other external factors also factoring for the fluctuations in the currency however a qualitative analysis is best suited for the research paper.

 

3. Results and discussion

In order to analyse the impact of crypto currency in the financial system it is important to address important factors like its decentralised systems, high volatility rates, cross border exchange rates and mitigation policies by the government.

Firstly, Crypto currencies decentralised systems provide its investors with a faster transaction system in comparison to its wire transfer counterparts this for example helps a user transfer their funds to another user without any interruption and a much more efficient and quicker system. The technology is also widely used in transferring money internationally, its ledger technology can help bring people into a more formal financial fold.

Secondly, its high volatility rates and scarcity levels hold the power to influence the inflation rate of an economy. They have a very limited supply which means only some units are available in the market, if the supply doesn’t grow rapidly and the value of crypto is low people will like to store their funds in their digital wallet which will spark deflation in the market and as a result it is less popular as a everyday payment method as people expect it to increase in the future rather then spend it. Similarly, if the price of crypto increases with its supply it will shift to a much more inflationary form as people will not want to hold onto it and spend it as quickly as possible. This creates an uncertain environment in the financial market where the wealth of investors could change overnight.

Thirdly, crypto currency has shown a great contribution towards international transactions. It is fairly easier and cheaper to make cross border transfers using crypto currency as they don’t require any intermediaries like banks, the quickness and cheaper transactions in cross border payments can also offer a lot of individuals with an opportunity to start a business abroad and also this may impact the payment systems, other financial institutions and various business models. These cross border transactions however are potent to money laundering and other illegal activities which has motivated the government to take actions to mitigate the risk. Actions like taxation on crypto currency, strict bans and restrictions, International treaties like FAFT and a counter money laundering approach provides the consumers with added safety and also allows a greater security and regulation over the crypto currency market. 

However, these strict regulations while may be for better security it can stagnant the overall growth of the crypto market, it can also have a negative impact on the macroeconomic stability of the economy and reduce the growth in the sector as crypto demands a free system to completely display its potential in. While crypto is quick its security risks make it a risky investment the regulations enforced on crypto currencies cannot be very rigid as it needs its decentralised system to maximise its potential.

 

4. Conclusion

Based on the result analysis and discussion done, it is possible to see the major impact crypto currency has had on the various traditional financial systems in place. It has on one hand crypto currency has made transactions easier, quicker and cheaper for individuals who invest in it. However, it is also prone to various security risks like money laundering, scams and other illegal practices when it is used for cross border transactions or it is used for personal investments. Crypto currency is also widely prone to its high volatility rates which have caused huge impacts in inflationary and deflationary rates by changing the flow of income in the economy which makes it a risky investment due to its everchanging value. Mitigation of these problems using strict regulations and policies has proven to be negative for the growth of crypto currencies as crypto currency needs a decentralised system to work which is separate from the standard central bank system in place.

 

References

1. Grant, Mitchell. “Digital Money: What It Is, How It Works, Types, and Examples.” Investopedia, Investopedia, 15 Mar. 2024, www.investopedia.com/terms/d/digital-money.asp. 
2. Sharma, Dewangi. “The Rise of Digital Currencies: Opportunities for Economies.” Investment Promotion and Facilitation Agency, 16 Apr. 2024, www.investindia.gov.in/team-india-blogs/rise-digital-currencies-opportunities-economies#:~:text=Digital%20currencies%20typically%20come%20with,a%20range%20of%20diverse%20options. 
3. Sukomardojo, Tekat, et al. Cryptocurrency and Macro-Economic Stability: Impacts and Regulations, 8 Oct. 2023, www.researchgate.net/publication/374562347_Cryptocurrency_and_Macro-Economic_Stability_Impacts_and_Regulations. 
4. Website, Investopedia. “Cryptocurrency Explained with Pros and Cons for Investment.” Investopedia, Investopedia, 31 May 2023, www.investopedia.com/terms/c/cryptocurrency.asp. 
5. Yue, Yao, et al. “How Cryptocurrency Affects Economy? A Network Analysis Using Bibliometric Methods.” International Review of Financial Analysis, North-Holland, 19 Aug. 2021, www.sciencedirect.com/science/article/abs/pii/S1057521921001976. 
6. Rodeck, David. “Digital Currency: The Future of Your Money.” Edited by Michael Adams, Forbes, Forbes Magazine, 10 Jan. 2024, www.forbes.com/advisor/in/investing/cryptocurrency/digital-currency/. 
7. White, Kathryn, et al. “The Macroeconomic Impact of Cryptocurrency and Stablecoins.” The Macroeconomic Impact of Cryptocurrency and Stablecoins, July 2022, www3.weforum.org/docs/WEF_The_Macroeconomic_Impact_of_Cryptocurrency_and_Stablecoins_2022.pdf. 
8. Yakes, Eric. “Monetary Properties of Bitcoin - Bitcoin Magazine - Bitcoin News, Articles and Expert Insights.” THE MONETARY PROPERTIES OF BITCOIN, 25 June 2021, bitcoinmagazine.com/culture/monetary-properties-of-bitcoin. 
9. RBA. “Digital Currencies: Explainer: Education.” Reserve Bank of Australia, scheme=AGLSTERMS.AglsAgent; corporateName=Reserve Bank of Australia, 4 May 2023, www.rba.gov.au/education/resources/explainers/cryptocurrencies.html#:~:text=Cryptocurrencies%20are%20digital%20tokens.,for%20them%20in%20the%20market. 
10. Karau, Sören. “Monetary Policy and Bitcoin.” Journal of International Money and Finance, Pergamon, 17 June 2023, www.sciencedirect.com/science/article/abs/pii/S0261560623000815#:~:text=The%20impact%20of%20monetary%20policy,economies%20subject%20to%20capital%20controls. 
11. He, Dong. “Central Bank Monetary Policy in the Age of Cryptocurrencies - IMF F&D Magazine - June 2018: Volume 55: Number 2.” IMF, 1 June 2018, www.imf.org/en/Publications/fandd/issues/2018/06/central-bank-monetary-policy-and-cryptocurrencies-he. 
12. Pfister, Christian. “Monetary Policy and Digital Currencies: Much Ado About ...” Monetary Policy and Digital Currencies: Much Ado about Nothing?, 17 Sept. 2017, publications.banque-france.fr/sites/default/files/medias/documents/dt-642.pdf. 
13. Chiu, Jonathan, and Thorsten V. Koepp. “The Economics of Cryptocurrencies – Bitcoin and Beyond∗.” The Economics of Cryptocurrencies – Bitcoin and Beyond, Sept. 2018, www.bis.org/events/eopix_1810/chiu_paper.pdf. 
14. Hacker, Phillip, et al. “(PDF) Regulating Blockchain: Techno-Social and Legal Challenges—an Introduction.” Regulating Blockchain: Techno-Social and Legal Challenges—An Introduction, June 2019, www.researchgate.net/publication/335296079_Regulating_Blockchain_Techno-Social_and_Legal_Challenges-An_Introduction. 
15. Tapscott, Alex, and Don Tapscott. Summary Blockchain Revolution: How the Technology behind Bitcoin and Other Cryptocurrencies Is Changing the World by Don Tapscott and Alex Tapscott. Edition Shortcut (Author). Distributed via Smashwords, 2016. 
16. Crawford, Jesse, and Yong Guan. Knowing Your Bitcoin Customer: Money Laundering in the Bitcoin Economy, May 2020, www.researchgate.net/publication/342756016_Knowing_your_Bitcoin_Customer_Money_Laundering_in_the_Bitcoin_Economy.