Frequently Asked Questions(Published 10 July 2017)
What are digital currencies?
Traditional or “fiat” currencies (NZD, AUD, USD etc) are issued by governments who in turn have influence over its value through the inflation or deflation of the money supply.
Digital or “crypto” currencies however are a relatively new revolution in technology and applied mathematics which negate the reliance upon a central issuer (i.e. government) instead basing itself on the decentralised cooperation of active participants in the network in a similar way to how the internet organises itself.
Bitcoin was the first and most well known digital currency launched in 2009 which is now valued at over $55b however today there are over 700 additional digital currencies in circulation with a combined value of over $140b.
For comparison New Zealand’s stock exchange the NZX has around 300 securities listed with a combined value of around $145b.
I heard Bitcoin was associated with cybercrime?
It is inevitable that any new technology is going to be adopted by a few for nefarious purposes. In the early 1900’s around the time of the first Ford Model T bank robbers began using motor vehicles as getaway cars. In the 1990’s pager systems were used by drug dealers to arrange deals. Mobile phones, credit cards and the internet in general are all misused in one way or another by a distinct few however like all of these technologies the legitimate uses and social benefits vastly outweigh the illegitimate uses.
Some of the main features of digital currencies such as their anonymity and decentralised nature (lack of control by a central government), as well as cases involving digital currencies are often sensationalised by the media and those with vested interests maintaining their advantage (i.e. traditional banks) however the reality is that in this sense digital currency it not too dissimilar to cash, gold etc which which cannot inherently be traced, and many mainstream institutions are actually increasing interested in digital currencies and their underlying “blockchain” technology as evidenced by the video “Blockchain Demystified” by Westpac Bank.
How are digital currencies obtained?
Digital currencies are typically initially allocated to active participants in the network through a process of “mining”; this involves running software on the miner’s computers which help to secure and organise transactions on the network.
Most digital currencies have a pre-defined limit on the number of units which will ever be generated hence are often analogised to digital gold - a scarce resource resilient to inflation.
Once a number of units of the currency have been mined and the currency has gained in popularity they usually begin to be traded on public exchanges in a similar way to how traditional currencies are traded by FOREX traders (NZD/USD, NZD/AUD etc).
What value do digital currencies have?
This question is not unique to digital currencies but is based on similar principles to those of traditional currencies.
Throughout history societies have used various tokens as a store of value or currency; from seashells to precious metals. For a large part of recent history gold has served as a universally recognised store of value.
In the 1900’s for example $1 US Dollar was backed by, and could be freely exchanged for 1.5g of gold with the US Treasury Department. The New Zealand dollar for a time was also pegged to the British Gold Standard.
Today most governments have moved away from a gold standard with the value of their currency now based on nothing more than people’s “faith” in the system.
Political instability, government insolvency, hyperinflation, world events, economic performance etc all have the ability to shake investor confidence in a national-backed currency, reducing it’s value thereby its local and/or international purchasing power.
Digital currencies are also based on the fundamental principles of supply and demand however instead of requiring faith in a particular government or institution to honor its debts and to refrain from manipulating its currency; investors in digital currencies place their faith in the mathematical algorithms which govern the systems and which to date have proven extremely robust.
For the month of June between 2013 and 2017 Bitcoin been traded at highs of $130, $880, $340, $950 and $4080 respectively. As you can see besides a drop in 2014 the overwhelming trend has been a staggering increase in the value of Bitcoin and digital currencies in general.
What investment opportunities exist around digital currencies?
There are currently many investment opportunities surrounding digital currencies however in its most simplest form digital currencies may be traded and invested in the same way as any other foreign currency; buying with NZD in anticipation of growth and selling at a later date in order to realise a return on investment. The main difference though being that digital currencies are growing at an extraordinary rate in relation to traditional currencies so in an investment sense they may be more likened to penny stocks with similar growth, volatility and risks.
Digital currencies do pose some unique barriers to entry though as currently there are limited options for consumers wishing to purchase them and particular digital security measures are necessary to protect digital assets which may otherwise be vulnerable to data loss, deletion, hackers, viruses etc.
For these reasons it is advisable to invest through a trusted digital currency broker who understands and can manage the associated risks just as you would trust your gold bullion to a secure bank vault more so than under your mattress.
Is investing in digital currencies a good thing?
Many believe that digital currencies and the underlying blockchain technology are as great an innovation to finance and decentralised systems as the internet was to the dissemination of information. It has the potential to revolutionise a number of industries bringing greater transparency, security, accessibility and trust.
By trading in digital currencies you increase the liquidity and stability of the market; making it easier for everyone to buy & sell at a consistent price in the same way that FOREX traders make it possible for you to trade your NZD for international currencies when you travel. Without a large pool of traders constantly buying and selling this would not be possible.
Furthermore investment in digital currencies increases their value, rewarding developers & early adopters, and incentivising further development in the field for the benefit of all.
How are digital currencies regulated in NZ?
As with any new technology regulation usually has to play catch up as we’ve seen over the past few years with online auctions, lasers, personal drones, self driving vehicles etc.
In NZ there is currently little direct regulation of the digital currency industry however with the exception of income tax requirements (on profits) it’s anticipated most regulation would be targeted at fund managers, brokers and currency exchanges as opposed to general consumers.