The challenges facing cryptocurrencies

Shireen Shaikh | Trainee Solicitor | Law | +44 161 3333 281 | sshaikh1@uk.ey.com

Despite the growing popularity of the cryptocurrency market, the market continues to grapple with a number of challenges, making it increasingly difficult for new entrants. While the market  capitalisation of the sector continues to rocket, reaching $573 billion at the end of 2017, the challenges posed by the immaturity of the market and the lack of understanding of the cryptocurrency space continue.

The cryptocurrency market has often fallen prey to hackers and cybercriminals with a number of high-profile cryptocurrency hacks resulting in millions of dollars being lost. The largest so far was on January 2018 when Coincheck lost US$530m. In the aftermath of these hacks, the price of particular cryptocurrencies has dropped considerably and in extreme cases, platforms have ceased to operate. Traders and platform operators have implemented precautionary measures which have been effective, but these have often come at the price of efficiency. Traders have also taken up offline storage, but this has created an additional layer in an already convoluted trading environment. Transactions on a blockchain are immutable and as such if funds get stolen, there is little chance of ever recovering them. Cryptocurrency trading platforms have had to focus on improving their security framework not only to defend against hackers and thieves but also to preserve and enhance trust in the nascent cryptocurrency marketplace.

Challenges facing the cryptocurrency market

One of the biggest challenges facing the cryptocurrency market is price volatility which inhibits their use for daily transactions. The price of cryptocurrencies can rise and fall dramatically over a short period of time, at times as much as 49 percent within 24 hours. The high volatility has the effect of making transactions unpredictable and undermining consumer confidence. One of the many contributors to price volatility are individuals that have large cryptocurrency holdings. They are able to drive up the price without actually investing in the market and then cash in on the price spike. This sort of manipulation is possible because of the lack of limits and fees on many cryptocurrency trading platforms.

Further, the decentralised and untraceable nature of cryptocurrency poses obvious threats to regulatory authorities. In order to thrive, cryptocurrencies require state legitimisation and endorsement. International bodies have played a significant role in researching cryptocurrency-related crime, developing regulatory frameworks and facilitating international collaboration. In the UK, the Bank of England has claimed that the size of the cryptocurrency market is not big enough to influence the financial stability of the UK or put the monetary system at risk. One of the few initiatives in the cryptocurrency space is the creation of the Cryptoassets Task Force. This is a group of senior representatives from the Bank of England, the Financial Conduct Authority and HM Treasury that is studying cryptocurrencies and their technology, evaluating the associated risks and potential benefits, and developing an approach to cryptocurrencies within UK regulations. The working group are yet to publish any significant results of their findings (though HMRC has recently published brief guidance on the tax implications for business of cryptocurrencies). The concern is that the UK Government has taken a ‘wait and see’ approach to policy, taking quite small steps towards a clear cryptocurrency regulation environment. There is a worry that if the UK does not have a clear cryptocurrency regulatory environment, it might fall behind other countries in this race.

Forming a cryptoasset strategy

Despite the risks and the confusing environment for crypto-related business, it would be amiss to not consider the potential for cryptoassets. We recommend our clients determine their crypoasset strategy by asking themselves a number of questions:

  • First, what are your business’s core competencies and how may these be applicable for cryptoassets?
  • Second, how strategic a position do you wish to take in the market?
  • Third, considering your desired strategic position, what is your appetite for risk, and how do you manage?
  • Finally, how do you design your project in the most scalable, secure way using industry leading practices ensuring you have the right skill sets for long-term success?

With increasing technical advancements in the cryptocurrency space, it is likely that this is just the beginning of a new financial ecosystem. The key for organisations will be to gain an understanding of how this technology works, build institutional expertise and monitor the technology as it evolves.