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Do cryptocurrencies impact traditional financial markets?

Photo by André François McKenzie from Unsplash.

Cryptocurrencies like Bitcoin are a form of digital money. They can be used to make digital payments just like standard currencies. What differentiates them from standard currencies is that cryptocurrencies are only exchanged electronically using lines of code.

Cryptocurrencies do not have legal tender status: there is no legal obligation for countries to accept them as a way of payment. They are controlled via blockchains. A blockchain is a shared ledger that makes the process of recording transactions easy in a business network.

Blockchains are important as they are immutable. Only permitted members can access it. Hence, only trustable information is shared on it, which makes the data impossible to be altered and no fraudulent transactions can be included.

Cryptocurrency prices

Many cryptocurrencies exist, but we will only focus on Bitcoin as it is the most used one.

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From 2016, prices started to climb up. Bitcoin’s price is determined by the supply and the demand. The more people will invest in it, the higher its price will be. Every four years, the number of coins is cut in half. Therefore, the supply is lower which makes the demand higher.

Bitcoin has become popular in economies where inflation is devaluating the currency. For example, El Salvador passed a law in 2021 to recognise Bitcoin as a legal currency, giving it equal status to the US Dollar. The country’s economy is heavily dependent on the remittance market, which is 20% of its GDP. 95% of remittances are from Salvadorans working in the US.

In developing countries with financial instability, the rise of the price of cryptocurrencies offers many opportunities for expanding their economic freedom.

Big companies investing in cryptocurrency

Companies like Tesla have started to invest in cryptocurrencies. There are several reasons why companies would choose this option:

  • It provides them access to new demographic groups. Customers with a low disposable income can afford luxury goods by being able to pay in cryptocurrency.
  • More companies find that their investors are more interested in investing in cryptocurrencies. Therefore, if these companies are more open about how one can invest in them, they widen their market.
  • Cryptocurrencies provide a real-time and secure money transfer. Moreover, the company has easier control over its capital.

Because companies can afford to invest large amounts in cryptocurrencies, they will gain more value over time.

Photo by Yiğit Ali Atasoy from Unsplash.

Why cryptocurrency prices change

As observed above on the chart, the price of Bitcoin and other cryptos fluctuates a lot. To make it simple: let’s say one sells off a lot of their BTC (Bitcoin) holdings. The market will be flooded with BTC, making the supply high.

If the demand isn’t equally high, the price will drop. However, if one buys a large amount of BTC, the supply will be low. Which will make the prices rise as there won’t be enough supply to meet the demand.

Another factor which makes the price vary is the investors. If the supply becomes high, investors will feel that it is the right time to invest before the supply drops down. There is a fear and greed index to help you determine the market sentiment.

Trading in digital money

There are different ways to invest in cryptocurrency. The easiest one is to directly buy the currency. You first need to determine in which currency you want to invest. The account you will establish will need to be filled with fiat money (USD, Euros, Pounds, etc.). Once you’ve purchased your cryptocurrency, you can store in it your digital wallet. You can then sell it once its value has risen.

You can also invest in cryptocurrency companies like Robinhood Markets Inc. or PayPal Holdings Inc. The reason behind investing in companies such as the ones listed is that the cryptocurrency value becomes higher quickly. Some of the biggest companies like Amazon are investing in blockchains, which as explained above, makes the demand lower.

Consequences on traditional financial markets

As explained above, the prices of cryptocurrencies fluctuate a lot in a short amount of time. Investors will see this as a new opportunity to invest their money.

Because of the risk of inflation in traditional markets, investors view cryptocurrencies as new assets to invest in. This shift in the investors’ behaviours affects traditional trading patterns and investment decisions.

As cryptocurrencies are gaining visibility, they are increasingly becoming part of the traditional investment scheme.

The introduction of Bitcoin futures contracts is slowly shifting investors’ behaviour. Cryptocurrency futures are contracts between two investors who will speculate on the future price of a cryptocurrency.

Example

One investor buys two Bitcoin futures contracts for 10 bitcoin. The price for a single bitcoin at the time of the purchase was $5,000, making a total of $50,000 for 10 bitcoin.

The margin requirement when investing in these contracts is 50% of the contract amount. This means you need to invest $25,000.

At the end of your contract, you can either roll it over to new ones or let it expire and collect the cash value of the Bitcoin’s price at the end of the contract.

Risks and dangers of investing in cryptocurrencies

No legal protection

Because investing in cryptocurrencies does not come with legal protection, it is risky to invest. A credit card is protected by the bank you have subscribed to. They can help you in case something goes wrong, which isn’t the case for cryptocurrencies.

Payments are not reversible

Before you start to invest, know the seller’s reputation. The only way you can have your money back is if the seller sends it back.

Some information about your payment is likely to go public

The ledger, as mentioned above, is a public list of every cryptocurrency transaction, both for payment and receipt. According to the Department of Banking of the State of Connecticut wesbite, “the information added to the blockchain can include details like the transaction amount, as well as the sender’s and recipient’s wallet addresses. It’s sometimes possible to use transaction and wallet information to identify the people involved in a specific transaction. And when you buy something from a seller who collects other information about you, like a shipping address, that information can also be used to identify you later on”.

Where to invest?

1. Kraken

Best for low fees and for experienced traders, Kraken offers advanced order types and support margin and futures trading. The San Francisco-based exchange enables investors to buy, sell, and store over 200 cryptocurrencies while charging low fees on its professional-grade trading platform, Kraken Pro. 

  • Large number of supported cryptocurrencies
  • Low fees
  • Highly liquid exchange
  • Not available in all U.S states
  • Limited account funding options

2. Coinbase

Best for beginners, Coinbase offers a large number of supporter cryptocurrencies, strong security, and advanced trading options.

  • Large number of cryptocurrencies and trading pairs
  • Offers both beginner-friendly and advanced trading platforms
  • Highly liquid exchange
  • Lack of high-quality customer service
  • Coinbase’s default wallet is a custodial account, with no control over your private keys

3. Gemini

Best for security, Gemini offers robust protocols and insures user funds. The New York-based platform ensures user funds remain safe in case of a security breach. The platform also encourages to utilise two-factor authentication to secure their account. Gemini is SOC-2 certified, which means that third-party auditors have verified the company’s security and compliance framework.

  • Available to users in al 50 U.S states
  • Highly liquid exchange
  • Insures funds held in hot wallet
  • Strong security framework
  • High fees on many trades
  • Supports fewer cryptocurrencies than many competitor exhanges

In conclusion, cryptocurrencies are changing the way financial markets work. People have started to invest more and more in cryptocurrencies, which makes their price rise significantly. Investors prefer investing in this new market rather than traditional ones where the risk of inflation and/or deflation is more risky. From big companies investing in them to governments making them legal currencies, cryptocurrencies are changing the way we think about money.

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