When cryptocurrencies fluctuate, they don’t just affect investors’ portfolios – they have widespread effects across the entire market, writes Luther Lie.

Over the past few months, the world has witnessed a explosion investment in notoriously volatile cryptocurrencies, distorting the financial market.

More recently, Dogecoin, a cryptocurrency originally started as a joke – jumped up 900 percent then plunged 30 percent in just one month, and increased 12,000 percent in total this year. On the other side of the spectrum Bitcoin recently fell 50% in just a few weeks.

However, volatile returns aren’t the only risk associated with cryptocurrencies – frauds are also present. Recently, an Istanbul-based cryptocurrency exchange, Thodex, closed, taking with it $ 2 billion in investor money.

This begs the question: How did the financial authorities allow cryptocurrencies to have such a huge impact on the financial market so suddenly?

Cryptocurrencies are digital, private and partially anonymous currency. Cryptocurrencies are mined by powerful computers to solve complex mathematical equations, then stored and transferred as files contained in an encrypted “wallet”. Many are stored on a decentralized network called blockchain. Hailed as a future medium of exchange, they are issued by private companies with the aim of fighting against central bank monopolies on the money supply.

They are not indexed to any real world currencies and users can trade between peers without intermediaries. This means that the value of cryptocurrencies is heavily determined by demand and supply, which makes them function much like a commodity, rather than being used primarily for transactions like a traditional currency.

The first cryptocurrency created was Bitcoin, established by Satoshi Nakamoto, who was inspired by a item about ‘b-money’ written in 1998 by computer scientist Wei Dai of the University of Washington.

Dai’s idea was to create a medium of exchange in which government intervention is “not temporarily destroyed but definitely prohibited and definitely unnecessary.” Ten years later, Nakamoto implemented this idea by creating Bitcoin.

Although it is a financial product, cryptocurrencies are hardly regulated. This contrasts with the highly regulated nature of financial markets for traditional currencies, commodities and stocks.

Earlier this year, the President of the European Central Bank (ECB), Christine Lagarde, expressed the will of the ECB intention to regulate cryptocurrencies. She also raised similar concerns as managing director of the International Monetary Fund, an international institution responsible for regulating the foreign exchange market. Although there is an appetite for regulation, little progress has been made.

So, should cryptocurrencies be regulated or will it undermine their value?

Some have expressed concerns about the regulation of cryptocurrencies, arguing that it could introduce transaction costs. Cryptocurrencies avoid these costs because they are traded peer to peer without the fees of intermediaries. Real-world currencies and stocks, which are regulated, have fees to trade, collected by banks or brokers.

Another concern is that the regulation of cryptocurrencies will affect their value. Unlike real world currencies, cryptocurrencies cannot be devalued by central banks, and some see it as one of their key assets.

These are valid concerns. However, cryptocurrencies should not be left entirely without regulation.

Cryptocurrencies are increasingly owned by retail investors – nearly 20% of respondents in an Australian survey said they owned cryptocurrencies, and 36% of institutional investors in the United States and Europe have also reported owning cryptocurrencies. As with any other financial product, regulators must protect the public – which often lacks the sophisticated financial knowledge to analyze these markets and make informed decisions – against the loss of large sums of money, whether through bogus investment projections, misleading information or personal error in judgment. .

Of all respondents who reported owning cryptocurrency in the past year, over 20% lost money on their investment.

The wave of personal bankruptcies that would follow a large number of people losing their cryptocurrency savings – similar to the ‘too big to fail‘phenomenon – could cripple a country’s economy. In such a case, the government bailouts would be necessary to save an economy.

The government’s response to the Thodex incident suggests the weakness of an unregulated cryptocurrency exchange. While Turkey’s central bank has now banned the use of cryptocurrencies, investors’ money has been irretrievably lost.

Amid the ban, a second Turkish cryptocurrency exchange, Vebitcoin, collapsed.

Cryptocurrencies are also very sensitive to negative externalities. Although seemingly difficult to extract and exempt from intervention by central banks and intermediaries, the supply of cryptocurrencies is not stagnating.

Unlike real world currencies, the production of cryptocurrencies is not controlled by a central producer. By monopolizing cryptocurrency mining resources, private companies that issue cryptocurrencies may be able to arbitrarily ‘control’ demand and supply to influence their value.

VSGiven these weaknesses in cryptocurrencies, regulation would be worth it. The huge gains offered by cryptocurrencies may seem appealing to public investors, especially during the COVID-19 pandemic, but the fact that they come from an unregulated market means there will always be big losers. in the game, to the detriment of everyone.

Governments cannot allow the financial system to be treated like a horse race, with investors adopting a ‘win big or come home’ attitude. A financial product like cryptocurrency affects the money of public investors, and if it fails, it will not only threaten their livelihoods, but potentially endanger national economies.

The opinions expressed in this article are those of the author alone.