6 Challenges For Cryptocurrency Management

Cryptocurrencies are very popular among financial enthusiasts and investors. These are digital assets that are meant to function as a medium of exchange in the same way that traditional currencies do. They use encryption to safeguard transactions, regulate the creation of extra units, and validate asset transfers.

 

But the volatility of these currencies is known by all. Navigating the cryptocurrency world needs talent and an awareness of the market's nuances, as well as a high level of risk.

 

The two most well-known cryptocurrencies, Bitcoin (BTC) and Ethereum (ETH) have attracted a lot of attention and witnessed substantial price fluctuation over the last year. 

 

However, as the number and variety of digital currencies grow, risk management is no longer limited to high-value coins. According to GARP, there were roughly 1,500 cryptocurrencies in 2018, but there are now over 4,500.

 

But, there are still a lot of challenges that one must be aware of before they plan on investing their hard-earned money in cryptocurrencies. In this article, we will learn about those challenges. 

 

Challenges for cryptocurrencies:

 

1. Cryptocurrencies are qualitatively diverse, not interchangeable:

 

The first issue that risk managers must deal with is the fact that cryptocurrencies are fundamentally different and not interchangeable. The confusing array of cryptocurrencies differs in a variety of ways, most notably in terms of security, programmability, and governance. 

 

Simply put, there is no such thing as a "cheapest-to-deliver" coin. As a result, while calculating, controlling, and monitoring risks, one must take into account the varied aspects of different cryptocurrencies.

 

BTC, the first cryptocurrency, is a pretty simple structure. It's intended to be used to transfer, receive, and store value in a virtual and encrypted format, with functionalities similar to those of money and gold. 

 

ETH, the second most actively traded cryptocurrency, adds more complicated, self-executing "smart contract" features to BTC's fundamental functionality, allowing users to digitally recreate complex financial instruments, transactions, and performance contracts. Furthermore, ETH has been utilized to launch exchanges.

 

Cryptocurrencies like stablecoins, whose value is pegged to fiat money, add to the complication (such as USD). By converting national currencies into non-stable cryptocurrencies, these digital assets give a fixed exchange rate. The nuances involved with the issuance and control of cryptocurrencies further complicate the picture.

 

2. Cryptocurrencies need to face legal dilemmas:

 

Investors and speculators are keeping a close eye on worldwide events as governments respond to cryptocurrencies in a variety of ways, ranging from hostile to apathetic. 

 

It's easy to see why crypto and Blockchain have taken more than a decade to adapt in an environment where they've had to deal with issues at the very heart of how our economy and society work.

 

Digital currencies are virtual entities that are decentralized. They are entirely digital items, and our authorities are ill-equipped to deal with such sophisticated technology. 

 

As a result, the absence of regulation governing digital currencies and ensuring any form of user safety has become a significant concern. The most important step in reducing the risk is to educate and teach individuals about the need of protecting their personal information. 

 

There is still a huge need that has to be filled with insurance and specialized laws. However, until that day comes, understanding how to use crypto properly is essential.

 

Aside from a lack of law, another major roadblock for cryptocurrency holders such as Bitcoin dealers and users is the inability to use their holdings. 

 

Bitcoin has become extremely controversial in some nations due to its untraceable nature and negative reputation as a form of funding for massive illegal operations such as terrorist acts and the drug trade.

 

3. Cryptocurrencies are still developing technologies:

 

Risk managers may not have the data they need to anticipate future bitcoin exposures and hazards. Indeed, a lack of transaction data makes it difficult to analyze the elements that influence bitcoin risk and returns, as well as compute basic measurement metrics like stress testing, VaR, and ES.

 

Cryptocurrencies are very volatile and may be traded 24 hours a day, 7 days a week, all over the world. Cryptocurrency marketplaces give a thorough but limited data set of real transaction prices, which is insufficient for modelling purposes. In fact, because there is no consensus on cryptocurrency pricing, return, or an equilibrium-generation function, modelling and predicting these digital assets is similar to a guessing game.

 

Many risk managers use statistical methods (such as spectral decomposition) to estimate their cryptocurrency exposures and find characteristics that may be integrated into pricing, risk, and trading models. These modelled prices, on the other hand, are not genuine prices, and their use - particularly for stress testing - is questionable.

 

4. Cryptocurrencies need to face trading costs:

 

In comparison to regular markets, the bitcoin market is often less liquid and more costly. Because the supply of many cryptocurrencies is restricted, with fresh units distributed on a pre-determined schedule, it should come as no surprise that cryptocurrency values are very volatile.

 

The bitcoin market is sometimes less liquid and more expensive than traditional marketplaces. It should come as no surprise that cryptocurrency values are extremely volatile because the supply of many cryptocurrencies is limited, with new units released on a pre-determined timetable. 

 

The fact that cryptocurrencies are untraceable is one of several problems that governments are attempting to solve through increasing regulation.

 

Because of the small user base, the currency has become more volatile. Once people accept a centralised authority system to govern it, the level of stability expected will rise. The uncertainty around Bitcoin's use, as well as major governments' opposition to integrating and legalising the system, will continue to depress values. (Source)

 

5. Cryptocurrency is still not legal in all countries:

 

With the exception of Iceland and Vietnam, cryptocurrencies are legal in the majority of nations. China has prohibited all Chinese financial institutions from dealing in bitcoins, while Russia, although claiming that Bitcoin is lawful, has declared it illegal. 

 

There is no law in India that says cryptocurrency is illegal, so it is still unclear whether it is legal or illegal. As a result, it is neither lawful nor criminal. In April 2017, Japan made Bitcoin legal and acknowledged it as a valid form of currency. 

 

6. Cryptocurrencies are still very risky:

 

Although blockchain is still in its infancy, it has grown to the point where it is more secure than a regular computer system. 

 

However, many financial breaches, data leaks, and massive losses as a result of system flaws have made it difficult for individuals to be content with their transactions. Due to its fatal centralised business strategy, $250 million was lost in a single transaction on the QuadrigaCX exchange at one point.

 

The popularity of cryptocurrency futures trading is growing among investors and dealers. Unlike derivatives on financial assets or commodities, however, these bitcoin derivatives are typically utilised to expand exposure rather than mitigate risk. 

 

Cryptocurrency derivatives are frequently exchange-the-difference contracts, also known as contracts-for-differences, by design. 

 

CFDs are cash-settled contracts between investors and brokers based on the value of the underlying (e.g., cryptocurrency) asset; investors often use CFDs to make price bets on whether the underlying asset's or security's price will grow or decline.

 

(Related read: 4 Types of Blockchain Networks)

 

 

Bottom Line:

 

Cryptocurrency is the way of the future in the financial world. Some of the current restrictions of cryptocurrencies, such as the digital wealth of cash being obliterated by a computer crash or a virtual vault being looted by a hacker, may be addressed in the future thanks to technical advancements. 

 

Because some institutions may issue their own cryptocurrency, there will be a lot more competition in the future as a payment mechanism. In the future years, decentralised and hybrid apps will dominate the market.

 

Overall, the consequences of large industrial giants, enterprises, and government agencies taking no action have never been as dramatic as they are now in all these years of crypto trade and mining. 

 

By the end of this year, cryptocurrency networks like Bitcoin, firms like Facebook, and countries like China will have taken a step toward dethroning the dollar as the world's most valuable currency. As a result, the US Federal Reserve will surge ahead of its digital equivalent.

 

(Next read: What is the Future of Cryptocurrency?)