Corvinus University of Budapest

Faculty of Social Sciences

World Economics Institute

BLOCKCHAIN TECHNOLOGY AND CRYPTOCURRENCIES

The Advantages and Risks of Cryptocurrencies

Spring, 2018

Sevinj AHMADOVA

MSc in International Economy and Business

International Economic Analysis

 The Advantages and Risks of Cryptocurrencies

Cryptocurrencies have some benefits and risks at the same time. Below major advantages
and risks will be discussed. It is apparent that as cryptocurrencies are not mature yet, they have
defined risks that is removed by the traditional financial system. Those are the main reasons for
the uncertainty from people’s side. However, those risks can be reduced via advancement which
will take some time.

Benefits of Cryptocurrencies

The benefits provided by cryptocurrencies can be examined in three main categories:

high transaction speed, transaction security and low cost.

Cryptocurrencies are fast

Cryptocurrencies are fast based on their processing time and availability of transfers.
Processing time may vary between centralized and decentralized cryptocurrencies. While for
centralized currencies it is rapid as one second, for decentralized ones it may take up to 1 hour.
But their availability of making transactions is a great advantage as immediate transactions can
be made even in non-office hours and receiver party can receive it.

Also cryptocurrencies do not have one location. They are worldwide which means that
location does not affect transaction fees or the processing time. In this terms, differences in the
time also does not matter as cryptocurrencies are verified automatically and office working hours
are not a matter of question (Messika, 2018)1.

Cryptocurrencies are anonymous

One of the advantages of the cryptocurrencies is that they do not require to enter personal
data information in order to proceed. They are anonymous. However, their anonymity has been
in used for taking illegal activities and that makes thoughts to be sceptical about them to be the
future. This feature is actually an advantage if cryptocurrency developers and governments will

1
Messika, B. (2018): Cryptocurrency and Blockchain: ‘Tis the Future. Medium Corporation, USA.
take actions against illegal money transactions through cryptocurrencies. This feature is
cryptocurrency similarity to cash, as cash is also anonymous (Messika, 2018)2.

Cryptocurrencies are cheap

Cryptocurrencies are cheap because of the various factors. Firstly, there is no fee for
creating a wallet for them and store. Secondly, there are very low transaction fees. Thirdly, there
are no exchange rates and commission fees. Finally, there are no fees for cross-border
transactions.

The price of cryptocurrencies is volatile. If the users do not have cryptocurrency in their
hands today, it can be more expensive for them to get this cryptocurrency tomorrow as they can
appreciate over their national currency.

The reason why cryptocurrencies are cheaper is that they are not regulated by the
government or authorities. If cryptocurrencies are regulated as a financial service by law, similar
costs may apply to cryptocurrency systems. These compliance costs will affect negatively the
cost advantage already borne by cryptocurrencies (EBA, 2014)3.

Risks of Cryptocurrencies

In above section, the benefits of the cryptocurrencies were discussed. As it was

mentioned previously, cryptocurrencies have some core problems that make people think
sceptically regarding their benefits. Below benefits will be discussed.

Cryptocurrencies make payment systems risky

In order to analyse payment system risks, two major sector should be analysed:
Centralized and decentralized payment systems.

Centralized payment systems

Centralized payment systems have those disadvantages (BOE, 2018)4:

2
Messika, B. (2018): Cryptocurrency and Blockchain: ‘Tis the Future. Medium Corporation, USA.

3
EBA. (2014). EBA Opinion on Virtual Currencies. London, pp.17
4
Bank of England (2018): CHAPS Reference Manual, pp. 105-106
  When the borrowers cannot pay back the borrowed money to lenders, it leads to credit
risk.
 When borrower does not have enough assets like cash to pay the debt back to the lender,
it causes liquidity risk.
 When there is technical issue like internet error or system error, the transactions are not
succeeding. This type of risk is operational risk.

Those are the payment risks. During making transactions, intermediaries are taking into
consideration those risks and try to avoid them by decent methods. As there are no
intermediaries, cryptocurrencies have those risks in which it is unavoidable. If those risks are not
prevented and cryptocurrencies are main payment methods, then crisis is inevitable.

Decentralized payment systems

There are no intermediaries in decentralized systems, because they are not gathered in one
centre and no intermediaries exist. As there is no intermediary, there is no central authority who
is interested in avoiding risks. In cryptocurrency cases, the main argument is that they are kept in
distributed ledgers, so everyone has the same “notebook” with same records. However, it is
undeniable that those systems can also collapse by hacks or fraud, or some operational risks may
happen due to the connection.

Government cannot intervene to cryptocurrencies

People who don’t believe in cryptocurrency are mainly arguing that cryptocurrencies are not
regulated by government and there is no control of money supply and demand. Fiat currencies
are issued by central banks and banks can easily manipulate supply and demand of them in order
to “play” with inflation and interest rates. Because of the fact that cryptocurrencies have no
centre and no “issuer” and they are public, they cannot be manipulated.

Cryptocurrencies have lack of transparency

For decentralized cryptocurrencies, it is not even clear who will provide information to the
user. Some cryptocurrencies carry features that are not specified by the user and impose
inconvenience to the user. Especially when users decide to invest in these cryptocurrencies or if
they try to make profits by mining activities. The profit is misleading because of the profit ratios
promised by investors or issuers. In some cases, after investors have obtained a certain amount of
cryptocurrency as the end of mining activities, these units are introduced to the market, and after
they are sold, the scheme is usually left to itself. Users in the blockchain cannot be followed by
their real names and only with cryptocurrency addresses. Although this situation poses a positive
role for cryptocurrencies in favour of users in terms of securing information, the risk of forgery
created is the other side of medallion (Harwick, 2016)5. For instance, because of the fact that
cryptocurrency transactions are anonymous, fraud can happen if some fraudulent people make
fake transactions and they are recorded. If those transactions are not reversed, it will decrease
public trust to the cryptocurrencies. This will become even more common in the process as the
use of cryptocurrencies increase.

Cryptocurrencies are not accepted legally

Cryptocurrencies are not real currencies and as far as they are not accepted as fiat currency,
they will not be judged legally. It makes sense when for example, people get their salary from
companies. No company will be ready to pay in cryptocurrencies as there is first challenge of
choosing one special cryptocurrency that perfectly fits their need from a million of
cryptocurrencies, and second challenge of the fluctuation of the exchange rates of the
cryptocurrencies. Also, there is liquidity risk that if people who receive their payments in
cryptocurrencies can spend them.

Since the legal framework for cryptocurrency transactions is not yet clear, users may face
unexpected legal requirements and their actions may be considered illegal or unfeasible. In many
countries, the tax rules in this area are not yet clear and may change unexpectedly, resulting in
additional costs for the users.

Cryptocurrencies are not sustainable

Cryptocurrency’ continuity is not guaranteed by anybody. Sellers can stop accepting one or
more cryptocurrencies without any reasons. In this case buyers will have illiquid assets in their
hands.

Cryptocurrencies are volatile

5
Harwick, C. (2016): Cryptocurrency and the Problem of Intermediation. The Independent Review, JSTOR.
 The main factor why still cryptocurrencies are regarded as investment rather than payment
method is their very high volatility. Due to this fact, it cannot be guaranteed that with the same
amount of dollars spend for cryptocurrencies, users can exchange them for goods with the same
amount of dollar value. That is why most speculators are using cryptocurrencies in order to gain
high income from their volatility.

Below standard deviations of daily changes of BTC prices for the eight different stock
exchange dates between 01.01.2013 and 30.06.2015 are calculated for 3 month periods and are
given in table. Standard deviations of exchanges range from 2% to 5%. Although there are
periodic fluctuations, it is generally observed that the volatility of BTC prices has decreased after
the first quarter of 2014 in the Bitcoin market.

Period Bitfin Bitstamp Mt.Gox Btce Okcoin Kraken Anx Coinfloor

Year Average
ex (US (US (US (Chine (Euro) (Japa (GB
(US Dollars) Dollars Dollar se nese Pound)
Doll ) s) Yuan) Yen)
ars)
1 - 4.12% 4.11% 3.97% 3.05%
2013
2 - 10.27% 8.91% 9.87% 7.26%
3 3.78 3.64% 4.17% 3.63% 3.68% 3.78%
%
4 10.90 9.59% 10.53% 9.88% 12.21% 10.62%
%
1 5.24 4.99% 21.35% 4.82% 4.83% 4.23% 7.58%
%
2014 2 4.47 4.51% - 4.68% 4.36% 4.40% 5.40% 3.98%
%
3 2.54 2.54% - 2.85% 2.57% 2.70% 2.25% 2.35% 2.23%
%
4 3.40 3.28% - 3.24% 3.86% 2.97% 2.30% 2.53% 2.70%
%
1 5.11 5.50% - 5.42% 5.37% 5.03% 3.85% 4.45% 4.34%
2015 %
2 1.96 1.95% - 1.79% 1.70% 1.62% 1.32% 1.42% 1.47%
%
Standard Deviations of Daily Changes of BTC Price

GARCH Modelling of Cryptocurrencies by Jeffrey Chu, Stephen Chan, Saralees

Nadarajah and Joerg Osterrieder6.

In their study, authors aimed to make GARCH modelling to 7 most important

cryptocurrencies in order to find their volatility risks from an investor perspective. Data used
here has been driven from the historical exchange rates of each cryptocurrency using

6
Chu, J. – Chan, S.- Nadarajah, S.- Osterreider, J. (2017): GARCH modelling of Cryptocurrencies. Retrieved on
November 29, 2017 from www.mdpi.com/1911-8074/10/4/17/pdf
BNC2database from Quandl. Authors made 12 different GARCH-type log returns. Authors
analysed Bitcoin, Ripple, Litecoin, Monero, Dash, Dogecoin and Maidsafecoin. Authors firstly,
have chosen correct model for the analysis. Then they checked the efficiency by comparing the
best fitting model and bootstrapping. After successful selection, authors controlled the models by
Kolmogorov-Smirnov test. In the end, authors conducted risk exceedances test to implement
unconditional and conditional coverage value. The results of the study are implemented to tested
cryptocurrencies and are indicated with high volatility. Those cryptocurrencies can be good
opportunity to high risk-high return seeking investors, but overall high volatility should be
considered by financial intermediaries carefully.

References
Messika, B. (2018): Cryptocurrency and Blockchain: ‘Tis the Future. Medium Corporation, USA.

EBA. (2014). EBA Opinion on Virtual Currencies. London

Bank of England (2018): CHAPS Reference Manual

Harwick, C. (2016): Cryptocurrency and the Problem of Intermediation. The Independent Review, JSTOR.

Chu, J. – Chan, S.- Nadarajah, S.- Osterreider, J. (2017): GARCH modelling of Cryptocurrencies. Retrieved
on November 29, 2017 from www.mdpi.com/1911-8074/10/4/17/pdf