How Do Cryptocurrencies Work, and What is the Impact of the China Ban?

On September 24, 2021, China’s central bank issued a statement explaining that all virtual currency-related business activities were illegal from that moment on in the country, effectively placing a nationwide ban on cryptocurrency transactions. The announcement came amid a largescale crackdown on the trillion-dollar cryptocurrency industry by the Chinese government.

According to the statement, which was published on the People’s Bank of China website, all financial institutions, Internet platforms, and payment companies in China will be banned from enabling cryptocurrency trading. The People’s Bank of China also seeks to target foreign exchanges, banning foreign entities from providing virtual currency exchanges for Chinese residents via the Internet.

What is cryptocurrency?

Cryptocurrencies are virtual assets that are bought, spent, sold, and traded via digital exchanges. Also known as crypto assets, they are cryptographically secured representations of value capable of being traded or used to pay for things.

Cryptocurrency does not represent a physical asset, so it has no intrinsic value, just as paper, or fiat currencies have no intrinsic value. The user of the $20 or $100 bill has to have faith (along with lots and lots of other people) that that $20 or $100 will indeed buy him a certain amount of good or services. Supply and demand dictate its value. Similarly, and put simply, cryptocurrency is only worth what a buyer is willing to pay for it, making it a somewhat speculative, unpredictable asset, like paper currencies, which have historically lost all or most of their value over time.

What are the benefits of cryptocurrency?

In traditional business transactions, agents, brokers, and legal representatives can complicate and generate additional expenses to even straightforward transactions, with things like paperwork, commissions, brokerage fees, and a variety of other expenses hampering the process.

One of the main benefits of cryptocurrency is that this peer-to-peer platform enables users to effectively cut out the middle man, creating accountability and reducing the possibility for confusion. With cryptocurrency blockchain essentially serving as a large property rights database, the medium minimizes the time and expense involved in making asset transfers. It also eliminates bank transaction fees.

Cryptocurrency transactions offer enhanced confidentiality compared with traditional cash/credit systems, where an individual’s entire credit history can be viewed by banks or credit agencies. Users are shielded against the threat of identity theft, account tampering, fraud, and invasion of privacy thanks to the strong encryption techniques utilized throughout the transaction process.

Digital currencies enable anyone with a viable data connection to complete cryptocurrency transactions, increasing access to credit. Though unrecognized as legal tender in many countries worldwide, cryptocurrency does facilitate cross-border transfers without complications, eliminating costly currency exchange fluctuations, transaction charges, interest, and other levies.

Most countries operate stringent rules regulating the banking industry, protecting the rights of consumers. Nevertheless, when we deposit funds in the traditional banking system, we are effectively signing over control of our assets to a third party. If an account holder impinges the bank’s terms of service, the bank could make them jump through hoops to access their money. One of the greatest advantages of cryptocurrency is that investors are the sole owner of private and public encryption keys, effectively ensuring that they retain full control of their money.

What risks are associated with cryptocurrency?

Virtual currencies have gained significant traction in recent years, but investing in Bitcoin and other cryptocurrencies is not without risk, with some seasoned investors warning that the phenomenon is a “mirage” and a “soap bubble”, while other big name billionaire investors and hedge fund managers have embraced it, and continue to add to their holdings.

One of the main dangers of investing in cryptocurrency is price variability. As with most types of investment, values fall as well as rise. With digital currency, these fluctuations can be dramatic.

As with any popular technology, competition is a big problem. An influx of new cryptocurrency competitors have entered the market recently, an issue any Bitcoin owner is acutely aware of. Unless investors keep their eye on the ball, they could lose a lot if the cryptocurrency they invested in suddenly loses value due to the emergence of a stronger rival, as we have seen over the years with countless tech stocks and companies.

Fraud is a risk that is inherent to owning any financial asset. In terms of buying and selling, crypto investors should keep in mind that if it sounds too good to be true, it almost certainly is. Also, because cryptocurrency details are stored on computers, if that hard drive breaks down or the key file is accidentally deleted, the investor could lose access to their digital currency. Similarly, if a hacker gains access, they could steal the contents of your digital wallet, as they can with your brokerage or bank accounts.

A significant problem with cryptocurrency is the lack of regulation. Unlike conventional bank accounts, cryptocurrencies do not benefit from FDIC insurance. Plus, the US government regards cryptocurrencies as securities, applying existing laws to digital assets and obliging investors to report realized gains. In other countries, like China, crypto investments are banned.

What is the impact of China’s cryptocurrency ban on the market?

In the wake of China’s latest cryptocurrency crackdown, many major cryptocurrencies took a massive tumble in value. Bitcoin fell 8 percent to around $41,000 by 9 a.m. on the day of China’s announcement.  However, less than two weeks later, Bitcoin had recovered to over $50,000, as the concerns about China’s efforts faded.

Although cryptocurrency continues to provide the opportunity for massive gains, equally, there remains potential for huge losses, making it a high-risk, high reward strategy for speculative investors. Therefore, cryptocurrencies or “digital assets” should only comprise a small percentage of the average investor’s portfolio.

Published by Robert Ryerson

A financial professional with more than three decades of experience, Robert Ryerson works closely with clients in the Freehold, New Jersey, area to meet their financial planning needs. As a Certified Financial Planner (CFP) at New Century Planning, he focuses on retirement income planning, as well as estate administration, regularly assisting his clients with legacy and estate planning. He also advises them on health and disability insurance, including Medicare, Medicaid, and Medicare Supplement Plans. Mr. Ryerson’s many years helping his clients navigate the complexities of retirement planning gave him a deeper understanding of the healthcare costs that retirees face. In 2013, he drew upon this knowledge to co-author the book What You Don’t Know About Retirement Will Hurt You. Outside of his work at New Century Planning, Robert M. Ryerson is a regular fixture at workshops and seminars on retirement. He has delivered several keynote speeches on the often-confusing topic of required minimum distributions. Mr. Ryerson continues to share his financial expertise as a facilitator of online courses for Certified Public Accountants through The Society for Financial Awareness. In the early 2010s, Mr. Ryerson became concerned about the threat of identity theft after noting the many cybersecurity breaches suffered by major companies. He became a Certified Identity Theft Risk Management Specialist (CITRMS) in 2014. He has since taught identity theft recovery courses at local community colleges. Mr. Ryerson also wrote a book on the topic entitled What’s the Deal with Identity Theft: A Plain English Look at Our Fastest Growing Crime. A graduate of Rutgers University with a degree in economics, Mr. Ryerson began his career in the financial services industry as a stockbroker. He obtained his CFP designation in 1991 and began working as an independent financial planner a few years later. In addition, he is a notary public.

%d bloggers like this: