Babu G. Baradwaj, chair of the finance department in the College of Business and Economics, on the past, present and future of digital money.

illustration of cryptocurrency

About 10 years ago, a person or people using the name Satoshi Nakamoto created a peer-to-peer digital currency called Bitcoin. Nakamoto, whose identity remains unknown, published a white paper outlining how it would work and executed the first transaction.

The idea was that people could buy anything with Bitcoin, and stores would accept it. People wouldn’t need to carry cash, just digitally transfer funds.

So how does it work?

Say you want to purchase something from someone who is willing to accept digital coins as currency. You can’t print Bitcoin or physically hold it. You offer the coin and establish your ownership through a secure electronic ledger. The other party says OK. You digitally transfer the coin or coins—Bitcoin can be divided fractionally—and that transfer is authenticated by other people on the network. This is called the blockchain, which is basically an immutable electronic register with the information stored in pieces on a decentralized network. Users initiate and approve transactions anonymously. The technology is not complicated, but not many understand it. Once the transaction is complete, that second party is considered the owner of the coin and can use it in a new transaction.

In theory, the concept of a cryptocurrency—Bitcoin is the most well-known but there are several others—makes a lot of sense. Digital transfer already works with established currency; just look at Venmo or PayPal. But in practice it doesn’t really fill a need for people.

It has not taken the place of existing currency—dollars, yen or the euro. So that begs the question: Is it a currency or is it another type of asset that people can invest in?

There are a lot of uncertainties around cryptocurrency right now.

If I want to buy a coin, what am I buying it for? Who will accept it? What can I buy? Even if I have the value in cryptocurrency of what I want to buy, will the seller accept it?

How is it protected?

The Securities and Exchange Commission (SEC) protects investors in things like stocks and bonds, but there is no regulator for cryptocurrency. Buyer beware. You could lose it. Someone could steal it from you. You could forget your electronic key to it.

A large barrier to the establishment of cryptocurrency is the government.

The U.S. government does not want anything to compete with the dollar. Why would it allow it? Why would any nation?

Regulations have sprung up in some of the world’s largest financial markets. India has banned cryptocurrency. China has banned it in some respects. South Korea—one of the biggest cryptocurrency exchanges—has put in a lot of regulations. Japan did the same thing.

I don’t see cryptocurrency as a legitimate currency. It can become an investment.

The company that owns the New York Stock Exchange (NYSE) is talking about setting up investments through its own coin exchanges. Brokerage houses—Fidelity, J.P. Morgan, Goldman Sachs—have invested a lot of money and hired a lot of people in the technology sector to create their own investments. It definitely interests our students. Every term they ask about it.

They want to invest in it, but they don’t know anything about it or how to buy it. Students are interested because they see the price skyrocketing. But I always tell them, if you go to Vegas, you may win. But for every win, you might have lost 20 times. You’re not going to talk about those losses. It’s the same with things like Bitcoin.

I should be careful saying it won’t take off in the future, though.

Right now, legitimate users almost exclusively see it as an investment. Cryptocurrency is a much riskier investment than perhaps a lot of others, and it has the potential to grow into a bubble, like real estate and the dot-com bust.

The fact of the stock markets is you are going to go through upswings and downswings, and everyone has a different risk tolerance.

That tolerance of risk also extends to using cryptocurrency in the same way we use real currency now. The value of coins varies wildly, and hackers frequently make headlines with the fortunes stolen from unsuspecting users.

In the end, I don’t really see cryptocurrencies as anything more than a type of investment. The average user does not have the specialized knowledge of mining and trading coins, and governments will always move to quash any threats to their currencies and monetary policies.