Cryptocurrency: Understanding the Definition, Functions, and Risks

Although not a new phenomenon, discussions surrounding cryptocurrencies have grown significantly in recent years. The surge in popularity of these cryptocurrencies is partly fueled by influential figures globally promoting their chosen tokens as future investments. The uniqueness of cryptocurrencies is often touted as a factor that can bring substantial profits to investors. However, behind these potential gains, there are risks that need to be understood more deeply. So, what is cryptocurrency?

Definition and Functions of Cryptocurrency

In general, cryptocurrency is a digital currency. Its primary purpose is to serve as a digital medium of exchange for online transactions. In terms of security, cryptocurrency transactions, both buying and selling assets, are protected by cryptography or secret codes as part of their security measures.

Transactions are typically conducted peer-to-peer, connecting one device to another over the internet without the need for a central server. In other words, cryptocurrency owners can transact freely with anyone without the involvement of a third party regulating the process. However, all transactions are recorded and monitored by the cryptocurrency network known as the blockchain.

Blockchain is the underlying computational system that forms the basis of existing cryptocurrencies. Functionally, blockchain consists of interconnected blocks that record asset transactions and online business networks. Beyond recording, blockchain also distributes transaction information worldwide to cryptocurrency owners who wish to view it. However, this information is confidential and only reveals codes as transaction identities.

Development of Cryptocurrency

Historically, the development of cryptocurrency began around 1983 when David Chaum introduced cryptographic electronic money in the United States. At that time, electronic money, known as Digicash, could only be used starting in 1995, requiring specific hardware or software that limited its widespread use.

It was only in 2009 that Satoshi Nakamoto introduced Bitcoin as the first decentralized cryptocurrency. This allowed Satoshi Nakamoto's cryptocurrency to be used on various platforms without the need for special equipment other than an internet connection. The acceptance of this cryptocurrency on various digital platforms paved the way for the emergence of other cryptocurrencies we see today.

Regulation of Cryptocurrency in Indonesia

In Indonesia, cryptocurrency owned by anyone cannot be used as a means of payment. However, cryptocurrency investment is still allowed. This is explained in a letter from the Coordinating Minister for Economic Affairs Number S-302/M.EKON/09/2018 regarding the Follow-Up Implementation of Coordination Meetings on the Regulation of Crypto Assets as Commodities Traded on Futures Exchanges.

According to this letter, cryptocurrency is considered a commodity that can be traded on futures exchanges. This decision is based on the potential for significant investment that can contribute to Indonesia's economic development. Cryptocurrency investments are also carried out under the supervision of the Commodity Futures Trading Supervisory Agency (Bappebti).

Through Bappebti Regulation Number 5 of 2019, it is explained that cryptocurrency is a non-physical commodity in the form of a digital asset traded as an investment instrument. Regarding the inability to use cryptocurrency as a transaction tool, this is already regulated through Law Number 7 of 2011 concerning Currency. This law states that the only legal means of payment in Indonesia is the Indonesian Rupiah. In other words, cryptocurrency cannot be used as a means of payment in Indonesia. The only way to transact is by converting your cryptocurrency holdings into Indonesian Rupiah.

Risks of Cryptocurrency

Despite being considered secure with a security system based on cryptography, cryptocurrency as an investment instrument still has its risks. These risks are explained by the Financial Services Authority (OJK) based on national media reports. OJK explains that the value of cryptocurrencies is highly volatile and uncontrollable. This causes fluctuations in the value of cryptocurrencies that can occur at any time and without clear reasons. Additionally, OJK does not supervise or regulate cryptocurrencies. These risks must be understood by the Indonesian public before embarking on large-scale investments.

Alternative Investment Instruments

For those who feel that cryptocurrencies pose significant financial risks, it is advisable to consider using investment instruments that have long been popular in Indonesia. These instruments include bonds, deposits, and mutual funds. Let's get to know these three investment instruments.

Cryptocurrency is a type of digital or virtual currency that uses cryptography for security and operates independently of a central authority, like a government or financial institution. Here’s a breakdown of its definition, functions, and associated risks:

Definition

Cryptocurrency:

Digital/Virtual: It exists only in electronic form and does not have a physical counterpart like coins or paper money.
Cryptography: Security is ensured through cryptographic techniques, which help secure transactions and control the creation of new units.
Decentralization: Most cryptocurrencies operate on a decentralized network using blockchain technology, which is a distributed ledger maintained by a network of computers (nodes).

Functions

Medium of Exchange: Cryptocurrencies can be used to buy goods and services, though their acceptance is still limited compared to traditional currencies.
Store of Value: Some people view cryptocurrencies, particularly Bitcoin, as a store of value similar to gold, hoping they will retain value over time.
Investment: Many people invest in cryptocurrencies with the hope that their value will increase. This can be highly speculative and volatile.
Unit of Account: Cryptocurrencies can be used to measure and compare the value of goods and services, though this function is less common due to their volatility.
Cross-Border Transactions: Cryptocurrencies can facilitate international transactions by bypassing traditional financial intermediaries and reducing transaction fees and processing times.
Smart Contracts: Some cryptocurrencies, like Ethereum, enable the creation and execution of smart contracts—self-executing contracts with the terms directly written into code.

Risks

Volatility: Cryptocurrency prices can be extremely volatile, with significant fluctuations over short periods. This can lead to substantial financial gains or losses.
Regulatory Uncertainty: The regulatory environment for cryptocurrencies is evolving and varies by country. Changes in regulations can impact the value and legality of certain cryptocurrencies.
Security Risks: While blockchain technology itself is generally secure, exchanges and wallets can be vulnerable to hacking, theft, and fraud. Loss of private keys can also result in the loss of access to funds.
Lack of Consumer Protections: Unlike traditional financial systems, cryptocurrencies often lack consumer protections. If something goes wrong, it can be challenging to recover lost or stolen funds.
Market Manipulation: The cryptocurrency market is relatively new and can be susceptible to manipulation and speculative bubbles. Pump-and-dump schemes and price manipulation tactics can adversely affect investors.
Technological Risks: Bugs, software flaws, and network vulnerabilities can pose risks to cryptocurrencies. The technology is still evolving, and issues can arise.
Legal and Tax Implications: The legal status and tax treatment of cryptocurrencies can vary. In some jurisdictions, they might be considered assets or commodities, impacting how they are taxed.

Understanding these aspects can help you navigate the world of cryptocurrencies with a better grasp of both their potential benefits and inherent risks.

Conclusion Crypto

In conclusion, cryptocurrency represents a significant innovation in the financial world, offering new possibilities for transactions, investments, and technological applications. Here’s a summary of key points to consider:

Summary

Definition and Nature:
- Cryptocurrencies are digital or virtual currencies secured by cryptographic techniques and often operate on decentralized networks using blockchain technology.
Functions:
- Medium of Exchange: Used for purchasing goods and services.
- Store of Value: Seen as an investment similar to traditional assets like gold.
- Investment Vehicle: Speculative asset with potential for high returns.
- Cross-Border Transactions: Facilitates international transactions with lower fees.
- Smart Contracts: Allows execution of programmable contracts on certain platforms.
Risks:
- Volatility: Prices can fluctuate wildly, leading to potential losses.
- Regulatory Uncertainty: Legal frameworks are still evolving and can impact value and legality.
- Security Risks: Vulnerable to hacking, theft, and loss of access.
- Lack of Consumer Protections: Limited recourse for issues compared to traditional financial systems.
- Market Manipulation: Susceptible to speculative and manipulative practices.
- Technological Risks: Potential for software flaws and network vulnerabilities.
- Legal and Tax Implications: Varying treatments across jurisdictions can affect use and taxation.

Final Thoughts

Cryptocurrencies offer innovative opportunities but come with significant risks and challenges. For those considering involvement, it’s crucial to:

Conduct thorough research: Understand the specific cryptocurrency, its technology, and its market dynamics.
Diversify: Don’t invest more than you can afford to lose, and consider diversifying investments.
Stay Informed: Keep up-to-date with regulatory changes and technological advancements.
Ensure Security: Use reputable platforms and practices to secure your assets.

Approaching cryptocurrency with a well-informed and cautious mindset can help you navigate its complexities and leverage its potential benefits while managing its inherent risks.

Cryptocurrency: Understanding the Definition, Functions, and Risks