This words are now very common. You may have heard them; bitcoin, cryptocurrencies and the blockchain.
How do they compared to regular currencies and how do they work?
The blockchain and the cryptocurrencies came in the wake of the frustration felt by the world after bad monetary policies from central banks like Federal Reserve, commercial banks and hedge funds. These new currencies systems come because there just had to be another way. People needed control over their own money again.
What are cryptocurrencies?
It is a form of currency that is built on a global digital distributor ledger called a blockchain.
Cryptocurrencies like Bitcoin are distinctly different from the digital Fiat currency in your bank account. For example Bitcoin has a cap supply of 21 million coins. This is similar to gold, another finite resource that can be used as money. As time goes on, bitcoin can be divided up into smaller and smaller units as the economy grows. With traditional digital fiat currency there is no telling how much money is circulating, and no one knows if the central bank will decide to stop printing more money. This can be a real problem depending on how you view economics.
There are two main schools of economics; the Austrian school and the Keynesian school. The Austrian school thinks the money printing is a silent robbery by inflation. It makes us poorer because the more money there is, the less its worth.
The Keynesian school actually thinks inflation is a good thing. Inflation is a general increase in prices and fall in the purchasing value of money. In our world most of the central banks are run by Keynesians. In this day and age, instead of these Keynesians focusing on GDP growth and wealth creation, they are focused on inflation. They actually want a steady-state inflation of 2% per year.
In contrast bitcoin and other cryptocurrencies are deflationary because there is a fixed amount making it worth more over time instead of less.
Why these new digital currencies are called cryptocurrencies
These cryptocurrencies use a form of mathematics called cryptography. Cryptography is a practice and study of techniques for secure communication so that only those for whom it is intended can read and process it. It allows the participants in the system to have a unique address called a wallet.
The wallet is like a bank account. Only the individual has access to their wallet. This personal digital address or wallet mathematically proves that money has been sent or received to this wallet and is actually going to the right person. A wallet can be mathematically checked for accuracy but can’t be altered or tampered in any way.
What is a Blockchain?
A blockchain is a decentralised peer-to-peer system. In the system millions of computers agree on a global record of the history of all transactions that have ever taken place in the system. This global record is called a ledger. Therefore, a blockchain is a digital ledger in which transactions made in bitcoin or another cryptocurrency are recorded chronologically and publicly.
When you transfer some money or a service on the blockchain, everyone in the system knows about it. This peer-to-peer service is like LimeWire or Torrents where instead of transferring files you’re transferring a transaction entry into a very long notepad of all transactions and the notepad can be seen by everyone. The fact that there are millions of computers keeping track of all the transactions, it becomes impossible to cheat and create multiple fraudulent bitcoins.
The computers that are looking after the ledgers and keep the system running are called miners. They solve complex problems of how the transaction have been put together. Each time a problem is solved, is called block. Each block holds 10 minutes’ worth of transactions and is put in a chain when completed hence the name blockchain.
The miners get rewarded in cryptocurrency for their efforts. This is how new Bitcoin is created. Notice this is all modelled on how gold is mined out of the ground.
Since the activity of mining actually costs electricity to do, Bitcoin is seen as an actual electronic unit of work. I venture to say the underlying technology of mining, will be one of the most influential inventions of the century.
Analysts like Don Tapscott places this technology above that of Artificial intelligence (AI), hailing it as a second Internet but much smarter.
Just as an example, Ethereum blockchain is theoretically capable of running entire companies and services like Airbnb automatically without human input while also automatically optimising company performance. The blockchain also behaves as an automatic auditor, an accuracy checker throughout the whole system. It is designed to ensure trust is built into the system. This will create an incredible impact on our world.
Advantages of cryptocurrencies
Cryptos are decentralized currencies, meaning no central entity regulates or controls them. There is no middleman, be it a bank, government or any other company. With normal currencies, when you have a middleman, they usually aggregate power and aid in wealth inequality. This happens all the time today. This is why for example a lot of the wealth created goes to those closest to the financial industry.
Harder to Hack
The fact that the cryptocurrencies are decentralized makes it harder to hack. Banks and other centralized powers are an easy target for hackers and have been hacked in the past. The blockchain on the other hand is impossible to hack. To hack just one block, you must hack all previous blocks in that system’s history including all the millions of computers at the same time around the world. It is impossible with today’s technology.
Low barrier to entry for anyone
There’s a low barrier to entry and anyone can join. No bank account or permission from the government or any other entity or even fee payment. All that is needed is an Internet connection and the software. Anyone now can get their money in and out of a country without being tracked. Today’s currency system is hard to get your money out. In political situations where individuals are financially oppressed it’ll be so easy to move money as one pleases.
Transferring cryptocurrency is faster
Transferring cryptocurrencies internationally is faster than traditional methods. It takes 10 minutes instead of days.
Help stop corruption
Because the blockchain is transparent and everyone in the system knows which transactions is going to what wallet, cryptocurrencies can help stop corruption in developing nations.
So in conclusion it’s clear that blockchain-based currencies have some attractive advantages over regular financial system of government.
With these all being said, this area is just so new that no one knows for sure what the upside and downsides could be. I think eventually there is a cryptocurrency that will get it right.
Whether you think this is good or bad thing, there is no denying the blockchain and cryptocurrencies are definitely going to shake things up.
Should you invest in Bitcoin and other cryptocurrencies?
The answer will depend on what actually the investor is looking for. People with Long-term vision may take cryptocurrencies as a store of value in case of a crisis much like gold. With this strategy people may buy when the price goes down but always accumulate more and never sell until years later.
Other may be speculators. Those looking to make quick cash. This is probably the hardest strategy because cryptocurrencies are actually a real free market. They are not influenced by financial instruments.
The last category is where you are in a crisis country and just need some financial freedom.
We all need to proceed with caution because there is an element of hype and only the real cryptocurrencies will survive.