As technology and financial bubbles go, there’s nothing that feels more like a bubble right now than the mayhem associated with the various cryptocurrencies such as Bitcoin. Holders are gaining and losing thousands of dollars (or more!), sometimes on an hourly basis. And if that feels like hyperbole, it really isn’t. One of the draws of the various cryptocurrencies is the chance to get into ground floor of a nascent idea that either could be significant fortune or end up a bust – and that introduces volatility. Here’s a high-level look at blockchains, cryptocurrencies and Bitcoin. Be forewarned that while this is not a technical discussion, there are some technology concepts that will be thrown around.
Holders are gaining and losing thousands of dollars (or more!), sometimes on an hourly basis.
So, what’s so different about cryptocurrencies than say your average Alexander Hamilton ten-note? To answer that, let’s start with a look at the history of money.
The History of Currency
Originally, money was literally anything you will trade for other goods and services, or for repayment of debt. A live chicken might be considered “money” just like the modern-day Euro. Let’s review the differences and similarities between these two transactions. Both are based on the value of what is being offered. A chicken may have unique value based on its ability to be converted into a meal, or to be used to create additional chickens, or maybe even as a pet. It has intrinsic value based on what it can be converted to. A Euro is similar in that when you pay someone with it, the person is thinking about what in turn it can be converted to. Why, it could be used to buy a chicken (but not for long in England)!
Clearly, it’s easier to exchange coins or notes on paper than it is to barter in livestock, so thousands of years ago the switch began to instead using placeholders of value (fiat). Initially, the value of these placeholders was in direct relation to the precious metals they were made of. In fact, the term “salary” originated in ancient Rome (“salarium”) where Roman Centurions were often paid in salt, a rare and precious spice that was used to cure and preserve meats. But trading salt, gold or other precious materials became unwieldy and portion control became a problem. Did I owe you handful of salt? Or a cup?
Coins made of more structured materials such as gold or silver began to be leveraged. They not only were easy to handle and ration, they often carried similar values across cultures and nations. This ultimately lead to the notion of a gold standard, where paper money is freely and easily converted to an equitable amount of gold held by the issuer of the currency, often a government. In the 1700s and over the following two centuries, countries began keeping quantities of gold to represent the outstanding amount of paper money they had in circulation. And this was ultimately adopted by all Western countries. But as gold reserves dropped worldwide, there was a movement away from this standard, leading ultimately to the US dropping the gold-standard in 1971. This conversion is technically called a move to “fiat”, where the value of currency is not related to the gold it can be exchanged for, but to fiscal policies and economic stability of individual.
When based on economic conditions however the value of a particular currency can vary and be manipulated artificially. This is the problem that cryptocurrencies looked to solve.
But how can a currency be created that is not controlled by any nation or world bank? How can it have any value? How can it be legitimized and certified so that it cannot be forged or counterfeited?
Enter Block-Chain
Blockchain is the technology that makes Bitcoin (and other crypto-currencies) possible. It was created in 2008 by a person or group (no one is sure) named “Satoshi Nakamoto”, who since has disappeared. In short, blockchain is global digital ledger that openly and accurately tracks a transaction between two parties, and allows those parties to remain anonymous. A transaction entry in this digital worldwide ledger cannot be modified or forged. Blockchain technology is useful for tracking any interaction where security and integrity must be enforced but is not under the control of any particular person. Financial transactions, rights ownership, medical records, land ownership transactions, identity management all could leverage this technology someday. But what does that have to do with cryptocurrency?
Cryptocurrency is just a digital asset that can be exchanged as money. Blockchain provides solutions for two fundamental cryptocurrency concerns: double-spending, and risks associated with control by a central authority. Double-spending would allow you to use the same “dollar” to buy multiple items without handing over that dollar. In essence, you could duplicate that dollar and use it repeatedly to purchase items. Control by a central authority would allow cryptocurrency to be influenced by nations or world banks, or if stored centrally would allow it to be hacked and polluted. Since a Blockchain is stored across the Internet on multiple computers, with redundant cross-checking to insure integrity, both of these issues can be addressed. The Internet has made it possible for computers all over the world to communicate and maintain integrity in real-time, and ensure no central point of hacking or failure.
How is Blockchain used to create secure and reliable cryptocurrency? It’s all about the “mining”. Mining is a term that describes the process of making sure that blockchain transactions are legitimate and intact. It’s a very complicated process that involves words like “nonces” and technical terms like “proof-of-work” algorithms. But the process to do this takes significant horsepower; more than one computer can provide. Thus, process is distributed to many computers across the Internet leveraging their combined horsepower. Computers work together to verify that all transactions that are added to the Bitcoin blockchain are valid. The complexity and scale of verifying transactions increases as more transactions involving unique Bitcoins occur, so there’s a practical limit to how many unique Bitcoins can be leveraged. The Computers who work together to mine and create additional transaction slots (coins) are rewarded with 12.5 new Bitcoins each time a new “slot” is created. The limit on the number of total Bitcoins that can be created is 21 million and will be reached in 2040, over half of which having been created thus far. At that time, these mining computers will switch to simply verifying the integrity of the Bitcoin blockchain transactions and will be paid in transaction fees. No more new Bitcoins will be created and the ones in circulation will all be linked and validated to each other.
Bitcoins are acquired and stored in “wallets”, which are digital credentials for your owned currency that relate back to the blockchains where they were created and transacted. The wallet owner is responsible for keeping their credentials secret. Keeping wallets is significant technological tasks so often people use “wallet providers” who manage your wallet for you. If you want to touch and feel a Bitcoin, there’s a standard hard-coin with a logo that can be created. On the coin is the transaction id that refers back to your wallet, that refers back to the history of the Bitcoin and how you came to own it. In fact, it’s easy see all the previous places your Bitcoin was used to purchase something, with the identity of the transaction-placer kept private. In this way, you can avoid purchasing Bitcoins that may have been used in dubious transactions.
“In 2015, there were over 100,000 merchants that accepted Bitcoin, including Dell, Microsoft and PayPal.”
I Wanna Play!
To purchase a cryptocurrency, you have to visit a “cryptocurrency exchange”, which allows you to trade assets (e.g. US dollars) for various cryptocurrencies. In the US, you can use Coinbase, Kraken and Gemini, and the list is growing. You simply log in and purchase the cryptocurrency you want at the going rate and place it in your wallet.
Since the value of cryptocurrencies is not tied to a standard but instead to a combination of supply and what they can be traded for, we’re talking about a very volatile market. The majority of the supply appears to be controlled by very early adopters and miners. If someone who owns a large quantity of Bitcoins suddenly sells them off for US dollars, the value of the cryptocurrency dives. And there’s some concern that artificial buying and selling by some large holders is creating millionaires under dubious circumstances.
As the chart below shows, over the last 3 years while steadily rising in value against the US dollar, there have been times of instantaneous dives that delivered masses losses to Bitcoin owners.
By Bitcoin Charts – https://bitcoincharts.com/charts/bitstampUSD#rg1460zigWeeklyztgTzm1g10zm2g10zl, CC BY-SA 3.0, https://commons.wikimedia.org/w/index.php?curid=27802663
Is there nothing that can be done to stabilize Bitcoin prices?
Yes, actually. In December 2017, Bitcoin were added as a “futures” commodity on the Chicago Board Options Exchange. This is the first time Bitcoin has been on any regulated exchange. A futures exchanges has to do with investors paying now what they think something will be worth in the future. It can be based on company performance, whether a particular crop should have a good harvest, plans by OPEC to increase production. It enables investors to speculate on the price of Bitcoin without buying it. And by adding some regulation, the side effect should be some price stabilization.
Finally, Bitcoin is but one of many cryptocurrencies in existence. In fact, anyone can create their own cryptocurrency. The programming code to create blockchain transactions and mine coins is open-source (freely available) so you can create your own variation, name it whatever you like, acquire a bunch of miners and have at it. What your new currency is worth is based on what it can be used to purchase, supply, etc. Examples of other cryptocurrencies in existence includes Namecoin, Litecoin, Swiftcoin and even one based on an Internet meme called Dogecoin. (Here you can find a current list of the various cryptocurrencies in existence:
https://en.wikipedia.org/wiki/List_of_cryptocurrencies )
Will cryptocurrencies become the standard for transactions across the world? Probably not in the short or middle term, but long-term there is something alluring about currency not controlled (i.e. manipulated) by a central authority – especially if the introduction of some regulation starts to stabilize its value.
Blockchains technology will definitely stick around as it’s a unique and certified way creating verifiable and secure transactions in a digital ledger. The use of blockchain technology unrelated to financial transactions continues to grow as well. Chronicled is an organization that is using blockchain to store contracts and legal documents. A startup called Follow My Vote is using blockchain technology to address voter fraud concerns. And MedRec is an effort to use blockchain to store private medical data.
While the technology behind blockchains, cryptocurrencies and Bitcoin is highly complicated and often confusing, the idea behind having a solid and verifiable way to exchange currency that is not in the hands of any government offers some interesting possibilities – and is not unlike the idea of “credits” in the Star Trek universe.
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