You may have heard of Bitcoin and Ethereum. You’ve also probably heard how people make thousands, if not millions of dollars, by “investing” in cryptocurrency. But what is it? Or a better question…what is the point of cryptocurrency?
The main point of cryptocurrency is to fix the problems of traditional currencies by putting the power and responsibility in the currency holders’ hands. All of the cryptocurrencies adhere to the 5 properties and 3 functions of money. They each also attempt to solve one or more real-world problems.
Let’s discuss how cryptocurrency works and why more people are beginning to appreciate this next evolution of money.
Why You Should Care About Cryptocurrency
A cryptocurrency is a digital form of money that is a more secure medium of exchange.
The big idea is that because transactions are public, irreversible, mostly unhackable, and controlled by the people, users and their digital finances are more protected.
Of course, many benefits come with cryptocurrency. Below are four key reasons why people have begun to care about cryptocurrency.
1. Cryptocurrency Is Owned By Everyone
Cryptocurrency functions similarly to any traditional, national currency with a few fundamental differences.
Current “fiat currency” is created and regulated by a governmental body, all of which now represent debt. Anyone that owns a country’s currency holds an “IOU” issued by that respective country.
Cryptocurrency does not stand for debt. It strictly represents itself, and its value is determined by what someone is willing to trade for it.
The fact that cryptocurrency is decentralized plays an essential role in how its currency value is determined.
Nobody owns or regulates a cryptocurrency. Its value is not subject to a country’s political whims or a central bank’s monetary policy.
Note: Some may view cryptocurrency’s lack of centralization as a method to avoid taxes. However, like stocks and bonds, cryptocurrency is considered an asset. In the United States, it’s subject to capital gains taxes upon a sale or exchange.
Currencies operating off a centralized ledger (meaning a single entity managing the transaction records like a national central bank) are exposed to human manipulation and corruption. By being decentralized, cryptocurrency operates on a “distributed ledger” or a shared transaction list. This type of ledger is the heart of cryptocurrency and leads us to our next reason why it’s worth the attention.
2. Cryptocurrency Is Almost Impossible To Forge
Cryptocurrency operates on a blockchain, which is the distributed ledger we talked about above. Understanding blockchain technology helps you understand why this is the key to the power of the digital currency.
The “block” is composed of chunks of encrypted data. The “chain” is the public database in which the blocks are stored and sequentially related to each other.
Every block in the blockchain has a specific code that distinguishes itself from all other blocks in existence. This unique code is called a hash. Blocks of information being added to a blockchain are added chronologically. A new block is added directly after the last block created, which also has its own unique hash.
The ledger or database of blocks in the chain is simultaneously distributed worldwide spread among thousands, or in Ethereum and Bitcoin’s case, millions of computers.
Suppose someone wanted to forge a single block of data on the chain. In that case, they need to manipulate all the blocks from a point in history forward AND update all the computers holding copies of the blockchain ledger.
This is theoretically possible, but the amount of power and money needed to do it successfully makes an attempt virtually impossible.
3. Cryptocurrency Transactions Are (Mostly) Confidential
With traditional currencies issued by governments, you can privately transact or pay for something in person using physical cash.
Paper, metal, cloth, and plastic currencies make up a tiny fraction of the total amount of most fiat money in circulation. Large withdrawals of physical cash are quickly flagged and reviewed by a central authority like governments and financial system regulators.
Note: Monitoring large cash transactions is a good thing. It upholds the legitimacy of the currency and deters criminal enterprises like money laundering.
Cryptocurrency is different. It depends on well-designed math to track the exchange between two people or companies. This occurs mostly anonymously. While the ledger or list of transactions is publicly viewable worldwide, the parties exchanging cryptocurrency are more private. By definition, cryptocurrencies are held electronically in digital wallets. The owner is the holder of the private key to the wallet. The currency is exchanged digitally from mostly anonymous wallets owned by the users.
Another Note: While cryptocurrencies are intended to be anonymous, advanced forensics can uncover wallet holders’ identities. Some crypto projects like Monero are designed to be resistant to identity discovery.
A few companies like Titan Bitcoin offer premium-quality, physical coins minted with cryptocurrency addresses and verifiable values stored on the blockchain. This is an exciting concept for enthusiasts, collectors, and even gifts. It brings a bit of digital cryptocurrency into the real world.
Disclosure: This is not a paid sponsorship. The author, Data Overhaulers, nor its parent company hold any Bitcoin currency at the time of publication.
4. Cryptocurrency Security Grows Through Time & Value
Earlier, we talked about how a hack or manipulation would require an enormous amount of power and money to the point that it would essentially become a worthless endeavor. To elaborate, a hacker would need to control over fifty percent of the computers making up the “consensus” network.
The consensus network is simply all the computers that receive copies of the blockchain or distributed ledger. For more established cryptos like Bitcoin or Ethereum, the cryptocurrency networks are so big that a hack undertaking is mostly impossible.
In the early days of cryptocurrency, it was easier to gain the majority of control as the cryptocurrency network itself was much smaller.
This is an important fact to remember for investors or users of newer cryptocurrencies whose networks haven’t grown to a relatively significant size. The smaller the network, the more vulnerable it is to hacking.
An example of this almost happened to Bitcoin early on: a group known as BitFury pooled together a large number of computers for “mining.”
What is cryptocurrency mining?
Mining is the process in which cryptocurrency transactions are verified, and blocks are assigned their hashes. It requires a lot of computing power. Users lending their computers to the cryptocurrency network of validators receive rewards (through transaction fees) paid in the cryptocurrency they’re supporting.
BitFury created a mining pool or verification network, which became very profitable as Bitcoin’s value grew. However, in 2014 they were about to hit fifty percent of the overall network’s strength.
Though hacking and manipulating the blockchain was not their goal, they decided to limit the size of their influence on the Bitcoin network. The pool owners promised never to go above forty percent of the network’s overall strength. They did this to protect Bitcoin’s value as currency holders might fear a 51% attack from one operator.
If the value of Bitcoin plummeted, then BitFury’s profits would have been negatively impacted if not wiped out entirely. The necessary balance between potential profit and network power is another form of blockchain security. Too much network power will result in a loss of profit and the stability of the currency.
Are There Any Problems with Cryptocurrency?
The issue of decentralization has been argued as a “false decentralization.” A large enough group of people verifying blockchain transactions does form a quasi-centralized entity. Those people are the miners, who validate the blocks in the public ledger and assign the blocks their unique codes, or hashes.
This argument is directly related to the 51% majority issue that plagues newer cryptocurrencies but becomes less of a problem over time.
Another issue that has been put forth is that the benefits of cryptocurrency either are not realistic or more efficient than traditional fiat currency.
An electronic transfer of funds for a real currency can occur in minutes. In contrast, many of the first cryptocurrency projects can take hours.
Some of the older crypto projects also require a lot of computational power, leading to high electrical consumption levels. Critics argue that this is an inefficient use of earth’s resources.
Recent developments have begun to work around the shortcomings of transaction times and energy consumption as add-ons to the established cryptos and new projects that do not contain the identified inefficiencies.
An interesting observation is that cryptocurrency isn’t really a currency due to its price volatility. Money must be a good store of value.
Some merchants or vendors may allow purchases for goods and services in crypto. They would need to adjust the real-world price being charged in tandem with the market value of whatever cryptocurrency is being used.
They argue that the point of any currency is to represent a relatively stable value. As adoption grows, the price should become more stable. Some cryptocurrencies are pegged to the value of a fiat currency like TrustTokens. Other projects are one-for-one representations of assets like gold and Tezos.
Cryptocurrency is a way for us to make electronic peer-to-peer transfers without the risk of a single entity gaining too much power over the monetary system.
The merits of cryptocurrencies are still in its early days. Early adopters and enthusiasts will continue to sing cryptocurrency’s praises. Pundits will continue to measure this new financial tool against established currencies and real money. The average consumer must decide when’s the right time to test how cryptocurrency fits into their lives.
As blockchain technology continues to mature, and the useful blockchains surface into the mainstream, the point of cryptocurrency and its place in your financial toolbox will inevitably become apparent.
Marko from the WhiteBoard Finance YouTube channel does an excellent job comparing Bitcoin, gold, and traditional fiat currency in this unbias and objective video (6m41s@2x).
Financial Disclaimer: This content is for educational purposes only and is not suitable as financial advice. Opinions and statements expressed herein are those of the author. They do not reflect the views of Data Overhaulers or its owner. Data Overhaulers is not a subsidiary of or owned by any ICOs, blockchain startups, or companies that advertise on our platform. Investors should do their due diligence and meet with a licensed financial advisor before making any investments in any ICOs, blockchain startups, or cryptocurrencies. Please be advised that your investments are at your own risk, and any losses you may incur are your responsibility.