Crypto Crazy - the currency of the future or just the latest trend?
Everyone’s heard of cryptocurrency and its rapid rise. It is, however, just a buzzword to most people. So before decisively predicting its future, we must decrypt cryptocurrency.
What is cryptocurrency?
Despite the prevalence of cryptocurrency, this is not an easy question to answer. But it is essential to understanding why it has disrupted the marketplace.
In today’s consumerist world, we have a pretty simple understanding of how transactions work: We pay money to a store to get our desired product. But it’s really not that easy. A majority of today’s transactions, especially large amounts of money, go through a third party – a bank or credit card company. This institution takes a tiny cut of the payment. Then, the rest goes to the store, and you get your desired product.
But, what if there were a way to eliminate this third party? After all, it completely relies on a system of trust. Who’s to say that the bank will protect your money from the sliest of thieves and hackers? Or, who’s to say that the bank won’t take a larger cut than they are supposed to? This is a possibility especially in unregulated third world countries.
That’s where cryptocurrency comes in. The idea is to eliminate the hassles of a third party bank or credit card company by creating a digital currency, which relies on a solid mathematical system rather than trust. And, you still get exactly what you wanted.
How does it work?
Cryptocurrency, at its core, is a ledger that contains names and balances; in order to exchange money, users must change this file. To fulfill its purpose of eliminating third party banks or credit card companies, which maintain one centralized ledger, cryptocurrency provides all its users with their own ledgers, on which everyone can see each other’s balances. The entire cryptocurrency community ensures accuracy in transactions. Of course, actual names are replaced with account numbers to preserve anonymity.
To keep these ledgers synchronized, a message is broadcasted for every transaction, containing details such as the sender, the recipient, and the amount transferred. So, how does cryptocurrency prevent thieves from broadcasting false messages? In other words, what is stopping Bob from releasing a message that Tom is sending him ten crypto-coins? Every message such as this one has a signature determined by a function, by solid math. (It can not be forged like a handwritten signature.) These signatures are generated for every message based on the account that releases the message and the content of the message. Another function verifies whether this signature is valid for the request. In the case of Bob, a red flag would go off that he is trying to send himself ten crypto-coins through Tom’s account.
Keeping track of who sent the message may be simple, but how does cryptocurrency keep track of when a message was sent? This is crucial, for without an account of time, double-spending may occur. Let’s say that Bob owes Tom and Joe ten crypto-coins each, but Bob only has ten crypto-coins in his account. Bob sends two messages simultaneously to Tom and Joe for ten crypto-coins. Remember that cryptocurrency relies on decentralized ledgers, so there needs to be a general consensus among users as to which request was first. However, due to the proximity of Bob’s two messages and varying network speeds, users may have a different account of which payment was first. Theoretically, each of these messages is valid because Bob has ten crypto-coins in his account at the moment he sends the messages. What is stopping both of these messages from going through?
The order of the transactions is determined by whoever can solve a certain mathematical puzzle (cryptographic hash) the fastest. These puzzles take quite a bit of time and computing power. Every time someone solves this puzzle to add the next transaction to the transaction chain (also known as “blockchain”) he earns cryptocurrency from thin air. This process is commonly known as “mining.” That is how more crypto-coins enter circulation. However, there is a limit to the amount that can be mined, like any other natural resource, and for Bitcoin this limit will be reached approximately the year 2140. At this point, to continue to incentivize miners, there will be a small transaction fee. Although one big benefit of cryptocurrency will have vanished (the benefit of minimal transaction fees), there are many other reasons why cryptocurrency is desired.
The Rise of Cryptocurrency
Let’s look at Bitcoin:
Last year, the value skyrocketed to a peak of approximately $20000 per coin. How did this happen? Like any other currency, cryptocurrency gets its value from the people. Why might anyone value a digital currency over a dollar bill? For a typical currency, the government gets a large say in its value. But, for a cryptocurrency, the government has no control. And the design of the currency allows any transaction to be made untraceable. Additionally, as mentioned earlier, there is a cap on the production of Bitcoin. This prevents any devaluation of the currency through inflation. Furthermore, it is a global currency, so its value does not change across borders. Bitcoin only rose so much because it became more and more accepted.
Predictions about Cryptocurrency
In the chart, we see Bitcoin dipped quite rapidly. There are various reasons that account for the bubble burst. One could be that people are not ready to invest in a concept that they don’t understand. How many people on the road want to know what a cryptographic hash is? Recall that a currency only gets its value from people who trust it.
Additionally, Bitcoin rose so rapidly because it became more widely accepted by people and stores. Cryptocurrencies are designed to allow untraceable transactions, which can facilitate criminal behavior. So, it will never become accepted by governments.
Moreover, the crypto-coins in circulation depend on the mining process, a process that demands an increasing amount of computing power. Statistics indicate that by 2020 based on the current growth of cryptocurrency, the energy required to mine Bitcoin will surpass the energy consumption of the entire world. And that is just accounting for Bitcoin – not other cryptocurrencies. This is simply not sustainable, especially in an era of environmental awareness.
There were the tulips in the 1600’s, the stock market in the 1920’s, the dot-coms in the 2000’s, and now, there’s cryptocurrency.