Bit-Bit-Bit Coin – What are Cryptocurrencies?

Ask any Indian, they will agree, 8 th Nov 2016 was an unforgettable day.

It was the day PM Narendra Modi announced demonetisation of Rs.500 and Rs.1000 banknotes. In an instant, 86% of the currency in circulation by value was deemed invalid.

On that fateful night, I & a friend of mine were poised to check out of a resort in Dharamshala. We had hired a taxi to travel to Delhi the next day and we were carrying cash for the journey. There was utter chaos and confusion on the way, small roadside dhabhas did not have the facility of a credit card or even a debit card. The ATM’s were empty.

The taxi driver refused our cash and my NRI friend who was on a holiday with me got a taste of India, when things go awry. All the nostalgia and romantic notions she felt for India went out the window that night.

In the weeks and months that followed after that day, there were massive inconveniences faced by citizens. There were many, many, many terrified people in India who had done no wrong, though they possessed cash in the form of those invalid currency.

Presumably, the noble idea of demonetizing those notes was to weed out corruption and black money. Nonetheless, it was a blunt instrument, indiscriminately impacting everyone causing unbearable agony even to a legitimate owner.

A lot of citizens must have wished then that they had money in some other form rather than the Indian Rupees in 500 and 1000 denominations.

What is Money?

Money is a common store of value to facilitate transactions. It started with, I have bananas, and you have firewood. Let’s trade. As trade got more complex, the barter system could go no further. Wheat, Salt, later gold was used as a form of money. Gold, then was universally accepted as a form of money.

But gold was inconvenient as a form of money. Its tough to carry gold bars around and how does one pay for a cup of coffee?

So, the government decided to take the citizen’s gold and issue paper receipts which were then used as money. If they wanted their gold back, go back to the government with the receipt and they presented them with the gold. The paper money represented a commodity that was gold.

Later on, governments decided to do away with the gold backing or standard and just print currency which was to be used as money. Why that was done is an incredibly complex economic concept and you can read about it here.

What is Money in today’s day and age?

The legal tender used today is called fiat money and has value because the government of the country says so. It is a promise of honour by the government representing the strength and the stability of the economy. There is no commodity backing it.

It is centralised and controlled by governments in terms of its issuances. They control the printing of physical money and monitor digital or electronic money. As countries develop, the use of physical money decreases, and digital increases. Transactions of larger monetary value are invariably done digitally via cheques, bank transfers or wire transfers, etc.

What exactly happens there?

The government via the central bank keeps an electronic ledger and makes entries of receipts and payments. It also protects against fraud and any errors which can be corrected.

So how does Crypto come into the Picture?

Cryptocurrency came into being in 2009 by a person named Satoshi Nakamoto. He used advanced encryption techniques and cryptography and created a new currency called bitcoin. Bitcoin uses blockchain technology using complex mathematical algorithms and problems.

The unique thing about bitcoin is that its supply is finite. The total number has been fixed at 21 million and now about 17.5 million are said to be mined or bought into circulation. Bitcoin is completely decentralized and not controlled by any entity.

All this sounds good, but why have another Money?

There are people who like the idea of the government not having the power to control everything they own. An independent store of value whose worth is not dependent on central banks and government does not have the ability to keep tabs on it.

Everyone can understand the motives of keeping secrets. It can be for illegal or criminal transactions or just for the love of privacy.

If possible who wouldn’t want to make sure that the government has no ability to freeze assets?

Also, the value of the government-backed currency can increase or decrease as they control supply or even cancelled via demonetization.

So why not have an alternative?

Why the value of government-backed currency changes?

It’s complicated. But the simplest reason is inflation. The purchasing power of currency reduces because of the policies of the country.

Post the Coronavirus Pandemic, governments have stimulated the economy to the tune of about 20 trillion dollars to save it from collapse. The world economy has printed a lot of cash. If there is a lot of supply of anything the value of it falls which is common sense.

It follows therefore that gold has been going up in value for this reason as a hedge against inflation. Sometimes, if a countries finances are mismanaged it can end up in a disaster. An extreme example is a country like Venezuela.

Venezuela, once a very rich Latin American country, has gone into hyperinflation and today you need a million bolivars (Venezuelan currency) to buy a cup of coffee.

You can read about the Venezuelan inflation crisis here. & here.

What is BlockChain technology?

In simple terms, blockchain is an online ledger maintained by multiple entities that record every transaction. Blockchain is secure because it enforces a chronological order to make it completely neutral. To make a transaction it must fit or packed into a block which is verified by the networks. It is very hard to modify one transaction as it would involve modification of all the previous blocks.

The technology is like a shared google spreadsheet allowing multiple parties to view and edit and validate a transaction and no one party can make changes that can go unnoticed.

You can learn more about Blockchain technology here.

Ok. The technology sounds interesting but so what happened after Bitcoin was born?

Well, the concept of cryptocurrency caught on in a limited way and there were some takers for it. The acceptance of the currency increased and many merchants started accepting payments in cryptocurrency.

Microsoft, Subway, PayPal, Starbucks accept Bitcoin and there have been reports of a LakeTahoe property in Sanfrancisco sold for 1.6 million paid via Bitcoin.

To get a list of a few merchants accepting Bitcoin as payment is here.

Merchants like Amazon do not accept bitcoin directly but you can use it to buy their gift voucher.

There are many other Cryptocurrencies like ethereum, litecoin,Primecoin but bitcoin is by far the most popular.

How do you buy these? How do they work?

There are exchanges like Unocoin, WazirX, and PayBito, CoinDcx operating in India from whom you can buy. Bitcoin is represented by strings of numbers that make up the public and private keys. You need both the keys to transact and transfer bitcoin. If someone gets hold of those digits, they can steal the bitcoin they represent. If you lose the keys, that bitcoin is lost forever.

So Cryptocurrencies are bought to buy stuff secretly?

Some maybe, but a lot of buyers of cryptos are not buying it to transact. They buy it in the hope that the value will go up and they make a gain.

The very fact that there is a limited, finite supply makes it valuable in the eyes of an investor.

But it was not a smooth one-way ride up as seen in the chart above.

The volatility in prices of this bitcoin is crazy and it traded at a high of 19000 USD in Dec 2017 and within a year went down to 4000 USD.

What are the risks to these cryptocurrencies?

There are a  lot of risks. They are not backed by anyone so if you lose them, there is no one you can turn to.

There have been instances of hacking, for eg in 2014, Japanese based Mt. Gox which was the largest bitcoin exchange lost USD510 million of customer’s bitcoin to hackers and filed for bankruptcy.

They are completely unregulated.

People may suddenly lose interest and if its acceptance as a means of exchange goes down then they may become worthless.

You may be invested in a Cryptocurrency, say Bitcoin, and a competitor say, Ethereum may gain more ground and become popular. Countries can ban their use. Like India had earlier banned the use of Cryptocurrency which has now been lifted.

So what’s the verdict?

The idea of a currency that is controlled by no specific central authority is appealing. At the same time having no one to hold accountable causes alarm. There are many supporters and detractors of Cryptocurrency. Warren Buffet, who is the world’s most-followed investor has said that they most certainly will end badly.

Nonetheless, the fact that Crypto even after 10 years of existence has not died a natural death means that there is a sustained interest in them.

If innovation is ignored, however implausible it may seem, there is a risk of ending up as an out of touch dinosaur. Cryptos are in no way threat yet to traditional currency as their use in trade is minuscule.

Could be farfetched, but it’s still a fascinating idea. A completely decentralized currency controlled by gigantic computers.

Wow!

For all the suckers for Sci-Fi stories, this one is certainly worth keeping an eye on.