I was perplexed and have been reading about Cryptocurrency (In short, Crypto and particularly Bitcoin) in the past few days. Recently, Bitcoin price plunged to about S$ 5,000 from its all time high of S$20,000 in Dec 2017 and it has gotten the market excited. Lets find out more this state-of-the-art technology
What is Cryptocurrency?
Cryptocurrency is simply a digital currency that can be transferred from one person to the other. To understand its origin, you first need to understand how money is currently transaction.
The traditional (or current widely adopted) way of transferring money is through a central controlling system, like a bank that keeps track of the transaction ledger. We place trust on banking system manage our transaction fairly and accurately. For that, users of the system will require to disclose their personal details to the bank for verification.
With cryptocurrency, no bank is involved and transaction is done via blockchain, which is a public ledgar that is available to everyone. No disclosure of personal information is required. Anyone with internet and a computer can access to transfer any amount of money to anyone across the globe.
Not one person or computer will control the ledger; the ledger is duplicated across all computers participating in blockchain. The ledger cannot be destroyed so long the internet continues to exist. The system is considered bulletproof because if someone tries to temper with any transaction on a single node, the other nodes will reject the change.
Any transaction taking place through blockchain will require to be verified by the participating computers. Each computer in the network will compete to place a block on the existing blockchain by solving a mathematical problem. The computer which solves the problem first will be rewarded with cryptocurrency. With increasing computational power against the number of transaction, the blockchain will increase the difficulty of mathematical problem. The reason is to prevent a soft fork, or simply branches of blocks onto existing chain due to varying internet speed across the computers network. By slowing down the computational power, the chances of having a soft fork will reduce.
The first and most popular cryptocurrency is Bitcoin.
In the following discussion, I will use the term Crypto interchangeably with Bitcoin
How can we use Bitcoin?
Bitcoin is a digital currency that is gaining popularity and is accepted as a mean of transaction in businesses.
You can find more about companies accepting Bitcoin from 99bitcoins.com
¹What is Bitcoin’s intrinsic value?
To answer this question, we need to understand the evolution of money.
Long ago, human started barter trades, which allows a person to obtain something he needs by trading away something he possessed. A major disadvantage with barter trades is the double coincidence of wants problem. It takes both traders to need each others goods to enable the trade.
Over time, humans evolved a desire to keep collectible items for rarity and symbolic status (e.g. shells, animal teeth etc).
Collectables served as “proto-money” by making trades possible and overtime, each human societies converged to their single collectable as a store of value. As trade increases, the individual stores of value that emerged in individual societies compete against each other. Two societies converged on a single store of value would see substantial decrease in trade cost. In 19th century was the time when most part of the world converged to a single store of value, which is gold and other precious metals. These store of value continue to be used as a trade medium that contributed to ease of trades and growing world economy.
Fast forward to the modern world, paper money is created by government in 19th century as they struggled to replenish the rapidly vanishing money in precious metal forms. Until 1971, paper money is backed by gold reserves.
In 1971, US President Nixon abolish US dollar convertibility to gold. It was done because gold supply grew too slowly that it held back economy growth.
Since then, US dollars and major currencies (simply called as fiat currency) are backed by government bonds. Bonds are guarantees provided by federal reserves that commits to pay the bond owners their capital money with dividend after an agreed investment period.
Unlike fiat currency, Bitcoin is not backed by government federal reserve. Neither its value is supported by gold or other valuable asset.
So, what is keeping Bitcoin at its current value of about S$ 5,000 a piece? The answer is a mix of investor’s (enthusiast’s) trust on its potential as a transparent, secure currency and SPECULATION; speculation that blockchain and cryptocurrency will become mainstream in the future by replacing fiat currency (or at least compete with it).
How does Bitcoin proponent defends its validity?
Bitcoin has a limited supply of $21M unit. Till date, 17M+ has been mined.
It is independent from the management of Federal Reserves. Unlike Bitcoin, the Feds are free to print fiat currency as long as there is demand and trust on the country’s economy. It is proven that fiat currency’s value is diluted over time because of excessive fiat money printing. The oldest fiat currency is pound sterling, which has existed since 1694 and has lost its value by 99.6%, while the US dollar lost 96% of its value since creation in 1916.
Bitcoin is similar to Gold because it needs to be mined and its quantity is limited.
It is not just a currency but serves as a secure and cheap way to transact money.
What would a value investor say about Bitcoin?
Its worth is purely speculative.
Not proven. Technology advancement may eventually introduce a better crypto than Bitcoin, thus driving down its worth.
Although Bitcoin is said to be limited in quantity, other new crypto currency can always be created.
Currently unregulated. Thus, its protocol can be changed purely by the Bitcoin owners through voting, that resembles a democratic system. In Nov 2018, a hash war started because there is no clear consensus by the biggest factions of Bitcoin owners on a competing proposals to change its protocol. Its value dipped more than 20% in that month.
What is Next for Crypto?
Blockchain technology is beyond Cryptocurrency. Its uses are yet to be fully discovered and developed
If Crypto is your type of investment, do it with caution. Don’t put your savings in it due its price volatility
Personally, I have yet to find a good reason to invest in Crypto (Bitcoin in specific). Its uses are limited to safe, secure and cheap money transactions, which meets its creation intent. But would anyone buy into Crypto just to benefit from its safe, secure and cheap money transaction, knowing its high volatility that has brought its price down from S$8,000 to S$5,000 in just a week? The answer is a clear “NO” for me until there is advancement to its utility and function.
If you like to learn more about Bitcoin as the future of money, I suggest you watch the debate between Peter Schiff and Erik Voorhees in this Youtube video
Disclosure: I do not own any Cryptocurrency and Bitcoin is worth about S$5,000 when this article was written. Any information, commentary, recommendations or statements of opinion provided here are for general information purposes only. The article is edited on 9 Dec 2018 to reflect additional information that was learnt after initial posting.
¹The Bullish Case for Bitcoin by Vijay Boyapati