There has been a lot of hype and despair around cryptocurrencies for the past few years. Some experts make crazy price predictions about how Bitcoin will reach $1 million by 2024. Others think it is worthless and will eventually be worth $0. In a decade will traditional currency be gone and all be replaced with digital currency?
A simple example of blockchain
Although there are literally thousands of different cryptocurrencies, we can focus on something like Bitcoin to understand the basic concept behind them. Imagine you live in a house with 4 other people. Lets call them: Alice, Bob, Charlie, and Denise. You want to keep track of when you pay each other some money. However, you don’t want everyone to have to keep their money in the kitchen since someone else could take it. Lets assume that everybody starts off with $20.
First, lets say Alice pays Bob $5, so they write a sticky note saying this and post it on the fridge. At the same time, Charlie pays Denise $10, so they also put a sticky note on the fridge. There is a problem though, after a while the fridge would be filled with sticky notes. Alice suggests that periodically they should take all the sticky notes on the fridge and put them into a page of a binder. So to start, she does just this.
One good thing about the binder, is because you know everyone started out with $20, you can figure out how much everyone has. One issue with this system though is that all of the data is in a centralized location, and you all have to trust each other that someone won’t go mess with the binder. A solution to this is that everyone in the house keeps their own copy of the binder. When a new page is added, you all add it to your individual binders.
If there is disagreement about what should currently be in the binder, then the majority who have the same transactions in their binder will stand true. When its time for the sticky notes to be taken off of the fridge, then the first person that compiles all the transactions into a nice document will be the one who goes and distributes the new page (the person who does the work).
This is a basic analogy for how a blockchain coin like Bitcoin works. There is a fridge where all current transactions that have not been saved in the binder are (the mempool). The person (miner) who puts in the work is able to compile the sticky notes into the next page of the binder (the next mined block placed on the blockchain).
I could continue on with these analogies for how this secures the network and prevents tampering. However, I think now it might be simpler to just read up on the technology in this article.
Is this any different from now?
Right now, you probably have a bank account with a major bank. When you spend money somewhere the bank is able to verify that you have the funds. When you click buy, they send the funds to the person you are buying from. This is a centralized solution, and requires trust with the bank. A malicious bank could choose to reduce your savings account balance and take the money for themselves. When it comes to blockchain, it spreads the trust out between all the people validating the network (miners or stakers).
The government is also a centralized entity that could just choose to print more money. If the current supply of money is $1 trillion, what stops them from just printing another $1 trillion. This will reduce the value of the money that you have without them directly taking it. With a coin like Bitcoin, the supply is controlled with rules that everyone has access to and is completely unchanging. It is certain that there will never be more than 21 million Bitcoin minted. This means if you own 1 Bitcoin, you are guaranteed to own at least 0.0000045% of its supply. This is a lot different than something like the US Dollar. If you own $1, you own a current percentage of all existing US dollars, but there’s no upper limit to how many of those dollars will exist in the future.
Unnecessary or Widely Adopted
The next big question is if crypto will become widely adopted or if it will become viewed as unnecessary. We know it is not widely adopted now. Just ask yourself what 1 Bitcoin is worth? Chances are you are going to look up the current price in your local currency (like USD). This is because its price is volatile and can change very quickly. You also don’t see prices listed in Bitcoin at the store.
The main thing that blockchain currencies like Bitcoin hope to provide is a decentralized system of currency that we can trust. Ask yourself this, how much do you care about the fact that you have to trust your bank. Even if you are infatuated with the idea of a decentralized currency, billions of people who don’t have a degree in blockchain will still have to trust that the system works. Instead of trusting an institution, you are trusting advanced algorithms and mathematics.
I personally think the case will strengthen for Bitcoin when censorship measures increase. Lets imagine that you want to go purchase a gun, but the bank doesn’t support gun purchases. They have the power to be able to stop this transaction and there is nothing you can do about it. Your options are to use another bank that allows it, or use an asset like cash. However, if you are buying an item from someone far away, it may not be the best idea to just send an envelope of cash and hope they receive it and consider your purchase legitimate. In a world with Bitcoin, this transaction is permanently etched into the ledger. No one can deny you paid, and no one can stop you from spending the Bitcoin you own.
Another thing that will strengthen the case for Bitcoin is governments causing their own currencies to hyper inflate. Would you hold cash where in a year from now that same cash will be worth 30% less? If Bitcoin was a stable alternative, it would make a lot of sense to keep your money in Bitcoin instead.
Final thoughts about whether or not to invest
The problems addressed above are that the prominence of Bitcoin will largely depend on how third parties behave in the future. The idea of being able to control my money and send it wherever I want is great, but with a centralized banking system I can do that now. Will the average person care about trust and decentralization enough to push Bitcoin to becoming the main global asset? For now it seems unlikely. That doesn’t mean that Bitcoin is a bad investment, but you aren’t investing in it because of its potential to become a currency, but rather that you place value in its scarcity.
Where do you see Bitcoin going in the future? How confident are you in it to become the dominant global currency, or do you think instead it will be just a great store of value like gold? If you are confident in Bitcoin’s future, it probably isn’t the worst idea to put a few percent of your portfolio into it. Regardless of what you invest in it is imperative that you choose a risk management strategy that is best for you and your goals. Check out my post here about picking the best investment options for you.
This post mainly talked about Bitcoin, but as mentioned above there are thousands of different currencies and an entire DeFi (Decentralized Finance) ecosystem. There are pros and cons to all of these different types of technologies. Just make sure you do your due diligence in researching before picking one to invest in.