Everything You Need To Know About Cryptocurrency And Why It’s The Future Of Money
In a matter of weeks in November 2017, bitcoin surged from a fringe investment to a global sensation. In mid-November, the price was around $3,000 for a single bitcoin; on December 6, 2017, it surpassed $19,000. At the time of publication, the value was hovering around $15,000.
Bitcoin is having a moment — really, it’s had a year. No matter if you think it’s a bubble about to burst, or hope your investments will pay back big in the long run, there is one clear takeaway: Cryptocurrency is changing the future of finance. What’s not yet clear is how the technology behind bitcoin, and cryptocurrencies like it, will alter our national and global financial systems.
Back on the Blockchain
Bitcoin, like all cryptocurrencies, relies on a technology called blockchain that makes its transactions so secure that experts consider them to be virtually unhackable. And because the transactions are assured, the cost of verifying transactions is less than in a central bank though, admittedly, the cost of verifying bitcoin transactions has become fairly expensive.
Cryptocurrency transactions happen directly between individuals instead of through a bank. Every time a person makes a transaction using a cryptocurrency — for example, using funds stored in his or her crypto wallet to send bitcoin to someone else — the transaction is recorded on a digital ledger called a blockchain. Every cryptocurrency has its own blockchain, and computers doing complex math in a large network maintain it.
Once users make a specific number of transactions using a cryptocurrency, the computers group these transactions into a “block.” In order to send a block, adding transactions to the blockchain and winning a monetary reward, a computer has to solve a complex math problem called a cryptographic function.
Basically, the cryptographic equation is throwing a pumpkin (the block) off a building and telling you what the splatter pattern looked like. The only way users can match the splatter pattern — and send the block — is to hurl a bunch of pumpkins off a building themselves. So people who “mine” cryptocurrency are actually just using their computers to smash billions of pumpkins in order to find the winning pumpkin with the right splatter, which validates their block.
In other words, the first computer that can solve a complex math problem gets to add its block of transactions to the blockchain and receive a monetary reward for doing so (this is what people mean by “mining” crypto). Every computer in the network adds the new block to its copy of the digital ledger, and the process continues.
Although bitcoin was created to avoid centralized banking and government money, the technology can be used as a national, centrally banked currency. In fact, the blockchain is so secure that it reduces the cost of verifying transactions, so banks are already looking into it, says David Yermack, chairman of the finance department at New York University’s Stern School of Business. In 50 years, Yermack says, cryptocurrencies could be used as national currencies.
Will Our Future Be In Bitcoin?
Bitcoin was created to work outside national currencies, which is a draw to people who don’t trust central banks, says Yermack.
Those who are hopeful about the rise of bitcoin may have noticed its popularity in countries like Zimbabwe and Venezuela, where it is being used as a major means of exchange when government-issued currencies have failed because of hyperinflation. Bitcoin and other means of exchange have become popular in these countries because transactions can be performed on cell phones, and their value is more stable than the hyper-inflated national currency.
But others believe that bitcoin is too riddled with problems to be the cryptocurrency upon which the future is built. First, it likely can’t be used on a national scale because of how few transactions per minute bitcoin supports. Bitcoin’s framework can only make seven transactions per second, says Ari Juels, computer science professor at Cornell University who studies cryptography and computer security. VISA’s credit card network, for comparison, can handle 65,000 transactions per second.
Issues of privacy also stop it from becoming the future of money, says Phillipa Ryan, commercial equity lawyer and lecturer at the University of Technology Sydney. “Bitcoin is problematic in that it provides too much privacy and not enough privacy,” says Juels. “Too much privacy in that it provides enough to give criminals the opportunity to perpetrate a lot of mischief, from ransomware to the Silk Road. Not enough in that transactions are actually traceable by pseudonym.”
Its value also fluctuates too much to provide a stable, functional currency. Unlike traditional currencies, which have a value that is set by the central banking system, the value of bitcoin is driven by speculation about its worth like a stock, says Yermack. So it doesn’t make the cut as a currency. “Traditionally, we think of money as a kind of means of exchange and a store of value,” says Harold James, an economic historian at Princeton. “[Bitcoin] is very good at the means of exchange, but not very good at the store of value.”
The future likely won’t be based on bitcoin. That’s not to say that the future won’t be based on other cryptocurrencies.
If you have a dollar bill, it’s pretty safe to assume it’s worth about a candy bar from day to day. One bitcoin, on the other hand, could be worth a candy bar one day, a car the day after, then next to nothing the day after that. It’s more like a stock than a stable national currency. James says that, based on the historical precedents he studies, bitcoin looks like the highly unstable private currencies created in Eastern Europe after the First World War. When speculation about the value of bitcoin is substantially more than its worth in the real world, bitcoin will burst, like the stock market crashed.
Economists studying cryptocurrency and computer security experts agree: The future likely won’t be based on bitcoin. Of course, that’s not to say that the future won’t be based on other cryptocurrencies.
In the meantime, bitcoin will remain as a grand test of the blockchain technology, says Ryan. Its value will continue to fluctuate, but Ryan is convinced it’s already a bubble. “I think that bubble will burst. It’s fun to watch though, it’s been a great ride,” says Ryan. “When bitcoin finally fails, I think we will look back on it as a really important, valuable experiment in which more lessons will be learned than there will be loss.”
A Shift In The Financial System
Bitcoin offers something groundbreaking, and a growing number of national banks, including the Federal Reserve, are interested in using blockchain technology to power a centralized national currency. Most experts agree that, in the future, countries will turn to cryptocurrency, as money is already moving from the physical to the digital realm. So a method that secures digital transactions is a necessary investment, and the blockchain technology used in cryptocurrencies is a top contender.
“I think the whole idea is probably horrifying to the bitcoin people, but it’s the ultimate harbinger of success when the person you’re trying to defeat co-opts your own plans and turns them against you,” says Yermack. “The ultimate victory is where the central bank co-opts their technology and makes it the basis of their own operation. And I can see it very clearly play out that way,” Yermack says. “Monetary policy and financial stability — I think those problems will be exactly the same in 50 years.” But in 50 years, a nationally backed cryptocurrency could replace the paper dollar, he says.
When it comes to the future of money, cryptocurrency’s influence will be felt in its improved ability to avoid technological problems like hacking, Ryan says. Based on the issues of cybersecurity looming ahead, Ryan thinks that the blockchain will be the technology to transform the money of the future.
Blockchain could make its way into the mainstream in two primary different ways. One option is to switch from physical to digital currency. A dollar would still be a dollar, but transactions would use blockchain to make them more secure. The second way would be to move your bank account from something like CitiBank and transform it into an account in the Federal Reserve itself. If all of a nation’s money were centralized, it would make the Federal Reserve more efficient at its job of stabilizing and regulating the economy, says Christian Catalini, assistant professor at MIT’s Sloan School of Management who studies the economics of cryptocurrency.
Some institutions are beginning to try it. Estonia is working to create an e-Residency program, and part of their plan includes launching the estcoin, the world’s first national cryptocurrency. The Bank of England is working to create its own cryptocurrency and has created an experimental cryptocurrency framework called RSCoin that would use a centralized system. To go crypto, the Bank of England would create digital money as if it was printing physical notes. For example, in 2017, there were 73.2 billion British pounds in circulation. A British economy using only cryptocurrency would have the same fixed number of pounds, just represented by a digital “coin” instead of a physical note. Since the value of the British pound is based on how many are in circulation, exchanging a physical note for a digital one has no economic significance — that is, a pound is still a pound, says Yermack. Like bitcoin, RSCoin would use a public ledger and the cryptographic system to distribute money.
In their paper on the RSCoin model, the authors write that a cryptocurrency backed by a national bank should help make cryptocurrency usable on a larger scale, since the central bank could employ other institutions to do the computations to verify transactions. In a model with one central bank and only 30 commercial banks, RSCoin could make 2,000 transactions per second — not quite up to VISA’s speed, but certainly fast enough for British citizens to move about their financial lives quickly and securely.
For a consumer, a centralized cryptocurrency won’t change much, says Catalini. “[Consumers] will just see cheaper prices in the denomination they’re familiar with, and blockchain technology may be used in the background to offer new or better types of financial and payment services.” So with a national cryptocurrency, bank fees would likely drop, and money transfers would happen faster.
And with national cryptocurrencies, it will be more difficult to conduct illegal activity. Even with the anonymous ledgers used today, governments can track users and financial information, says Aniket Kate, a computer scientist at Purdue University. Since all transactions on the blockchain are recorded on every connected computer, it would be difficult to hide financial indiscretions from the government, Kate says.
Over the next fifty years, Yermack thinks that law-abiding citizens, banks, and governments alike could benefit from moving to some form of digital currency. “There is a huge opportunity cost in not making the central bank more efficient,” says Yermack. “I think what you’re really going to need in the long run is a reorganization of the branches of government and probably more levels of political control over the central bank.”
As countries creep closer to creating their own cryptocurrency, they will have to decide just how private they want transactions to be. Bitcoin’s famous openness might not be so appealing for all transactions — you might not like it if your neighbor could see that you’re buying vibrators and cat food in bulk (of course, you could also find all their weird purchases). However, cryptocurrencies can protect user privacy in varying degrees, Kate says; a future system could inhibit your neighbor’s prying eyes.
But the issue of privacy is potentially more of a social problem than a technical one. In Norway, all tax records are public knowledge. In other parts of Scandinavia, electronic banking is also on the public record, says James. Citizens of Denmark, Sweden, Norway, Greenland, and Iceland rarely use their physical currencies, James says, making those countries a microcosm for a possible future of digital-only currency.
“The only question that seems to be open is: would it be the kind of Scandinavian system we talked about, where every transaction can be monitored [and] that lends itself to a surveillance state?” James asks. “Or will it be a kind of Bitcoin-like system, where there is an anonymity built in?” As countries start to make the switch to digital currencies, their societies, along with the governments themselves and the economies upon which all rely, will have to figure out how to adapt.
Disclosure: Several members of the Futurism team, including the editors of this piece, are personal investors in a number of cryptocurrency markets. Their personal investment perspectives have no impact on editorial content.