What Are Cryptocurrencies?
It’s likely that in recent years you’ve started hearing the term Cryptocurrency. You may have heard it in relation to Bitcoin or in relation to “digital currency” or some other financial term. But unless you’ve already used Cryptocurrencies yourself, it can be confusing to understand what they are, why they exist, and whether you should look into using or investing in them.
Basically, Cryptocurrencies are a digital form of money. They can also be used to represent and exchange other types of digital assets.
The Cryptocurrencies themselves don’t exist in any physical form such as notes or coins. Instead, they are a digital token that represents something with value, similar to Frequent Flyer points or other types of rewards programs. The digital tokens that make up Cryptocurrencies are created by software code and stored as encrypted data on a blockchain, which is a form of a permanent database.
Cryptocurrency tokens or coins can be bought, sold, or traded on Cryptocurrency exchanges. These exchanges operate in the same way as traditional stock exchanges with the main difference being that they can be bought or sold 24 hours a day. This provides a major advantage to traders because unlike traditional exchanges that normally operate between set hours during weekdays and are unavailable over the weekend, Cryptocurrencies can be traded 24 hours a day, 365 days a year.
A Short History of Cryptocurrencies
There were many previous attempts at creating a digital currency during the 1990s but each of these failed for one reason or another. Some of these were due to traditional business hurdles such as funding issues but the primary challenge was around the centralization of the transaction verification process.
Each of these attempts was based around a Trusted Third Party approach where a single organization was responsible for verifying each transaction to ensure that fraudulent transactions didn’t occur or that people didn’t try to spend the same amount of currency twice in two different transactions (the double-spend problem).
The double-spend problem turned out to be extremely difficult to solve in any kind of decentralized system where there was no central authority to check that no fraudulent transactions were accepted by the network.
But that all changed in 2009, when an anonymous programmer or group of programmers using the alias Satoshi Nakamoto created Bitcoin.
It was a completely decentralized peer-to-peer electronic cash system that used some very clever coding to solve the double-spend problem. After launching Bitcoin, Satoshi Nakamoto continued to assist with the development of the project until 2011, when they sent the last confirmed email from that identity that indicated that they would no longer remain actively involved in Bitcoin.
Cryptocurrencies are innovative for a number of reasons. One of these is their peer to peer nature, which means that people can send and receive value independently of any third party. In this way, it is similar to cash, except everything is done digitally. It also means that for a transaction to be approved and verified, no government, bank, or central authority is needed to authorize it.
How Do Cryptocurrencies Work?
Cryptocurrencies use cryptography to verify and secure transactions as well as to govern the creation or total supply of each particular cryptocurrency. The original and most well-known cryptocurrency, Bitcoin, for example, has a fixed total supply of 21 million bitcoin that can never be increased.
Transactions on the Bitcoin network are verified by Bitcoin “miners” who solve complex mathematical problems using computers dedicated to the task. In return, the miners are rewarded for solving the problems by being given fixed amounts of newly created bitcoin. This serves the purpose of verifying transactions, rewarding those running the computers that keep the network going, and providing value to Bitcoin as there are significant electricity costs associated with the Bitcoin mining operations.
These newly minted Bitcoin are created roughly every 10 minutes at the completion of each “block”, which is a group of transactions on the Bitcoin network that are all verified together and written to the Bitcoin blockchain. A blockchain holds secure entries in a type of tamper-proof database where entries cannot be changed once they have been verified by the network.
The record of each transaction and in fact every transaction ever associated with each cryptocurrency is stored on the blockchain. It is considered a permanent ledger that cannot be altered or erased because the entire blockchain exists as copies spread across all the participants in the network of users for each cryptocurrency.
What Can Cryptocurrencies Be Used For?
Cryptocurrencies provide a way to send units of value of any size from one person or entity to another very rapidly, anywhere in the world. There is no need to interact directly with existing banking payment infrastructure, which significantly reduces the total transaction cost. Transactions of hundreds of millions of dollars worth of bitcoin have been sent in the past with total transaction fees being only a few dollars. This simply isn’t possible using the traditional banking system.
In addition to more traditional uses such as making purchases online, cryptocurrencies can also be used as the drivers of many different types of decentralized networks. These networks can be used to operate supply chains and the Internet of Things, to securely manage and transmit digital identity information, to make private transactions, or to store data in a decentralized way.
Cryptocurrencies that incorporate smart contract features (such as Ethereum) even allow transactions to occur without any direct human input, so devices can complete contracts between each other or make payments based on the terms of that contract. This opens up the world to a whole host of new digital networks that are more rewarding for network participants. Digital networks that are based on cryptocurrency transactions have a wide range of other potential applications across a range of areas including social media, decentralized finance (DeFi), web browsing, gaming, and even the tokenization of real world assets such as real estate.
How Much Is Crypto Worth?
There are currently more than 5,000 listed cryptocurrency projects, with a total market capitalization of around $270 billion. Bitcoin is by far the most prominent and with a market cap of $170 billion makes up around two-thirds of the total market cap. The second-largest project, Ethereum, has a market cap of around $26 billion. These may sound like fairly large values but as a comparison, the value of the tech company Apple, is $1.7 trillion. This means a single company is currently valued at more than 5 times the total value of the more than five thousand cryptocurrency projects around the world.
As another point of comparison, the global gold market cap is $9 trillion. While gold has some industrial applications and is commonly used in jewellery, a huge part of its total value is as a store of value. Gold has been seen as a very reliable store of value for thousands of years because the total supply is limited and there are significant costs associated with mining and storing it.
Bitcoin has often been referred to as digital gold because it is considered by many as a secure digital store of value. This is because its supply is limited to 21 million bitcoin and there are significant electricity costs associated with producing it. In contrast, with traditional fiat currencies like the US dollar, British Pound, or Euro, there is no limit to how much of this currency can be created by Federal Reserve banks, so these currencies lose value over time as more and more currency is created.
Are Cryptocurrencies a Good Investment?
The simple answer to this is it depends on which cryptocurrencies you choose to invest in. And in what time frame you invest. Due to the emerging nature and enormous potential for cryptocurrencies and blockchain technology projects in the future, many cryptocurrencies are subject to much higher levels of price volatility as compared to traditional stocks or commodities.
This is one of the principal criticisms of Bitcoin, that its price is too unstable or too volatile. However, as you can see in the table below, If you had invested in Bitcoin at almost any time over the past decade, it would have been a very profitable investment. While it is true that there are large variations seen between the highest and lowest value of Bitcoin each year, by looking at the annual minimum price, you can see that the price has been steadily increasing year after year.
The return on investment is also far above any other asset class. In fact, Bitcoin is by far the best performing asset over the past decade, providing returns orders of magnitude above US treasuries, global equities, or gold. Other top performing cryptocurrencies such as Ethereum or Chainlink, tell a similar story with high levels of price volatility but huge gains in the token price when looked at over a multi-year time frame.
Of course, with over 5000 cryptocurrencies in existence, for every major success story, there have been many underperforming projects, projects unlikely to ever succeed, as well as some outright scams. Similar to any other new industry such as the Dot Com bubble that accompanied the introduction of the internet, there were many business failures as well as success stories. So carefully selecting which cryptocurrency projects to invest in and which ones to avoid is vital.