Cryptocurrencies fix a fundamental flaw with the monetary system in the world today.
Our society has evolved into a debt-based society that looks at debt as a good thing. Credit reports show that you can pay your debts. It is seen as a bad thing if you have never carried debt because then how are we supposed to trust you?
Cryptocurrencies and the blockchain look to remove the need for these trust relationships, as the technology provides the trust layer that the transfer will happen and happen on time.
With super volatile prices in recent weeks, the question has been posed:
Are we in a cryptocurrency bubble?
Well, we do not know because this huge increase is fundamentally different than the bubbles that have happened in the real estate and stock market over the last century.
It is different because Bitcoin and cryptocurrency, in general, is fundamentally different. Cryptocurrency creates a new medium of exchange that has a mathematically controlled volume. There is a limit on the number of bitcoins available at any one time and that volume increases over time with Bitcoin mining, but the sun will set on mining one day and no more Bitcoins will be created.
Bitcoin / Cryptocurrencies Are Not Valueless
Bitcoin mining requires “Proof-of-Work” to create Bitcoin. When you mine Bitcoin you are brute force solving a double SHA-256 hash. The only way to solve this is through brute force and when you correctly solve it, you are given the block award of Bitcoin. This how Bitcoin is created and why it has value. There was energy input to create Bitcoin.
In contrast, paper money requires very little energy input to create. It is basically free money printing. Bitcoin is compared with gold fairly often, and it is a good comparison. Both require energy input to create and become a store of value once mined.
The Great Recession
The primary driving factor of the recent recession was bad loans that were then bundled together and sold to each other under leveraged positions. If you don’t understand what all that means it is okay.
Basically, banks made loans to people that were too risky, and they knew it. Then they took those loans and packaged them together, selling them bundled to other banks as high-quality products (they weren’t). These terrible products were bought with leverage. Leverage is a loan so you can buy more of a product and get larger gains. Once you sell it you repay the leverage back and you are left with larger profits than without leverage.
The problem with using leverage to buy these bundled mortgage-backed securities was that they were garbage and were not going to appreciate in value. We all know what happened when everyone found out that the mortgage-backed securities were actually garbage…
Everyone started to sell and try and pull their money out. When that happens, all the banks try to recall their loans at the same time and no one has any liquidity to actually repay those loans resulting in a financial collapse.
Why Cryptocurrency Is Not The Same Type of Bubble
Cryptocurrency is fundamentally different from what caused the Great Recession. Until recently, there were very few if any ways to use leverage to buy and sell cryptocurrencies. Many of the exchanges are starting to implement ways to use leverage for the purchase of cryptocurrencies, but it is not a large percentage of the market.
In comparison with the housing bubble, where nearly everything was leveraged, cryptocurrencies are primarily bought and sold with fiat money or assets that people/investors actually own. They are not leveraged loans allowing them to manipulate the marketplace.
Now, Bitcoin may be in a bubble, but the cryptocurrency as a whole will continue to rise into the foreseeable future. Bitcoin and its many competitors have to deal with scaling issues among others issues to stay viable. Bitcoin’s main issue currently is that the volume of transactions is going up and up and the transaction time is going up with it.
Originally the blockchain for Bitcoin was able to process a Bitcoin transaction in mere seconds, but now it can take hours or longer. This is still quick compared to the 2-5 days for bank transactions, so we do not have too much issue with it. However, other cryptocurrencies have faster networks, more frequent blocks (blocks are the bundles of transactions that are processed at one time), and better algorithms.
Bitcoin can overcome these issues if the developers can come to a consensus and move the technology forward, but there are other cryptocurrencies out there that can take up the reigns if not.
So, Bitcoin may be peaking out or may not, but others like Litecoin are ready to take its place as the go-to cryptocurrency.
Cryptocurrency is Transparent
Everything is out in the open for people to see. Bitcoin and cryptocurrencies, in general, are open-source projects based on the blockchain. This means that anybody has access to view the code to understand how it works. You can also view the entire ledger online. The power of the blockchain is that none of it is opaque. It is all open for mass inspection to verify its authenticity.The blockchain itself verifies authenticity for transactions which takes the human factor (read high cost and higher possibility of error) out of the equation. It allows the cost of transactions to lower because you no longer need a third party to verify the transaction that went to your bank in the first place.
Now you have a true peer-to-peer currency that is as good as cash that can be transmitted over distance and between cultures and countries.
The true disruptive power and the reason that it will eventually take over the world is the distributed ledger. The concept of the distributed ledger goes by most people without a thought, but it is the crux of the cryptocurrency movement.
The blockchain distributes the ledger (where all transactions are recorded) around the world on all computers connected to the blockchain. Some of the networks require all computers to store the entire ledger, but with continued inflation of the size of the ledger over time, most networks are moving towards partial storage of the ledger.
Because the ledger is distributed around the world, no one person or entity has control over it and it is available for all to see and verify.
In a traditional transaction with a vendor, you may swipe your credit card and “pay” them. Let’s look at what actually happens here:
- Swipe credit card
- Verification that the transaction was legitimate (this is the pending transaction period which is several days long)
- Credit card company acts as a trusted 3rd party to the transaction.
- The credit card company moves funds to the vendor and credits your account.
- You then get to wait some amount of time before you pay the credit card company for your transaction.
- You transfer money from your bank to the credit card company.
- The bank verifies this transaction.
- The transfer to the credit card company takes 2 days to post.
Only at this point, have you truly paid for your item. Why do we need so many verifications when we are transferring money?
We verified that we wanted to transfer money to them while we were there.
All of the verification issues are fixed with cash transfers. You receive it and you are happy.
Blockchain Distributed Transaction
Now let’s look at cryptocurrency transactions:
- Enter a transaction on the blockchain to your vendor’s account.
- The blockchain processes it near-instantaneously along with verification.
- The vendor can see the transfer on his account.
That’s it. It is so much more streamlined. Cryptocurrencies take out all the middlemen of the financial industry, which allows money to move from place to place with much lower costs. That is the true power of the distributed ledger, speed and accuracy. You now have the efficiency of cash without the paper and over distance.
Cryptocurrencies will take over the world. There is no doubt about that. There have been very few revolutionary monetary ideas since money was first developed, but cryptocurrencies is one of them. Once the technical issues are all resolved in the coming years, I foresee it taking the place of traditional fiat money. Will the US Dollar still be around in 50 years? Who knows, but cryptocurrencies are here to stay.
So readers, what are your thoughts on cryptocurrency?
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