Over the past three years, I've been periodically dipping my financial toe into the choppy waters of cryptocurrency, to the point that I actually vaguely know what I'm talking about at this stage (full disclaimer: this blog is for information only - I am not your financial adviser and I am not offering financial advice! Yada yada).
So, in a break from my running escapades, this blog's going to be a breakdown on the cryptocurrency basics. Let's dive in.
What is a cryptocurrency?
Cryptocurrency, usually referred to simply as Crypto, is a digital currency or asset.
Put simply: it is a given store of value (in the same way that traditional 'paper' money or 'fiat' is), however rather than it being a physical asset such gold, silver, bond, piece of paper denoting value etc, it is non physical, i.e. it is entirely digital, stored on what's known as the blockchain. More on that in a bit.
To take it back a step, Cryptography comes from the ancient Greek 'kryptos' (hidden/secret) and 'graphene' (to write/study): it is using code, which needs to be deciphered, to store messages and meanings.
Thus, when we look at the idea of cryptocurrency, we are looking at: 1) the message and meaning here being stored value (currency) in a 2) cryptographic manner, i.e. scrambled through code and needing to be re-deciphered.
I hope that makes some sense so far - it's difficult to explain and the word crypto itself is annoying me at this stage because its a real bugger to spell correctly each time. Anyway...
The term 'blockchain' refers to the method in which cryptocurrency (such as Bitcoin) is securely transacted.
I am not going to get into specifics here as that really is deep into the rabbit hole and frankly I don't have anywhere near enough know-how to adequately explain it. Suffice to say so that it refers to the method of how the crypto is stored and exchanged: i.e. a chain of digital blocks is created each time; these cannot be retrospectively altered, so in effect they securely log every single transaction takes place over time.
What is Bitcoin? Why are people interested in it? Isn't it a scam?
Bitcoin was the first cryptocurrency ever created. It is a 'coin' (currency) that is entirely digital, so therefore made up of data 'bits': Bitcoin. It was invented by someone pseudonominously named 'Satoshi Nakamoto' in 2009, as a direct reaction to the financial crisis of 2008. Satoshi's vision was to create a monetary system that was entirely decoupled from a traditional, centralised financial system (i.e. no banks).
This is the reason that Bitcoin is referred to as a decentralised asset: the asset itself is not stored in one central place and then distributed (such as, crudely, a bank with it's millions locked away in its vaults, which are then centrally distributed to customers); rather, the asset is stored remotely across the entire network of people owning and trading it - in this way, there is no 'third' party here.
Why is this important? Well, let's just *suppose* that a bank gets into financial difficulty (think 2008) and eventually collapses (government doesn't bail it out in this example). What's happened to your money? It's gone. It was stored centrally by the bank; the bank no longer exists; 'your' money is no longer yours.
This cannot happen with a decentralised asset such as Bitcoin, because there is no centralised bank: it is distributed and stored by everyone interacting with it, through the cryptographically-secure blockchain.
So Bitcoin is essentially a two-fingered salute at the banking system? So what? Well - partly this is true. Proponents of Bitcoin see the decentralised aspect as one of it's key draws. However, this isn't it's only benefit. Most significantly, it is becoming seen as a genuine hedge against 'fiat' (traditional currency) devaluation.
Over time, fiat currencies naturally succumb to devaluation: put simply, as more physical money is printed by successive governments (sometimes euphemistically known as 'quantative easing') the overall purchasing power of that currency naturally decreases over time: the more there is of something, the less it is worth.
This is why £10 forty years ago would have comfortably bought you several rounds in a London pub with some change to spare, whereas now it'd get you a single pint and a packet of crisps if you were damn lucky.
When it comes to long-term saving, this is a big problem. Not only are interest rates historically low at the minute (0.1%), the intrinsic value of the £ is also decreasing over time.
So, (and this is crudely; I know it is more complicated that this), if you had £10,000 and put it in the bank at base interest rates today, it would make a paltry £100 in one year. Over a period of ten years, you've turned your £10,000 into just £11,000 (assuming no changes to rates).
However, remember that you also have ten years' worth of currency devaluation during this time (more money has been printed), so that £11,000 is probably actually worth less now than when you started in real terms (actual purchasing power).
One final aspect of Bitcoin is that not only is it a decentralised asset, and not only is it a hedge against inflationary fiat currency (as explained above), but perhaps most importantly, Bitcoin itself is a deflationary asset.
So, what does this mean? When Bitcoin was created, only 21 million were made. There cannot be any more Bitcoin ever beyond the 21 million (the correct term here is to 'mine' - the term used to describe those who release the cryptographic bitcoin from the network to be distributed). This means, of course, that there is a limited, finite supply, in just the same way as gold; this is the reason why Bitcoin is often referred to as 'digital gold'. On top of this, the amount that is able to be mined (released) is halved every four years. This is supply and demand 101: not only is Bitcoin a finite digital asset, the amount that can actually be owned by anyone is itself halved every four years. To use the crude gold analogy:
Imagine there is a limited supply of Gold (there is). This gold is not stored in one place (like a bank); rather, it is of course stored across the world (decentralised, like Bitcoin).
Miners (see where the crypto term comes from now) mine the gold and then sell it to consumers - HOWEVER - the amount of gold, in this example, that can be mined is reduced by half every four years - so it becomes increasingly harder to mine and increasingly scarce to own. Stock to flow ratio dictates that the given asset (in this case Bitcoin) will go up in value over time.
This is the reason that Bitcoin was worth $0.0008 in 2010 and currently sits at $56,228 as of writing this.
So, is Bitcoin a scam? Is it a 'ponzi' scheme (think of those pyramid letter schemes)?
No; hopefully I have illustrated above that it is absolutely neither of these things: rather, it is the evolution of money, from the physical to the digital. In 50 years' time, the economic system across the world will look very, very different.
To sum up:
- Cryptocurrency is a digital, cryptographic store of value.
- Bitcoin is one such crypto, created in 2008.
- Bitcoin is a decentralised store of value, distributed on the blockchain
- Bitcoin is finite (21 million) and the amount released (mined) is halved every four years
- In this sense, Bitcoin can be seen as a deflationary asset and a hedge against the inflationary fiat currency system
- Due to the above factors, the value of Bitcoin rises exponentially every four years
There is a lot, lot more to cryptos as you might expect - this has scratched the surface really.
I hope I've at least sparked your interest. In part 2, we'll dive into understanding Bitcoin's price trajectory in more detail and consider the world of 'alt'-coins.
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