Cryptocurrency - Bitcoin
Cryptocurrency is the new financial trend at the moment. One month ago, it was at new record highs, with Bitcoin and Ethereum each having peak market caps of $1.1 trillion and $470 billion respectively. However in the last 7 days, a crash occurred which wiped 50% off their respective market caps. This volatility is part and parcel of cryptocurrency and I don't see this ending any time soon. But I do see some cryptocurrencies breaking out and sticking around for the long term, it will all depend on their fundamentals, institutional adoption, governmental regulation and ease of use. One of these is Bitcoin (BTC), and below I'll go over why I think it could possibly stick around for the future, and possible reasons why it wont.
The blockchain
If you transfer some cash such as £100 from one bank account to another, a bank or financial institution is doing all the back-end work. It has to check a private ledger of your account; to make sure you have £100 then possibly contact the other bank to send over your money. One reason why people want cryptocurrency to succeed is that it takes out the usage of banks, whom many blame for the 2008 financial crisis. How can you send money to someone if there isn't a third party to check and verify the funds? One answer is a decentralised public ledger which stores all transactions on blocks which doesn't rely on trusting anyone but relies on huge computing power to verify transactions and secure the network - the bitcoin network.
A copy of all BTC transactions ever made is present on a public ledger, and a copy of this ledger is in all the computers that are connected and securing the network. All these computers combined secure the network as a consensus of 51%+ of the computers is needed to make changes to the ledger. In the bitcoin network, this makes it practically impossible to hack the network as the power needed to run these computers needs more than 7 nuclear power plants. In other smaller blockchain cryptocurrencies where less computers are working, 51% attacks to the network have been done and currency has been stolen.
Why would these people use so much electricity and computing power to secure the network and verify transactions? The reason are the blockchain rewards. All transactions are put into blocks, roughly 2000 transactions per block currently. Every 10 minutes, the block is verified and then added to this public ledger, adding onto the chain of previous blocks before it. To verify the block, the computers need to do lots of work effectively guessing a huge number - the computer that successfully solves the problem first will broadcast the solution to the network, if it is verified to be correct, they will get a block reward, some BTC. They will also receive transaction fees that are associated with the transactions in the block. Back in 2009, the reward started at 50 BTC per block but has reduced every 210,000 blocks, currently the reward stands at 6.25 BTC. These rewards will eventually go down to 0, estimated to be around the year 2140. This makes bitcoin a deflationary currency as there will only be a maximum of 21 million BTC ever made.
Wallets
So how do you store bitcoin? Just like with normal money, you put it in a wallet, but not a physical one but a digital one. It consists of two parts, a public address and private key. The public address is one you can give to anyone to allow them to send you money. The private key is for you to keep and never tell anyone. This verifies you as the owner of the wallet. In bitcoins case, it is a huge random number (in binary, 256 1's or 0's) but usually converted to a series of random words or password, which makes it easier to write down. Using cryptography, the public address is made from the private key, but the private key cannot be worked out from the public address (practically). To crack someone's address from their public key, it would require an unfeasible amount of time and computing power.
If every human on Earth had a computer program that allowed them to take a guess at your Bitcoin private key 1 Billion times per day per person, every day, for 100 years straight, the chances of anyone correctly guessing your private key number would still be in the ballpark of 1 in 3,512,469,265,893,923,428,170,004.
There are two types of wallets, hot wallets and cold wallets. Hot wallets are ones connected to the internet and are seen to be less secure than cold wallets, which are offline and usually in the form of a portable hard drive or USB stick. However, hot wallets are more convenient to do transactions due to it being connected to the internet. It is relatively simple to open a wallet online on a cryptocurrency exchange (Coinbase or Gemini for example) and use that to store your BTC. The worry would be if the exchange was hacked, and then all your BTC was stolen. Other institutions like BlockFi state they hold your BTC in cold wallets and they have the added benefit of paying you interest on your holdings.
Below is a great video discussing the more technical aspects of bitcoin network, the nerd inside me absolutely loves it.
BTC
The currency itself is what most people care about in terms of finances and making money. Here are some reasons why I feel it has the potential to be a good currency to 'invest' in.
- Like gold, there is a finite supply. Unlike fiat currency like USD or GBP, governments cannot create more by printing more. It is deflationary as there is less supply of it as time goes on. This means the value of it is not governed by its supply in the economy, so it is sometimes seen as a hedge against inflation of fiat currency.
- BTC is seen as a digital gold, a store of value which is easier to exchange than a physical heavy object. Sending 1 BTC is much easier than sending 1kg of gold.
- Increasing institutional adoption by big companies such as Tesla, Square and MicroStrategy hopefully indicates that BTC is here to stay. The biggest exchange Coinbase has also listed on the US stock exchange, showing that cryptocurrency is becoming more mainstream. A BTC ETF (exchange-traded fund) has been rumoured for a while, and if this occurs then it's likely more money will pour into this space.
- International transfer of money. Whenever you need to transfer money to someone abroad, it requires a lot of hurdles and fees. One of BTC's initial goals was to be a global currency, and whilst there are better cryptos now better for use as a currency, it is still easier (and cheaper) than fiat currency that requires conversions and use of money transfer services. All that is needed is the public address and you can send to anyone globally.
- Discretion - as you only have to show a public address to receive or send funds, you can stay anonymous if you so wish. However if you use some of the mainstream exchanges to store your currency, many will have you do several ID checks to confirm who you are. This is likely for tax and money laundering purposes. You would have to transfer the BTC to your own personal wallet to stay anonymous.
- For some people in certain areas, it is hard for people to set up a bank account. With BTC, all you need is a mobile phone or computer to create a wallet and start transferring BTC. This makes financial independence accessible to people who may not have access to bank accounts, credit cards or other forms of payment.
- It has the biggest name and liquidity of all the cryptocurrencies and it is relatively easy to purchase or exchange. It also has the biggest market share of all the crypto currencies, termed 'Bitcoin Dominance' which currently sits at 46.55%. Because of this, it is likely the safest in terms of all the cryptocurrencies.
- BTC can be traced back to its origins as a block reward. This can cause potential issues where BTC won't be allowed onto exchanges due to it's previous use in criminal activity. Fiat currency like GBP and USD has no history so can be used wherever it is accepted. This may just mean that there are less usable BTC available (and therefore make BTC more scarce).
- Risk of scams or hacking. Though brute forcing a private key is practically infeasible at the moment, human error can occur which can give criminals access to their wallet. Whilst this can happen with normal banks, banks are able to do a reverse transaction to recover your money. This can also happen at exchanges where most of the BTC is held. This happened most famously at Mt Gox where 650,000 BTC was lost to hackers and caused the collapse of the exchange.
- Currently there is no practical way to crack wallet private keys or hijack the bitcoin network, modern computers have to brute force the work needed to maintain the system (requiring huge amounts of energy). However in the future, quantum computing may make it very easy to break this type of cryptography as it can represent 1's and 0's at the same time. Google have already made supposed progress with quantum processing, solving problems in a fraction of the time of traditional computing. This could potentially break the security of the network and reduce the value and trust in BTC.
- This huge usage of energy has been a controversial topic. Elon Musk has stated on his twitter that Tesla wont be accepting BTC as it uses too much energy such as fossil fuels. However the counter argument has been that BTC mining uses predominantly renewable energy and drives advancement in this field. It is in the best interests of BTC miners to find cheaper energy sources and renewable energy is cheaper than fossil fuel energy.
- Once all the 21 million BTC is mined, there will be no block reward. Miner's will have to rely on transaction fees alone which may not be worth their while to maintain. There is no obvious solution to this.
- Use as a practical currency is limited currently. Bitcoin currently handles roughly 4.6 transactions per second, Visa does 1,700 transactions per second on average. Also to verify your transaction, you will need to wait at least 10 minutes for the transaction to be added to the block and then added to the blockchain. There is a limited amount of space for transactions inside each block so you may have to wait for the next one though you can pay higher transaction fees to try to get your transaction put through quicker. All these things can make it inconvenient if you wanted to just buy some milk at the supermarket. Upgrades are planned to try fix all these things but will require time and consensus from the network.
- No safeguards. If you forget or lose your private key then there is no password reset function; you have lost your wallet and it's BTC forever, like this guy. They say 20% of all BTC in circulation is in wallets that can never be recovered.
- Governments banning it can make it hard to realise its aim as a global currency/store of value. So far countries such as China, India, Turkey, Nigeria, Egypt and Iran. A full list can be found here.
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