Cryptocurrency concepts and applications

Cryptocurrency

A cryptocurrency is a medium of exchange (currency) that is digital in form, non-governmental, and relies on cryptography for its security (Investopedia, 2018). It is the latter component of the definition that gives cryptocurrency its name. The vast majority of currency in the world comes in the form of exchangeable units that are issued and have their value controlled by governments. Nations will either allow their currency to float freely on the market, where the value derives in part from supply and demand, and is backed by the ability of that state to raise revenues. These are considered to be the strongest currencies. Other currencies have values that are fixed by the state – as a medium of exchange those official values may or may not reflect the ability of the state to raise funds, but the value is enforceable by law regardless.

A cryptocurrency is different in that its value is derived solely by its supply and demand. The demand for cryptocurrency is driven by consumer trust in the currency as a medium of exchange, which is common to all currencies, and by the demand for a currency that is not subject to government control. The lack of oversight over the exchange of cryptocurrencies makes them especially popular for illicit activity (Investopedia, 2018), and from that they can derive demand.

Bitcoin was introduced in 2009 and has become the most well-known of the cryptocurrencies. A major feature of Bitcoin that has helped it rise to prominence is the idea of the blockchain. Bitcoin works when the Bitcoin client software generates" unique, mathematically linked keys", one private and one public, and these keys are used to bring two parties together and verify that the money being exchanged is real (Simonite, 2011). The client will then verify the transaction by sending it to all other users who are online. The transaction will be logged by Bitcoin miners who race to solve a cryptographic puzzle (Simonite, 2011). This process in theory guarantees security and trust in the transaction.

The mining is the means by which Bitcoins are created, answering the supply part of the equation. The necessity for transactions to be verified and entered into the public log means that the system only works when there is incentive to perform these tasks, and the creation of Bitcoin for the miners is how that occurs.

Blockchain technology is now being explored for other applications. Specifically, it is viewed positively by many for its ability to verify transactions without the need for an explicit, paid intermediary. Of course, the intermediaries are being paid (in Bitcoin) and the costs are actually very high (Bitcoin mining is computationally intensive, requiring substantial energy resources), but those costs are offloaded onto the environment, not the people performing the transaction. By offloading transaction costs and reducing the role of intermediaries, transactions through a blockchain are faster, cheaper and theoretically at least as safe if not safer than transactions conducted by conventional means. This is the aspect of Bitcoin that appeals the most to the business community.
Cryptocurrency itself, because it has not intrinsic value, is likely to be quite volatile, and of limited appeal because of that, it may never become a mainstream thing, even if everybody has heard of it. There are also countless competitors to Bitcoin now. Bitcoin was the innovator in the cryptocurrency space, and is justifiably famous, but over time doubtless competitors will emerge that solve some of Bitcoin's weaknesses, and end up as the cryptocurrency of choice. But Bitcoin's rise is what made all the other cryptocurrencies possible, so blockchain and cryptocurrencies (Bitcoin or otherwise) are going to be the legacy of Bitcoin, and both have made interesting and important contributions to economics, technology and finance.

References

Investopedia (2018) Cryptocurrency. Investopedia. Retrieved April 13, 2018 from https://www.investopedia.com/terms/c/cryptocurrency.asp

Simonite, T. (2011). What Bitcoin is, and why it matters. MIT Technology Review. Retrieved April 13, 2018 from https://www.technologyreview.com/s/424091/what-bitcoin-is-and-why-it-matters/