Are Cryptocurrencies the Money of the Future?
Aug 07, 2015 04:49PM ● Published by Parker Martin
The governments of various nations are usually the ones backing up the different forms of currency in the world. A US dollar is a sheet of green paper, but it can be exchanged for a can of soda because the US government has assured everyone that the dollar has value and both the buyer and seller believe the government. If the government decides that more money needs to be printed, they can do so at will, though it will cause inflation that devalues each piece of that currency. The government has a large, but not total, degree of control over the currency it prints and it has promised that it will exchange that currency for something of value. As long as the government stands, its currency will not be completely worthless.
Now imagine a currency backed by no government. No one has promised anyone that the currency is worth anything. Instead of the government printing more, it just shows up in the pockets of some people who work for it at a relatively steady rate. It can be exchanged for goods and services, but only if both the buyer and the seller agree on a price. No one tells them what a piece of the currency is worth, they and all the other people in the universe who use the currency must figure it out for themselves.
This situation more or less describes cryptocurrency, but it’s only half the story. To find out the rest, I met up with a group of cryptocurrency enthusiasts here in Raleigh.
What Is Cryptocurrency?
Cryptocurrency is currency created and secured through encryption techniques. These are the same kinds of techniques used to protect computer passwords, but applied towards making complex strings of letters and numbers in addition to hiding the strings. Creating units of cryptocurrency is commonly referred to as “mining.”
While cryptocurrency can and has been made into physical forms, it really only exists as a number kept track of by many computers over a peer-to-peer network in what is called a “block chain.” This means that most, if not all, of the computers using the cryptocurrency have a continually updating record of where every piece of that currency is.
Even though every piece of a cryptocurrency is kept track of, it is difficult to figure out who actually owns the piece of currency. Instead of real accounts that have to be registered, cryptocurrency is usually just associated with an address that looks something like this: 1PHYrmdJ22MKbJevpb3MBNpVckjZHt89hz. On top of that, someone could easily split their cryptocurrency between several addresses or use a new one for every transaction. Compared to a bank or credit card where a person’s name is almost always associated with their account, this makes cryptocurrenices extremely easy to use anonymously.
What Kinds of Cryptocurrencies Exist?
There are dozens of cryptocurrencies out there, and anyone can make their own. Here are a few of the more popular ones:
Bitcoin: The most popular and legitimate form of cryptocurrency is Bitcoin. While it was not the first attempt at creating a crypto currency, it is the first one with any real success. A person or committee calling itself “Satoshi Nakamoto” created the Bitcoin software, though no one is entirely certain of the true origins of Satoshi. Because Bitcoin is open-source, anyone can look through the code and use it for a new program. Most cryptocurrencies that exist today are “altcoins”, which means that they have the same underlying structure as Bitcoin with minor tweaks.
Dogecoin: Dogecoin (usually pronounced “Dohj coin”, but it can also be called “Dohg coin”, “Doh-geh coin”, or “Doggy coin”) is what happens when people on the Internet are allowed to make their own money. It is essentially Bitcoin with a few changes and uses the Doge meme as its mascot. Originally intended partly as a joke and partly as a way to tip people online, this cryptocurrency has gained immense popularity and has achieved a level of legitimacy.
Dash: Dash is for people who want their cryptocurrency usage to remain as anonymous as possible. All Bitcoin-based cryptocurrencies use a block chain to keep track of the currency that can be viewed by anyone. The block chain is already difficult to decipher, but Dash goes a step further with another level of encryption for complete anonymity. They also claim to be much faster at processing transactions than Bitcoin is.
Ripple: Unlike the vast majority of cryptocurrencies, Ripple isn’t based entirely off of Bitcoin or mined. Ripple’s reason for existence is not to take power away from centralized institutions like banks, but instead to help them work together. For example, by transferring US dollars into Ripple, someone in the US can quickly, easily, and securely send money to someone in India with no transaction fees. That person can then get the money from Ripple as Indian rupees from any bank or business that accepts Ripple. While the same could be said for most cryptocurrencies, Ripple aims to do it better.
What Is the Value of a Bitcoin?
There are a couple ways to look at the value of a bitcoin, but the shortest answer is that a bitcoin is worth whatever someone will pay for it. Because there is no institution that backs Bitcoin, the price has fairly volatile fluctuations. For example, Mike Drew, one of the cryptocurrency enthusiasts I met with, bought $3 worth of a bitcoin from the miners and was kind enough to give it to me through apps on our phones that scanned QR codes. Before the next morning, the 0.010791 of a bitcoin that I owned had fluctuated to $3.02, back to $3, and then once again to $3.02.
Mike told me about Sean’s Outpost, a homeless outreach program in Florida that operates entirely through cryptocurrency donations, and I donated the partial bitcoin to them. This worked by scanning a QR code on my computer screen with my phone, which was much quicker and easier than typing in a credit card number. The transaction immediately showed up in the block chain and honestly just felt more secure than using a credit card online. I knew for sure that the transaction had gone through and the entire world was my witness.
The main reason why Bitcoin works as a currency, crypto or otherwise, is because bitcoins are scarce. If there is an infinite number of a resource available, its value approaches zero because anyone can get the resource, but if a resource isn’t available at all, its value approaches infinity because it is difficult to obtain.
“The underlying value of a bitcoin is the electricity, time, and equipment required to mine it”, said Justin, another cryptocurrency enthusiast. The mining process contributes to the scarcity of bitcoins and makes it so that only people who make a significant investment can get new ones. Buying a bitcoin from a miner is essentially paying them for the effort required to obtain this scarce resource.
Mining involves having computers spit out random answers to an impossibly difficult math problem until one of them gets it right. Whoever gets the right answer first mines that block of bitcoins and a new block is started with a new problem to solve so everyone can try again. The software is built to adjust the difficulty of the problem in order to make each block take an average of 10 minutes to mine. Bitcoin mining is a lot like a rapid lottery where whoever has the greatest computing power has the best chance of winning.
To further enhance its scarcity, there will never be an infinite amount of bitcoins. Bitcoin is designed so that every block that is mined gives a set amount of bitcoins, but this number is cut in half about every four years. Originally, every block gave 50 bitcoins, but mining a block today would only net the miner 25 bitcoins. This will continue until just under 21 million bitcoins have been mined, which should happen sometime early in the year 2140, and then no more bitcoins will ever be produced.
As bitcoins are lost, due to things like people forgetting how to access their bitcoin wallets, bitcoins will deflate. This is at odds with most currencies, which try to slowly inflate themselves, but no one can agree whether this is good or bad; a deflating currency is largely uncharted territory. Bitcoin does have one advantage over traditional currencies that should make it usable when deflated: Even if only a single bitcoin is left spendable, that bitcoin can be divided almost infinitely.
Are Cryptocurrencies a Danger to Society?
The jury is still out on whether cryptocurrency is a good or bad thing, but it’s definitely something. Most of the problems with cryptocurrency are viewed as advantages by some people and vice versa. Right now, people can learn the facts and try to make up their own mind, but only time will tell what the true effect of cryptocurrency is.
Cryptocurrencies don’t require a third party to authenticate them. There is usually no extra fee to pay when sending money to someone, transactions are confirmed much faster than it takes for a bank to clear a check, they can be used anonymously, and, unlike a bank account, a person’s cryptocurrency assets can’t be frozen. While this all sounds great, it isn’t without its dangers. The owner of a cryptocurrency wallet is in charge of keeping up with it, and if they forget how to access it, there is no one that can help them to recover it. If they give someone else access to the wallet, there is no one to help them recover what that person may steal. The lack of a third party also lets criminals purchase illegal goods and services with ease, but this is not really different from cash except that it can be used over the Internet.
Some economists are worried that having an unregulated currency could spell disaster for the economy. First and foremost, the inflation and deflation of Bitcoin and most other cryptocurrencies are tied to an algorithm set up years ago instead of a government agency with actual human beings who can make assumptions and come up with new ideas. If a cryptocurrency becomes hyperinflated or hyperdeflated, there isn’t really anyone with the power to make large, helpful changes. On top of that problem, taxing cryptocurrencies is a pain. Because people can be paid with cryptocurrency, it should be taxed as income, but the currency’s anonymity makes it extremely difficult to figure out how much any person has. The rules governing whether or not cryptocurrency that a person mines himself should be taxed are also vague.
For some people, these economic issues aren’t a problem. Many people would rather trust an algorithm that they can understand the logic of to manage inflation and deflation instead of human beings who can make unpredictable decisions. While taxing cryptocurrencies will likely remain a problem, tax evasion is nothing new. Legislators are already working on cryptocurrency laws and other solutions, like a value-added tax, would likely get around many of the issues.
Mining cryptocurrency takes a lot of work and electricity, making a horrendous carbon footprint. Peercoin is one cryptocurrency that attempts to reduce its carbon footprint by gradually transitioning away from mining. Producing energy more cleanly, such as with solar panels could also greatly reduce the carbon footprint of any cryptocurrency. It should be noted that the energy consumed for cryptocurrencies is still well below that used for fiat money that needs to gather materials, be printed, and be secured from counterfeiters, but this could change as cryptocurrency becomes more popular.
Perhaps the biggest problem with the costs of cryptocurrency mining is that it is an inefficient use of processing power. The math problems used by Bitcoin and most other cryptocurrencies are only used to help secure the currency and are otherwise pointless. Primecoin is a cryptocurrency that has its miners look for scientifically valuable Cunningham chains, essentially chains of prime numbers that follow a set of rules. Even the random calculations of Bitcoin can have a use beyond security if used correctly. Cryptocurrency mining provides a perfect way for hardware developers to test new chips. Because doing so allows the creators to earn money simply from testing the product, this can make the development needed to create incredibly powerful chips more economically viable.
The future of cryptocurrency is still unknown, but the genie has definitely been let out of the bottle. For good or for ill, cryptocurrency is here to stay.