While I am a fan of disruptive technologies and embrace new ideas and ways that challenge our norms, I always look at the downside to make sure it stands a chance at succeeding.
We have all been hearing about Bitcoin and cryptocurrencies the last little while and all the mania surrounding it, so I want to talk a bit about this as I’m getting a lot of questions on this topic.
First off, what is a cryptocurrency? A cryptocurrency is a virtual currency that only exists in cyberspace and it has been designed to act as money (medium of exchange) and it uses cryptography to secure its transaction. Think of our currencies we use, like Canadian dollars, US dollars, Euros, etc… except that you cannot go to the ATM and take out a cryptocurrency and physically have it in your hands. You can use it to buy stuff, but only from retailers that accept that form of payment. Bitcoin is the most popular cryptocurrency out there and some retailers currently accept it, while some countries have banned it outright.
Cryptocurrencies, like Bitcoin, was literally created out of nothing and this is basically how it started.
Some dude named Satoshi Nakamoto (if this guy even exists) decided to (and I’m speaking metaphorically here) plant a limited amount of “virtual gold”, Bitcoins, in cyberspace for people to “mine out” using software and complex algorithms. Anyone can mine it, and these miners are an important part of the Bitcoin network because, collectively, they provide the functionality, stability, and security.
It’s important for you to understand that the environment, being 1) high government debt, and 2) low-interest rates, have created the opportunity for cryptocurrencies to hijack the current financial system.
Why would they do that? What is wrong with the current financial system?
Well, the current central banking system is government-controlled. Centralized. Every country’s government controls their own money supply -whether they print more money to create more supply or raise interest rates and reduce the amount of supply of money. The amount of money a country can print is unlimited. But, keeping in mind, having a shit ton of money printed reduces that value of that currency -which is why a country doesn’t just print an unlimited amount of money as great as it sounds. The more money that is out there, the less valuable it is (supply and demand) because it causes inflation (increased prices), which means each unit of currency, buys less. Currency is devalued when there is more of it.
In comes cryptocurrencies.
Cryptocurrencies, let’s say Bitcoin, was created with a finite amount. There’s that scarcity effect that challenges the centralized system. More importantly, no one controls it. It is completely decentralized, which sounds amazing at first (imagine, no government control over money!), but it isn’t amazing as it sounds as we have quickly learned how vulnerable cryptocurrencies were to hacking and stealing -and once it’s stolen, it’s gone forever. You cannot trace it or recover it. This is the problem with a decentralized system -nobody can help you or protect you.
Why would cryptocurrencies, like Bitcoin, not thrive beyond speculation?
- Power. No single government on this planet would ever give up that control over their own money. To allow Bitcoin or any cryptocurrency to be “freely exchanged” into any one single type of fiat currency out there (like how we can freely exchange CAD to USD or vice-versa) would destroy the entire financial system. Don’t get me wrong, I love disruptive technologies. We’re not talking about disrupting the taxi industry (Uber/ Lyft) or hospitality industry (AirBnB), we are talking about government power here.
- Medium of Exchange. Money is only as good as it can be spent. Remember Walter White in Breaking Bad when he was holding millions of dollars in cash, that cannot be spent without raising flags – while it is legit money, what good is it when you cannot use it? Yes, he could have used small increments of it, but when it comes to large purchases, that was out of the question. Similarly, with Bitcoin, you can only cash out in small increments. Unless Bitcoin becomes widely accepted as a form of payment for everything, it is pretty useless. Everyone hanging on to Bitcoin or speculating on it to go up in value, is eventually going to cash out into a fiat currency (e.g. USD, CAD, EUR).Which brings me to the next point.
- Volatility. Why would any retailer accept a form of payment that is so volatile. If you accepted Bitcoin, and let’s say one Bitcoin is worth US$13,000 today, but the next day, one Bitcoin is worth US$11,000, would you be okay with accepting that as a form of payment for your business? Remember, the amount of Bitcoin out there is finite, and a small number of people hold a pretty large amount of Bitcoin (1,000 people hold 40% of the Bitcoins). This makes Bitcoin illiquid and allow for these large upswings and down swings -because not enough people trade it. When not enough people trade something, it makes cashing out of this “currency” difficult without losing some value in the process.
- Purpose. This brings me to my final point -people just want to “cash out” of Bitcoin. Simply because, Bitcoin has no purpose to it. If you were given a choice to hold a piece of land, USD, CAD, or Bitcoin, I imagine most people would not choose Bitcoin as their first choice. There is no purpose in holding Bitcoin because you’d want to convert it in to something else anyway.
So, why has so much wealth been created off nothing?
When enough people hold it, like a network, and people are willing to buy and sell this – value is created. If I were to create a Sassy Coin and I convince enough people there is perceived value in it and they buy into it, then I just created value for it. The network effect is where the value lies. Underlying the Sassy Coin, however, there is literally nothing because it came from nothing.
The underlying technology behind these, blockchain technology, on the other hand, is a different story.