Since the debut of the world’s first cryptocurrency, Bitcoin, on January 3, 2009, the value of the entire cryptocurrency market has grown to $1.9 trillion, which is equivalent to Canada’s GDP, and even exceeds it. Today, the world’s largest companies and asset managers buy, sell and exchange cryptocurrencies, as well as accept them as a means of payment. So what is cryptocurrency and what risk is associated with its use?
The Birth of Bitcoin and Blockchain
As many will recall, 2009 was one of the worst financial crises in history, caused by the fact that some of the world’s largest banks benefited from government bailouts and a monetary easing program (also known as money printing, or QE), which fundamentally changed the financial systems of most developed markets.
Interestingly, much of this was foreseen by the creator of the world’s first cryptocurrency – Bitcoin (BTC), who in 2008 released a “White Paper”, a document describing a new revolutionary monetary system based on a new form of technology – blockchain.
According to Coinmarketrate.com In fact, the blockchain is a pipeline on which cryptocurrencies work. A huge digital ledger (registry) is a blockchain that manages and records all transactions that occur with the cryptocurrency located on it. However, unlike a traditional ledger, the blockchain is completely transparent and 100% protected from hacking.
In the blockchain, anyone can check when a transaction was made. This transparent ledger is constantly stored and updated on thousands of computers, which makes the blockchain secure from hacking, since any illegal changes are instantly detected thanks to a massive chain of cross-references.
Miners and cryptocurrencies are unwinding the chain
The security and immutability of the blockchain make the existence of a cryptocurrency possible. Since it is impossible to change the values in the blockchain unnoticed by everyone, it is impossible to forge or duplicate cryptocurrency on the blockchain. And this makes the blockchain an ideal environment for issuing tokens that can be trusted.
Bitcoin and cryptocurrencies are digital forms of money that, unlike real world currencies or fiat currencies, cannot be forged. This makes cryptocurrencies very attractive to people.
Each blockchain exists with the help of a large number of miners, on whose computers the entire blockchain works. In order for the blockchain to work safely, earning cryptocurrency is an incentive for miners to use their computing power and energy to check and update the blockchain.
Ethereum and Cryptocurrency Opportunities
Bitcoin and blockchain were invented hand in hand: a secure system produces a secure currency that motivates people to maintain the security of the system. This is an ingenious invention by any standards, and it was the first of its kind. However, the way Bitcoin has been designed and coded limits the use of its blockchain.
The Bitcoin blockchain is not amenable to programming: it can only store BTC, and this restriction led to the creation of the second largest blockchain in the world – Ethereum.
Also known as the world computer, Ethereum is a fully programmable blockchain, and its open source security and encryption provide a platform for developing innovative projects that are then launched on the blockchain.
Like Bitcoin, Ethereum mines its own cryptocurrency: Ether (ETH), which is used as a form of payment for all transactions taking place on the blockchain (also known as “gas” fees). In addition, projects running on Ethereum can issue their own form of cryptocurrency, known as ERC-20 tokens, which can be independently mined by these projects, and then traded in the Ethereum ecosystem.
The next generation of blockchain, Blockchain 2.0, is proving to be more open, dynamic and full of use cases. Creative and inspired minds are coming up with countless possibilities for blockchain technology. New networks are constantly emerging, and many blockchains are currently functioning, each of which has its own currencies, software developments and capabilities.
The value of cryptocurrencies
Being a completely digital invention, it can be difficult for some to understand what gives value to BTC, Ether or any of the thousands of different cryptocurrencies. We can hold banknotes of rubles, dollars or euros in our hands and exchange them for goods and services, but cryptocurrencies are less tangible.
The answer is that all money is conceptual, its value is simply a product of the market’s decision of how much it costs. This applies to both the US dollar and Microsoft shares. Several different entities, including central banks and investors, set parameters and then buy and sell assets whose value is determined by this activity. The same is true for cryptocurrencies.
Like any other asset, each cryptocurrency has its own factors that affect its value. In the case of Bitcoin, this is a shortage: only 21 million coins can be issued, which means that it is not infinite, like the US dollar, and therefore valuable, like gold. For Ether, this is its position as the native currency of Ethereum – the engine of the crypto industry.
However, in the end, the value of any cryptocurrency will be determined by the number of people buying and selling it, which often depends on changeable moods, like stocks on the stock market. And, as with stocks, it doesn’t always make sense.
And so, the risks associated with cryptocurrencies
The risk associated with cryptocurrencies is often mentioned, and with good reason. Being an unregulated area, the world of cryptocurrencies offers no guarantees. If you put your money in a wallet or on a blockchain exchange, security is determined and controlled by the company or developers who created it.
Cryptocurrencies are vulnerable to abuse and fraud.
These include thefts on some of the largest early cryptocurrency exchanges, in particular on Mt. Gox, where $460 million disappeared in 2014, which was never returned. The euphoria from the initial coin offerings (ICOs) of 2018 also led to the fact that many investors were deceived by the developers of new projects and tokens, which turned out to be completely fake (which forced the authorities of many countries to completely ban ICOs).
Moreover, cryptocurrencies are notorious (controversial) for their volatility, and Bitcoin is often subject to wild daily fluctuations. While in traditional finance, a 20% drop is a technical indicator of a full-fledged recession, for BTC it is a day of work, and for some new, more exotic cryptocurrencies it is almost nothing.
Pitfalls of traditional financing
However, much of this is not too different from what is happening in the world of traditional finance, an example of which in terms of scams and losses can be the events preceding the global financial crisis. In addition, depending on the jurisdiction, the only thing guaranteed in the “real” world is cash in your bank account, and often only up to a certain amount.
It is also important to take into account that we live in very different times. The safe and secure savings opportunities that traditional banks once offered are no longer available in most developed markets. Today, money printing has led to shockingly low interest rates, which cause depositors to lose money every year, adjusted for inflation.
In fact, for more than a decade, the only way to get a real return on capital was to invest it in the stock market, where the risk can be as great as in cryptocurrencies. And note: with or without regulation. Those who are not interested in the traditional volatility of cryptocurrencies can now also pay attention to stable coins indexed to fiat currencies of the “real world”, which can be invested using a cryptocurrency platform to earn APR (annual percentage yield or APY).
For many people, cryptocurrencies and blockchain technology are just a continuation of the global movement towards greater digitalization, a world in which we increasingly lead our lives online.
Indeed, when viewed in this light, it seems more likely that a currency based on an incorruptible and transparent digital chain will be much easier to understand than a currency based on the whims of disparate ledgers stored in disparate banks.