Cryptocurrency: between speculative madness and promising technology
In October 2017 I decided to buy some cryptocurrencies after it showed signs of rapid growth. 3 months later the bitcoin was on its way to reaching20k dollars, my 100€ investment then had doubled, and I decided to sell everything. Shortly after the bitcoin had its first course crash dragging the other currencies with him and hitting a low 3200$ in December 2018. Today, the bitcoin is worth 40000$, a 13-time increase in 2 years! Is cryptocurrency a speculative madness or a promising technology?
What happened during those 2 years that could make cryptocurrencies back on track? If the cryptocurrencies seem to have regained some popularity the opinions around cryptocurrency are still divided. For some they are just a financial bubble, for others, they are money laundering assets due to their anonymous characteristic and more and more people see it as a safe haven like gold.
In this article, I’m going to try understanding how cryptocurrencies made such a comeback in 2020 and what factors are determining their present success whether they are economic, political, or technological.
The blockchain technology
To understand how cryptocurrency works, you need to understand the technology behind it: the blockchain. The blockchain is a complex technology but a simple way to explain it is through the image of a shared database among the users that collects data in a storage space called a block. When a block is full of data it is then connected with the previous block creating a chain of blocks. The data in the block can be viewed but cannot be modified anymore. A new empty block is created that will receive new data and the process repeats again and again.
The data that is written inside the block whether it is a transaction, a contract, or any document is secured via the proof of work system used to validate the authenticity of the data. The proof of work system uses advanced cryptography methods called “hash” which are mathematical algorithms that are very difficult to resolve to secure the data that are written in the blocks. The most used hash algorithm is called SHA-256 and is the algorithm that secures the Bitcoin blockchain among many others.
In order to validate the data via the proof of work system, users connected to the blockchain have to generate the hashes using processing power such as graphics cards for the Etherum. These people are called “Miners” and are rewarded with some cryptocurrency for their processing power contribution to secure the Blockchain. The cryptocurrency along with the timestamping of the data serves as proof that someone used some processing power to secure a transaction. This method is very secure but consumes a lot of energy. In 2020 the electricity consumption of Bitcoin peaked at 77.78 TWh which wich is around what Chile consumes in a year. Now that we know how a blockchain works let’s see some of its application possibilities.
The most used application of the blockchain is a secured transaction system and the most famous is Bitcoin. Bitcoin with its 480 billion market capitalization is essentially an alternative to the banking system and trades pros and cons with the banking system. The first difference is that the system operates without a central authority or a single administrator. It is managed in a decentralized way thanks to the consensus of all the nodes of the network. The transactions are anonymous the drawback is that it is used in illegal activities. The transactions are also faster, have no amount limit and the fees are way smaller than a credit card.
Etherum is the second cryptocurrency in terms of market capitalization after Bitcoin with 90 billion and a completely different take at the blockchain. As the Bitcoin blockchain, it is a decentralized open-source blockchain with smart contracts as the key feature. Smart contracts are programs that automatically execute as soon as a sum specified in the contract has been transferred in Ether. This means that the verification of an incoming payment is no longer necessary because the transfer directly starts the consideration specified in the program.
Another promising feature is Dapps for decentralized apps. Dapps are applications that use smart contracts and run on the Etherum Virtual Machine. The main characteristic of Dapps is that they are running on a decentralized network and not on a central server. The application of Dapps are very broad and include e-commerce, gaming, marketing, banking, process automation, and many more.
There are many other cryptocurrencies like Ripple or Litecoin that have their own uses, but these have a lower market cap.
Why is Bitcoin successful?
But why this sudden increase in the price of cryptocurrencies? One answer comes from political and economic factors. With the Corona crisis severely impacting the economy, both the US and the EU launched a massive economic recovery plan to save it by printing large quantities of money. The result is the increase of the US monetary mass M2 by 30% in 2 years going from 14 trillion to 17 trillion. People aware of this want to invest in assets that will retain their value rather than losing it over time and will invest in safe-haven assets. Recently PayPal allowed transactions in Bitcoin, Etherum, Bitcoin cash and
Cryptocurrencies and especially the bitcoin are now seen as safe-haven assets and a good way for investors to diversify their portfolio. The recent creation of a USD coin backed by the dollar sent the message that institutions are now accepting Bitcoin and that cryptocurrencies are here to stay.