A MOMENT OF CLARITY
The news is full of stories on “cryptocurrencies” – from Bitcoin to Facebook’s new concept called Libra coin. But what are cryptocurrencies? Is this the new wave of the future or the next Beanie Babies fad?
What are cryptocurrencies?
Just as the name would suggest, cryptocurrencies are a form of digital currency that use cryptography, or encrypted codes, to secure and verify transactions. The encryption allows transactions to process between two parties, rather than requiring a middleman such as a bank or a payment processor. In the world of credit cards and checks, fraudulent activity is rampant and it’s difficult to trust that the information someone else gives you is legitimate. How can additional trust be added to monetary transactions and how can you ensure that funds you receive are valid?
Enter the world of blockchain. Blockchain is a new technology that keeps an immutable ledger/record of all transactions that occur with a cryptocurrency. By using cash, you may have dollars in your wallet but no record of their origin and no proof that they aren’t counterfeit. Their acceptance by a third party, such as a bank, is the main way to verify validity. A blockchain removes these obstacles, by keeping a record of all transactions used by the currency – from its origin to the moment you receive it. This lengthy record of all transactions is held on computer servers owned by several different anonymous parties rather than by a single company or bank. Once a transaction is made and saved on the blockchain, it can never be edited, modified or changed – making it a reliable record without the need for a trusted third party. And just like that, banks and their fees are cut out of the monetary system, allowing you to trust in financial transactions with anyone around the globe.
It’s important to note that cryptocurrency, blockchain and bitcoin are not synonymous, and each of these terms represent different aspects of this new technology. For comparative purposes:
Are cryptocurrencies a fad?
Although cryptocurrencies have received significant attention and their values have struck bubble levels, the underlying technology has significant use cases for the future. Unless major governments and institutions begin accepting cryptocurrencies (as they do the U.S. Dollar or Euro), their widespread adoption will be limited in scope but remain a valuable tool in a world that continues to digitize and automate our lives.
How do cryptocurrencies differ?
While there are countless cryptocurrencies that have varying abilities, processes, and use cases – the three most popular in the media today are Bitcoin, Libra and Ethereum.
- Value based on supply and demand
- Largest adoption/acceptance rate in the cryptocurrency world
- Value will be tied to the US Dollar
- Will likely be used for transactions throughout Facebook’s platforms
- Value based on supply and demand
- Transactions are contractual. The coding within the currency allows transactions to be conditional
- For example: you pay for a service upfront, but the payment doesn’t settle until you confirm that the service is complete.
Picture this: You are at a widget manufacturing facility in the Midwest when you notice the factory floor doesn’t have any humans. No one is keeping track of the resources being used to build the widgets throughout the factory and yet the process continues to hum without a hitch. How could this be? It turns out, the computers within the system are keeping track of all the materials being used and when the raw materials for the widget run low – the machine puts in an order to their suppliers. An algorithm calculates how much will be needed based on recent output and uses a cryptocurrency to purchase the material. The cryptocurrency (like Ethereum) has a built-in contract to pay the supplier once materials are confirmed as received at the factory. And the automated system rolls on.
Given that the values of top cryptocurrencies are often based on supply and demand, their price can rapidly fluctuate and perform in a manner you’d never expect from a stable government currency like the U.S. dollar. This volatility results in a speculative financial product that can potentially lead to substantial gains, but also the risk of total loss. If you would like to discuss cryptocurrencies at greater length, please reach out to a Round Table advisor.