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Cryptocurrencies 101 Author: Aditya | Date: October 6, 2020

Undeniably, I love watching movies & TV series and one of the reasons is that you get amazing content ideas from these shows! Before I jump on to talking more about the subject at hand, let me ask you if you have ever heard the Hindi adage “Hath ko aaya par muh na laga”! Well, Crime-Master Gogo immortalized this dialogue in the iconic movie “Andaaz Apna Apna” when he lost all the diamonds after making a big play for the same.

Fast forward to today and if we were to think of a similar situation, this is what comes to my mind –
Any guesses? This is when the Caltech smart crusade realized that they mined several bitcoins only to lose the folder when the bitcoins assumed magnanimous value! AKA – “Hath toh aaya par muh na laga”

It’s been three years since Bitcoin rallied to a price of nearly $20,000, following which it’s hype quickly dissipated. A multi-year bear market followed and, well, here we are and the price of bitcoin is $10,738.40 per unit (at the time of writing this piece). The current market capitalization of all cryptocurrencies is around $330 billion, out of which Bitcoin accounts for a whopping $200 billion. 

Where do we stand as of today with respect to this emerging asset class? Clearly, the obnoxious bitcoin evangelist of a friend who cornered you at every social gathering- preaching of the cryptocurrency-driven impending “financial revolution”, has mellowed down. Perhaps even found a real job. But, what exactly are cryptocurrencies?

Allow me to introduce bitcoin to the uninitiated. For those who have gone over this a zillion times, bear with me.

Bitcoin is a decentralized, peer-to-peer digital cash system, with a mechanism for logging every single transaction that occurred, since its inception. It also comprises a set-up for deterring any attempts at a fraudulent activity. The transaction log is called a distributed ledger and no single entity has complete control over it. The bitcoin network is controlled by multiple actors who are anonymous and anybody who wants can partake in the verification of occurring transactions, which are thereafter added to the blockchain. Why would anyone want to do that, you ask? Because the act of verification is incentivized with a lucrative reward – bitcoin. Miners verify transactions and are perpetually in competition with each other on who can verify the fastest, for only the quickest miner gets rewarded. This bitcoin reward furthermore promotes the concept of a decentralized system since miners support, secure, legitimize, and monitor the Bitcoin network and its blockchain. Keep in mind that the term mining could be a little misleading since cryptocurrency mining is basically the search for a specific string of characters called a hash that meets certain conditions. The hunt for this hash is called mining and when found, rewards the miner with a fixed amount of bitcoin. This hunt occurs every 10 minutes. The entire system is governed by a set of rigid rules, the details of which are not important for a basic understanding. For those who are interested, feel free to go through the bitcoin whitepaper.

Be safe, Use Blockchain.

One might wonder, why can’t somebody simply tamper with the data inside the log and spend money they don’t have? Well, they technically can but the entire network of miners determines the legitimacy of transactions by consensus, which acts as a pillar for the decentralized network. Any honest miners would identify a case of double spending and reject the transaction. Another important discussion comes up here. Can somebody control more than 50% of the network, then tamper and fraudulently arrive at a consensus? Yes. This is termed as the 51% attack which was also introduced in the HBO hit show, Silicon Valley. However, it would mean that one must access more than 3.5 Gigawatts of energy to be able to control more than 50% of the network. To put things in perspective the power consumption of Switzerland is 7 Gigawatts.

What I have explained is just one part of the bitcoin ledger. The entire log is maintained with the help of a slightly more complicated system termed as the blockchain, which is essentially a chain of transaction sets. Each set is called a block and each block comprises transactions occurring within a 10-minute timeframe. 

The bitcoin system is innovative and has grown in adoption over the last 10 years. Financial instability in countries such as Venezuela has led people to use bitcoin. The number of bitcoin ATMs worldwide has surpassed 10,000. MicroStrategy recently adopted bitcoin as a primary treasury reserve asset. Fidelity Investments is also preparing to launch a bitcoin fund. However, bitcoin is serving more as a store of value instead of electronic cash. People speculate heavily on the price leading them to hold on to it and even accumulate more expecting major upward price movements.

Is it worth the hype?

One might not religiously follow crypto news, but every now and then, you are bound to encounter a pictographic representation of the steep rise or fall in the price of Bitcoin, or perhaps dear Ol’ Warren antagonizing the concept. So, there must be a reason behind bitcoin price speculation and why it has been continually gaining traction as an alternative investment! An understanding of the fundamental qualities of “sound” money would help answer this question. A medium of exchange needs to have some value, and anything of economic value must be scarce. Only 21 million bitcoins will ever come into existence. The rate at which they come into existence is also fixed. In contrast, the US federal reserve has printed over $3 Trillion in the last few months. There is no limit to how much fiat money can be printed and there is a minimal correlation of the amount printed to economic growth and development. This even led to hyperinflation in countries such as Zimbabwe and Venezuela.

Verifiability is another trait of sound money. It is not possible to produce counterfeit bitcoins due to its verifiability. Portability is another exceptional utility, whereby we can transfer billions of dollars’ worth of bitcoins in 10 minutes across the globe for a transaction cost of under $10. Wiring fiat money, on the other hand, is quite cumbersome with a transfer time of over 2 working days in many cases. Other characteristics such as fungibility: one unit of the currency being identical to another unit, divisibility: transacting in small units of the currency, and censorship resistance are valuable traits bitcoin possesses.

Despite all these utilities, people argue that it lacks underlying fundamental value and is something created out of thin air. We could argue the same about fiat currencies. How countries’ central banks have gone about printing currency under the garb of stimulus packages during the COVID crisis, is testimony to fiat’s loose fundamentals. The value of gold saw a new all-time high recently because people saw it as a store of value as compared to holding cash.
Crime-Master Gogo was seeking a store of value in the form of diamonds, but bitcoin, on the other hand, is considered a digital store of value by many. Who knows, if there is a remake of Andaaz Apna Apna, the entire ordeal might be centered around bitcoin. 

New Age Sons Of Anarchy

Cryptocurrencies are a dream technology for libertarians who believe in minimal government control. In fact, it seems like a medium of exchange for a truly free utopia in which your money is completely owned by you and nobody can stop you from using it whichever way seems fit. It has, for this reason, been widely criticized for promoting illicit activities such as weapons and drug trafficking. Also, the technology does come with its own problems as of now which include the lack of scalability of the network. When there is network congestion, this drawback of poor scalability entails high transaction costs and transaction time. However, it is being currently tackled by the evolution of technology-driven by the open-source and collaborative bitcoin community.

The burden of promoting illicit activities cannot solely be placed on innovative technology with the potential to bank the entire human population. It is upon us as a society to ensure such a powerful idea is not misused and used as a force for good. 

Samjha Kya? 

What I have touched upon is not even a droplet in the massive ocean called the crypto sphere. There are over 10,000 cryptocurrencies with widely varying and interesting applications. The space has gone beyond just digital cash to decentralized applications which I shall touch upon in future articles.

A lot of the details mentioned are not particularly important in having a layman’s understanding of bitcoin. What needs to be kept in mind is that:

  1. Bitcoin is not controlled by any third party, meaning if I were to transfer some bitcoin to you, the transaction is just between you and me and is not mediated by a PayPal or an Alipay. Just like how a hard cash transaction would work.
  2. Transactions are verified and secured by a network of miners. Miners are rewarded in bitcoin.
  3. Any amount of bitcoin can be sent to anyone anywhere in the world for a minuscule transaction cost, having a transaction time of a few minutes.

In conclusion, cryptocurrencies, if leveraged effectively could bring about a fair and secure financial network. This technology is disruptive and challenges the predominant global financial order.

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy of any agency, organization, employer, or any company. Fintuned Co. LLP shall not be held responsible in any manner whatsover, for any decision/action taken by readers on the basis of the content mentioned in the article. Readers are requested to exercise their best judgement before taking any decision/action. Fintuned Co. LLP shall also not be held responsible for any copyright infringement committed by the author in the process of writing and/or publishing this article and in the event any such offence is found, cooperate with necessary authorities to take remedial action

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