I was twirling the thought of Chaum's Protocol in my head, its intricacies filling the gaps between my synapses. Impressed by its cryptographic properties, I could not at the same time escape a nagging sensation in another part of my brain: DigiCash.... is ... tooooo..... faaaar... ahead... of its... tiiiiiiiiiiiiimeeeeeeeeeeee...........
CRASH!! The toppling sound of the once mighty walls of Mt. Gox, the worlds's largest Bitcoin exchange, finally brought me back to my senses. Talk about falling asleep at the wheel! Fast forward a decade or two later from my ruminations on DigiCash, virtual currency (aka "electronic currency", "digital currency", "cryptographic currency", "cryptos") has suddenly made such headway into mainstream thought as to capture the attention of CNN, speculators, The Wall Street Journal, Bloomberg and professional traders alike. Some have described it as the next killer app, akin to email when it first began gaining momentum in the 1980s. What is cryptocurrency and why is it interesting? This post is intended as a primer to answer just that.
What are Cryptocurrencies?
In the simplest sense, cryptocurrency is just electronic money. There is no physical representation of them in the form of paper bills or metallic coins. They exist only in your electronic wallet (software on your computer or in the cloud) and are sent between users by debiting the sender's wallet paired with crediting the recipient's wallet. The "crypto" part is short for "cryptography", a branch of computer science dedicated to securing communications. Cryptography is what keeps military messages secret during war, trade secrets protected as they are passed across the Internet, and your credit card number from being stolen when you register for Amazon. Cryptography is also what drives the cryptocurrencies of today.
This is where things get interesting. Once upon a time, most money came in the form of gold or silver coins. How much a dollar was worth was tied directly to the amount of precious metal it could be exchanged for. Over time, governments have found it more convenient to simply print paper and declare it valuable, without backing their fiat currency with a physical commodity (fiat is Latin for "it shall be"). Every country today uses fiat currency and governments control their worth through laws and regulating supply. Most often this leads to accelerated inflation as governments print more money to get out of the crisis of the day. Remember when a bus ride was only $0.25?
Except cryptos are not fiat. Their value is derived from demand, but supply is not government mandated. Most crypto coins are created by miners setting their computers to work on solving cryptographic problems. A miner can be anyone in the world with a computer and an Internet connection, since generally all crypto technology and protocols are Open Source and free for the Public to download, study and run. If you choose to become a miner, you become part of a peer-to-peer global network of miners and the very infrastructure used to transmit and validate transactions for that particular currency. When a miner finds a solution, they are awarded a few coins through a process known as mining or minting. Most cryptos are designed such that the cryptographic problems in mining become exponentially harder to solve as more coins come into existence, effectively throttling supply growth. Some even have a preset supply so that no more than X coins can ever be created. This leads me to one of my points of why I think cryptos are interesting.
Why are Cryptos Interesting?
To the General Public
If you own a business and accept credit card, you'll know that 2%-4% of your revenue is immediately taken by your payment provider. Wouldn't you like to pocket that yourself or pass it on to customers in the form of lower prices, while still offering the benefits of cash-less transactions? An number of well-known merchants accept Bitcoin (the most popular crypto today) according to this nasdaq.com article. Save for the $103,000 Tesla paid for in bitcoins, most of them are online merchants. Bitcoin transmission and validation is still a bit slow for say, a restaurant, but newer cryptos clear much faster. You also won't need any special hardware with support contracts, just a commodity computer and an Internet connection to accept crypto payments.
To Speculators and Traders
In 2009, a bitcoin (BTC) sold for... well, nothing. At its peak earlier this year, it traded for $1,000 USD. Talk about ROI! There are about a couple of hundred different cryptocurrencies last I checked with new ones being announced everyday. I would not be surprised if we have already surpassed the number of types of fiat currency. Many are pump-and-dump schemes admittedly, but some have real innovation that can be valuable to the world. As a trader, none of this matters though. There is tremendous opportunity for quick profits (and loss) due to high volatility and arbitrage gaps on cryptomarkets, even more so than traditional forex. Retail investors and Wall Street professionals alike have been trading for some time, and recently CNBC reported a Wall Street-backed Bitcoin fund.
To Researchers, Scientists and Mathematicians
Remember when I said mining is computers working on cryptographic problems? In the case of Bitcoin, the work done is to help validate transmissions on the public ledger. But what if a crypto was designed to take all that computing power and work on something useful to other people? Primecoin awards miners for finding Cunningham chains and bi-twin chains, reaaaaallly large special prime numbers useful in mathematics and cryptographic research. Gridcoin takes miner's CPU power to work on BOINC projects, projects that involve finding a cure for cancer or compute-heavy problems in clean energy. Sometimes the altruistic machinery is simply associative. For example, Ripple, a startup with investment from Google Ventures, gives away their currency for compute time donated to BOINC.
To Software Developers and Entrepreneurs
Inventing your own crypto aside, there's a world of software and sites to build if cryptos continue to gain traction. Wallet aggregators, improved merchant and payment tools, wallet backup and recovery solutions, wallet address contact list management, price movement and news alerts, social media integration, weapons-grade trading tools found today only for equities, cheap micro-transactions for tipping your favorite blogger (hint hint :D).... it's a whole new frontier. Nuff said.
To Other Trades
As if that wasn't enough, since cryptos introduce a cryptographically secure infrastructure independently validated by multiple nodes on a public network, there is even talk of using them as a vehicle for legal documents such as deeds and titles, replacing an entire layer of lawyers, brokers and middlemen. Just as exotic is a vision to create companies that exist entirely on the Internet with its own crypto representing shares of said companies, which can then be traded against other "traditional" cryptocurrencies.
Some may point to the Mt. Gox debacle and other lesser known exchanges being hacked as a reason cryptos will fail. To me these are just indicators of current industry immaturity. The Bitcoin protocol had a weakness which was fixed by designers, but not applied by Mt. Gox to its operations. As the technology hardens and "real" professionals build real businesses with common best practices around the technology, these problems will become fewer and farther in between (shoot - for all I know Mt. Gox could have stolen their own customer's bitcoins).
Some may point to Warren Buffet's comments as reason to stay away from cryptos. I respect his investing philosophies a lot and undoubtedly his track record, but for all things Internet, I would look elsewhere for advice in a heartbeat. By his own admission, he doesn't understand technology companies and stays away from them. If anything, the fact that Warren Buffet has heard of bitcoin makes it that much more interesting to me.
What I see as a major hurdle for cryptocurrencies is the cryptocurrency community itself. The fast, anonymous, unregulated nature of cryptos draws a lot of organized crime, scammers, hackers, money launderers and noobies. Businesses running exchanges, gateways, web applications or multi-pools need to be that much more vigilant and responsible for ensuring their users' safety and understand they are pioneers of something much greater than making quick buck. Joe Public needs to be that much more careful when traversing crypto sites which could be laced with malware, be leery of providing any kind of personal information and do enough due diligence before selecting an exchange or gateway. Crypto inventors should focus less on pump-and-dump schemes, and focus on innovations with real value and real problem-solving. The same is true for traders, speculators and investors. Only by building a more secure, faster, reliable, value-creation-focused platform will cryptos realize its full potential.
The next challenge is that incumbent industries threatened by cryptos will surely not simply roll over and die. Goldman Sachs's "All About Bitcoin" report estimates a $200 billion industry involved in payments and the movement of money, an amount that can be theoretically saved by consumers and merchants if they switched to cryptos. You can be sure companies like Visa, Mastercard and Paypal are keeping a close eye on things, if they haven't already mobilized aggressively to quell the threat politically, technologically or business-wise.
Another challenge for cryptos of course is government regulation and intervention. Some of their intent I'm sure will be honorable, such as regulation to protect legitimate users of cryptos and to persecute criminal uses of cryptos. Other intent will be more debatable depending if you believe in big government or not. After all, cryptos can debase a fundamental pillar of a government's strength, their ability to create and control money. The whole point of today's peer-to-peer cryptos is that there is no central bank or authority. Then of course there is the question of taxes. How will fast, anonymous movement of money be taxed as it circulates across all sorts of jurisdictional boundaries? My hope is government will be relatively laissez faire to cryptos, at least in its infancy.
The Next Killer App?
So are cryptos the next killer app? My guess is about as good as yours. What I do know is that despite challenges ahead, the technology involved and their applications hold tremendous, disruptive, earth-shattering potential. If you take the top 100 cryptocurrencies of the world today, their total market capitalization is only approximately $10 billion USD, a tiny fraction of the estimated $40 trillion (with a "t") worth of fiat currency circulating the world today, and an even smaller drop in the $225 trillion of estimated global wealth. If you believe in cryptos, it seems like we have only begun to scratch the surface of how this technology can transform our world.
* Photo credit: bitcoinmagazine.com