What Do Cryptocurrencies Mean To The Common Man? Why Should He Care?
Bitcoin is the original and the most valuable cryptocurrency which was launched in 2008 and pioneered this whole asset class of virtual currencies
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What are Virtual or Crypto Currencies?
Crypto currencies are currencies introduced by parties privately, without the permission of governments, and which function as substitutes for fiat currencies. Some tokens and coins may not serve the function of currencies.
Practically, cryptocurrency has come to mean a new form of wealth, a new globally valid form of currency.
Cryptocurrencies can be seen as a new class of asset - in addition to the familiar standard assets such as stocks, gold, silver, real estate, cash, and intangible assets like personal reputation, brand, intellectual property.
The fascinating thing about cryptocurrencies is they can combine some characteristics of above standard asset classes and can also introduce some new features on top.
A Fiat Currency (or national currency like $, £, CHF, INR etc) is issued by one single institution - say the country's government or ruler or their central bank, and is meant for public to use in trade and commerce. Fiat currencies usually serve the purpose of being a tool for exchange of goods, services, or payment of taxes or indeed anything of value, within the country's borders as well as outside. There is an exchange rate for every pair of currencies to convert one fiat currency to another.
Technically speaking, cryptocurrency is just a piece of computer code or an encrypted message transferred between two parties. In USA, sending of private messages falls under the constitutionally protected freedom of speech so bitcoin cannot be banned by the government. Even if a dictatorial government bans it, it is impossible to implement the ban, so it is a futile exercise in attempting to control the uncontrollable.
Who controls crypto currencies?
No one. The code controls it. Someone can only control it to the extend they can alter the code which runs the algorithm of supply and consumption.
As opposed to fiat currencies, whose supply is strictly controlled by the central banks of each country, virtual or crypto currencies are minted, published or distributed privately by individuals or firms. For fiat, you are trusting the governments not to intervene in ways that harm the currency's value, and for crypto currencies you trust those mathematicians / developers who create its code.
Privatisation of money is the core concept behind cryptocurrencies, just like privatisation of airlines, banking, healthcare, education, insurance or chit funds etc. Though privatisation of money was already achieved earlier to an extent by Paypal, it was still within the control of Paypal. Paypal could still refund money to the buyer if he disputes the value of goods received, or paypal money may still get stuck within paypal without reaching the beneficiary even after it leaves your account. So Bitcoin introduced decentralisation feature to the privatised form of money, which means that not only can we transfer money peer to peer, but also it is recorded on a globally distributed database, which is an irrefutable record of transactions, even more unforgeable and robust than a bank's record.
What determines the value of crypto currencies?
As opposed to companies and shares that are valued by investment banks based on discounting cash flow methods etc, the value of crypto currencies is purely derived from future expectations of popularity and use of the currency, the gap between supply and demand, and the network effects of the closed economy which uses the currency. Currently future expectations far exceed whatever has been delivered by blockchain. Supply is far exceeded by demand, and network effects are growing wildly for strong currencies like bitcoin and ether, which explains the huge price appreciation of most crypto currencies. The initial value of a currency set by its creators is arbitrary and almost immaterial, because there is no inherent value at the beginning, and it is not pegged to or derived from anything concrete, anyway. Therefore buyers purely go by percentage appreciation of prices, rather than the beginning value.
Why are crypto currencies important?
Bitcoin is the original and the most valuable cryptocurrency which was launched in 2008 and pioneered this whole asset class of virtual currencies. Bitcoin is the underlying crypto currency for the most widely known blockchain - the bitcoin blockchain. Ether is the second most valuable and popular cryptocurrency, which is also the token used in running its underlying blockchain - the ethereum blockchain - which supports the creation of a new form of code called smart contracts. Smart contracts are agreements between two parties or two institutions that can be executed automatically by computers or machines and do not need human intervention for the completion of the contract. Typically, there is also an exchange of financial value in smart contracts. This happens through the transmittance of a token via the blockchain, simultaneously along with the execution of the computer code. There is no time lag. So crypto currencies for the first time introduce a fool-proof way of sending and receiving value between two parties, without the need for banks or middlemen or other financial institutions such as post offices to make that transfer. This value can be anything - from a bitcoin to a digital asset , a token representing a piece of land or ownership of a patent. This is revolutionary in the history of money, wealth and economics.
Now the recent crop of innovators are building next generation applications on top of ethereum and bitcoin, and indeed some altogether new parallel protocol layers that can be alternatives to bitcoin and etehreum and also the traditional infrastructures we have seen across industries such as banking. For example, cryptocurrencies can create novel inventions like - a new data storage alternative to google and dropbox, or gold backed coins, or payment mechanisms to refugees that do not have bank accounts, or an alternative global stock exchange to NASDAQ like we are proposing to do with Himalaya Capital Exchange, This would mean more benefits to the users in the long run, and more direct control and more empowerment. Societies will take on the role of administering fairness and justice in these distributed economies. Crypto currencies are just an enlightened, and advanced avatar of shared economies we see today such as Uber, AirBNB, SoundCloud, Kyuki etc. Crypto currencies can be seen as the force to democratise most things, without relying on the clout or goodness of rulers or policy makers to act in citizens' best interests all the time. So, the are a hedge against institutional corruption.
Will crypto currencies replace fiat currencies?
No. Crypto currencies are an irreversible trend, and a worldwide phenomenon. But Mass adoption of anything takes many decades and old systems will co-exist with new while the population adapts to new technology.
In order for currencies to have a mass adoption or a broad appeal, they must meet a few criteria. These are Unit of Value, Medium of Exchange, and Store of Value. While Gold can be a good Unit of Value, and a good Store of Value, it is not a good medium of exchange because it is not easily divisible. While US Dollar or Rupee is a good Unit of Value and a good Medium of Exchange, it is not a good store of value because it is subject to inflation and suffers from deprecating value meaning Rs10000 could buy a lot more 10 years ago, than what they can buy today, as compared to Gold. Currently, bitcoin and the entire cryptocurrencies class suffer from too much volatility and bullish sentiment on price appreciation, which prevents it from being a good Medium of Exchange. So though it is infinitely divisible as compared to Gold, it still cannot completely replace fiat currencies because people do not freely use bitcoin to buy essential items. Think of demonetisation times. If you can only withdraw limited cash everyday, you would want to ration paying for goods with cash and use other means of payment as much as possible. This is happening with bitcoin now.
Should common man invest in crypto currencies?
Because the way these markets operate is highly technical, unless you are a developer or a savvy crypto investor who has been following the markets avidly, the potential for scam is high - as seen in the example of Amit Bhardwaj who promised 10% monthly returns on Bitcoin and fled the country with Rs2000 crores of investors money. While true blue innovations will fetch huge returns far in excess of other asset classes, because of the nascent stage of the industry, a common man will not be able to discern between a fraud and a genuine innovator. Govt of India has only said bitcoin is not legal tender, which it is not in many developed countries like UK, Europe, China too. It being not legal tender, does not make it illegal in India. So, even though bitcoin can be traded and speculated upon, only sophisticated investors who can stomach the risk of losing all crypto portfolio must speculate and others should stay away from active trading until they understand the risks better. Like all other risky class of assets, the risks as well as the returns are high. But, it is a sunrise industry and therefore a golden opportunity for anyone that can get upto speed on this new economy.
What should the Indian Government do?
The SEC testimony on virtual currencies of Feb 2018 admitted that governments would be foolish to keep away such cutting edge innovation. Reasonable governments worldwide such as Switzerland, Japan, France etc are laying down clear guidelines for issuers of cryptocurrencies with a view to encouraging new issues, while minimising potential for fraud. The idea of floating a central bank run cryptocurrency defeats the purpose of a decentralised currency and is antithetical to principles of distributed economies. It is a pointless exercise! India and the Indian Government are both laggards in blockchain and cryptocurrencies. There are tokens which do not compete with fiat. They are similar to a smart phone app and are equally non-thereatening! The Govt would do well to keep an open eye and learn from other countries and take advantage of this once in a life time strategic opportunity to leapfrog many other nations. India has the numbers and the youthful talent required for industry wide disruptions, which other countries lack. Indian entrepreneurs can avail of the Initial Coin Offering (ICO) to access huge international capital which does not cost the country anything! India should conquer its fear of the unknown with knowledge, and educate its youth on a war scale on blockchain technologies, and make blockchain and cryptocurrencies its soft intellectual weapon for the coming century!
Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.