Long before I get to trends I see in cryptocurrency development I want to write some foundational posts on the basics of what this new asset class entails. I consider cryptocurrency innovation that solves problems with the current monetary system, mainly transactional security, inflation, and settlement issues.
This one is a simple primer on blockchain. Blockchain is thrown around as a buzzword in financial and industrial circles, yet few understand the concept and how it functions. Though I’m not a technologist, I’ll offer a very simple, perhaps simplistic, explanation. From here I can build on some inevitable questions that will come my way:
‘Blockchain is great, but do we need cryptocurrency?’.
‘Isn’t this a solution, trying to find a problem?’
We’ll get to these questions, but let’s explore some basics.
At a core level, blockchain is a public ledger. It is a list of debits and credits in the account addresses on the network. Those transaction may carry a value or it may carry data. All of those transactions are strung together in encrypted blocks, which make up a chain.
As mentioned, blockchain is public. While the person behind the address may not be known, their holdings, which are less a value, than a series of transactions with value, are known.
The system of ownership in blockchain is key to understand. Every address has a public key ,viewable by all, and a private key known only to the user, unless compromised. She that holds the private key has ownership of the transactions in the address.
Whereas in the centralized banking system, your assets are tied to your identity and documentation (KYC), in blockchain your key is all you need. This key can only be decrypted by using a blockchains cryptographic algorithm (SHA256 for Bitcoin), and that would take more than ages with a typical computer.
Of course, this puts the security responsibility on the owner. As is said in ‘crypto culture’, ‘With crypto, you are the bank’. That makes you also the bank’s cyber security department. Though an important distinction must be made when your funds are on a service like Coinbase. In that situation, they hold the keys and they are the bank. You have a user name, password, and authentication in order to access them. And, with some you may have done KYC.
It is here that we find the libertarian roots of cryptocurrency, as it provides a system of fungible value, with a transparent inflation rate that is coded into the blockchain, and one that allowed divorce from the risk of the centralized banking system. Further, one can walk across a border, download a wallet app and enter your keys to retrieve your assets. Assets on the blockchain are therefore borderless. Your funds are available to you as long as the lights remain on for the internet.
Here is an example of a Bitcoin private key (fake):
When a transaction is broadcast to the network, the transaction requires the public and private key as shown below. This is usually done with the help of a wallet app.
Transactions on a blockchain are authenticated, and added to the blockchain through processes called ‘proof of work’ (often called mining) and ‘proof of stake’ by computers sync’d to the blockchain’s network. I will discuss the difference between these at a later date. Participating in either process is an opportunity to gain income which I will discuss.
Note that one can philosophically divorce cryptocurrency from blockchain, but blockchain Is still a ledger, and therefore a list of transactions. Let’s explore the forming of a new blockchain where the transaction are not technically value, but rather data. In this situation, I propose we transfer digitized pictures of cute bunnies. Yes, I think many will take great interest in such a concept. If you have private keys to an address, you are able to decrypt these pictures of cute bunnies and do something with them. For example, you will be able to download them, and print them on sticker paper to make bunny stickers.
And, of course you can share those cute bunnies with friends by sending them to their public addresses. With their private keys they can enjoy them as well.
But happens, when someone starts to consider that these bunny pictures have a value. We may soon discover some entrepreneurial character selling those cute bunnies on the web. They may even get them listed on a cryptocurrency exchange. Suddenly those cute bunnies are a trade-able asset- for other cryptos, and even fiat.
You see, the value of cryptocurrency is established by a believing market, exercising sentiment. In the end of the day, one purchasing bitcoin is simply purchasing the latest end of a series of ledger transactions.
While I can agree that blockchain can exist separate from a concept of monetary value, and there are use cases where this is true, one cannot control the mind of the market. What started as a technological exploration borne of libertarian values, has taken on a mind of its own. And, the usefulness of blockchain now transcends those original values. Sometimes we’ll see the market ascribe value to certain blockchains and their transactions This is how we get cryptocurrency.
As we move forward I’ll talk more about use cases. I believe blockchain is a useful technology, and sometimes the use cases demand a native means of exchange or value. Drawing from the mindset of behavioral economics, I believe utility has value. So, it is natural to me that the market ascribes value to these transactions naturally.