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Understanding cryptocurrencies : A crash course

13 Dec 2020

By Patrick de Kretser Perhaps one of the biggest stories in the economic world right now centres on the subject of cryptocurrency. In particular, Bitcoin, which was the first major cryptocurrency that was created back in 2008 and launched in 2009. What Bitcoin is and the role it plays in today’s world was a question that I wanted to seek the answers to. For that reason, I sought the guidance of a close friend of mine who currently studies economics at the Royal Institute of Colombo. As an economics major, the subject of cryptocurrency is probably one that comes up fairly frequently, which is why Yohann Gunatilleke seemed like the obvious choice for me to sit down with and discuss this fascinating subject. I chose to ask Yohann a series of basic questions about Bitcoin and how it operates, with the hopes of getting some answers that can help many of us understand, on a simpler level, how the trading world operates with virtual currencies. Whether you study economics at a school level or university level, or whether you do not even study the subject at all or might be considering it in the future, I am sure you will find a lot of insightful information about the payment network that you can use to your benefit on an academic level. As a disclaimer, I would like to point out that neither Yohann nor I support the use of Bitcoin yet nor are we trying to use this article to encourage people to start using it. This article is purely based as an academic evaluation of the subject, written purely for the interest of those that study economics and to shed a bit more light about the virtual currency network which we still know so little about despite the fact that Bitcoin has existed for 11 years already. What exactly is Bitcoin? How does it work? According to its creator’s definition, Bitcoin is described as “a purely peer-to-peer version of electronic cash that would allow online payments to be sent directly from one party to another without going through a financial institution”.  Bitcoin works by processing all transactions on a shared public ledger known as the “blockchain”. This allows users to verify incoming and outgoing payments by referring to the chronological order of the blockchain, therefore providing security without the involvement of a third party. Transfers of value between Bitcoin users get included in the blockchain. Bitcoin is then stored on what is called a Bitcoin wallet which is basically an app or programme on your phone or computer.  Economics students will certainly come across the term 'cryptocurrency' at some point. How exactly does a virtual currency fare in today's world in comparison to tangible currencies? I think the current status quo is a perfect backdrop for why I believe that cryptocurrencies such as Bitcoin can be a valuable asset compared to fiat currencies. Take the US dollar for example. Due to the endless stimulus that has, granted, been necessary to hold the US economy together during these trying times, the US dollar has sunk to the lowest value it has been in decades. Plus, with the endless money printing and inflation, the reduction of purchasing power is a real worry. We depend on our governments and third parties like banks and financial institutions to uphold our financial system. This means that regardless of our say in the matter, we need to acknowledge the fact that there are parties that are also motivated by self-interest such as profit and power. Bitcoin bypasses this issue because firstly, there's a limited supply (21 million) that will ever exist. So in terms of value, there is some assurance that Bitcoin can be a store of value compared to fiat money where supply can be increased on a moment’s notice. Furthermore, Bitcoin’s blockchain is fully democratised and decentralised, which means that no single party can alter how the system works. This completely removes the element of needing to trust anyone but yourself when it comes to finances. As you can see by Bitcoin’s popularity, a lot of people want the liberty of being able to use their money freely without the restrictions imposed upon them by governments and banks. What makes Bitcoin stand out from other cryptocurrencies like it? Is there any real difference? Bitcoin was the first cryptocurrency to be created back in 2009. The main innovation that sets it apart from other cryptocurrencies is that the sheer amount of computing power dedicated to maintaining and securing its blockchain (a process called mining) completely dwarfs any other cryptocurrency. It is a system that hasn’t failed thus far and has continued to improve with time. The infrastructure behind it is solid in my opinion and next to impossible to take down. So compared to other cryptocurrencies, Bitcoin is a lot safer. Plus, greater adoption means that there are more uses of it for things like transactions and so forth. Other cryptocurrencies also differ in how they are programmed which supposedly make them better or worse than Bitcoin on paper. But honestly, I wouldn’t know enough about coding to go into detail. My basic principle is that Bitcoin very clearly works and has continued to work for over a decade. Is it harmful? How should the next generation approach something like this in today's market? It can be harmful of course – but so can cash. People can obviously use it for nefarious purposes just like they can with cash. I think at the end of the day, the hardest thing to trace is real money. Bitcoin on the other hand is traceable, even though many people may not know about it. Like I mentioned earlier, the blockchain stores all valid transactions that happen with Bitcoin. This means that it is all public information. So although you may not see my name and address, if you know the code of my online wallet, you can look at every transaction that I have ever done. Law enforcement in the US have on many occasions used information from the blockchain to track down criminals that use Bitcoin to make transactions. I think it's important for people to just be aware of how these things work. There's so much to cover which can be a daunting task. But if you are interested, it is definitely worth researching. There can be a lot of Bitcoin and other cryptocurrency-related scams as well. So as a rule of thumb, it is super important for traders to never give out their private details to anyone on the internet. Where do you think it'll go from here? Is Bitcoin becoming the next big superpower in the world economy? Or is something else due to replace it? I think mass adoption is definitely on the way. Many big names in Wall Street and around the world, in the last few months, have come out in support of Bitcoin as a valuable asset. Paul Tudor Jones went as far as to call it a “hedge against inflation”. PayPal has also announced its plans to bring on Bitcoin on its platform early next year as a valid means of exchange. I think people are definitely starting to notice that Bitcoin isn’t going away anytime soon and adoption will follow suit in my opinion. As for it becoming a “superpower”, I really can’t say. We will have to wait a few years to find out! PHOTOS Forbes, Coin Revolution, NewsBTC, Yohann Gunatilleke


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