Recently there has been a resurgence of interest in cryptocurrencies coinciding with record gains in the original one—Bitcoin:
I first stumbled on cryptocurrencies back in 2013. That’s when I bought few bitcoins after a conversation with a friend in Copenhagen, Denmark. We had just finished a heavy Brazilian Jiu Jitsu training session and were driving back to the city. He was visibly excited about the technology. Not only he couldn’t stop talking about, but he was very intent on convincing me to buy it as well. I eventually relented and bought some bitcoins later that week.
At the time, I didn’t understand cryptocurrencies and had zero interest in them. I discounted them as “nerd money” that had no chance of mainstream adoption.
Fast forward four years, and my interest in this technology has grown by leaps and bounds. In fact, earlier this year, I sat down and learned everything I could about this technology by reading everything I could get my hands on. My humble conclusion is that it’s absolutely the best innovation since the Internet.
I came to that conclusion when I realized that bitcoin’s underlying technology—Blockchain—elegantly solves a lot of problems that were plaguing early forms of “digital currency.”
The first problem it solves is the problem of “double spending.” Anything digital is by its very nature is easy to duplicate. If I have a photograph, I can give it to you and, I unless I delete the original, I still have the same thing. Because it isn’t possible to give a piece of digital information to someone without the original owner relinquishing its control means that I can “pay” you for something and then with the same money pay someone else.
Bitcoin solves this problem nicely with the concept of value that’s either marked “unspent” or “spent.” Once I spend something, that transaction is no longer “spendable.” I receive the change (if any) and that’s about it. It’s now spendable to the person who receives it until they also spend it. If two transactions happened almost at the same time, the newer transaction is invalidated through a network-wide consensus (see below).
The second major problem that blockchains solve is doing all that without a central clearinghouse. Many things in our society revolve around a central authority that validates transactions between multiple parties. Banks currently serve this role. When I write you a check for $5, the bank first checks that balance is in my account before transferring the money to your account. The bank then withdraws the money from my account and credits your account.
Since bitcoin is based on a distributed network called blockchains, there’s no central clearinghouse. Instead, different nodes (computers) on the network take turns validating transactions and adding them to the blockchain (a permanent record of all transactions). The trick is that each specific computer isn’t chosen by anyone; they’re chosen at random based on which computer solves a difficult mathematical problem (called “mining” in bitcoin terminology).
This allows different computers on the worldwide network the chance to verify new transactions without a monopoly that certain computers or a group of computers are controlled by a specific authority.
Enormous apartment building
The best way to think about the blockchain technology (that bitcoin is based on) is to imagine a big apartment building with lots and lots of apartments. Each apartment is essentially a place where you can store money. When money is sent from one person to another, it’s not moved anywhere; only the keys are switched between the locks for each apartment.
For example, let’s say you currently have 5 bitcoins that are stored in apartment #113. When you send them to me, the system verifies that a) you control that money by proving you own the lock and b) you have 5 or more bitcoins. Following that, the system switches “locks” so that now my keys control those 5 bitcoins and not you.
The way you manage your transactions such as paying, receiving or viewing your balance is via something called a “wallet.” There are many different wallets for any platforms: mobile, desktop, hardware and even paper wallets (called “cold storage” because their keys aren’t exposed on the Internet). The purpose of a wallet is to securely store the private keys (i.e., the keys to the apartments) and determine which of the “apartments” out there are secured by those keys. Once a wallet knows the apartments where these coins are “stored,” they sum up the values and display your total balance.
The keys to the “apartments” are called “private keys.” Private keys should never be exposed to the public because whoever has the private keys controls the money. On the other hand, a public key is converted to a “bitcoin address.” These addresses can be shared with anyone because they serve as destinations for payments from others.
Here’s my address: 1MKHTkZhJGxSCaRw9N8W3oChHbTzUS5igu (In case you were wondering where to send a small donation.)
It’s crucial to understand that if you don’t control your private keys, you don’t control the money. This happened when people kept their bitcoins on some exchange without controlling the private keys. The exchange had their private keys and controlled their money. So, when the exchange stopped went down (for technical or criminal reasons), all the money disappeared with it.
Another key point that can’t be emphasized enough is that if, for any reason, you lose your private keys, you can kiss your bitcoins goodbye. They’re gone forever. Actually, they’ll still be floating out there recorded on the blockchain, but they won’t accessible to you or anyone else for that matter. In the short history of bitcoin, there have been several highly publicized cases where individuals lost many bitcoins (worth a lot of money today) through utter carelessness as a result of misplacing or destroying their private keys. A lot of those bitcoins are now worth a lot of money. That money is gone forever.
The power of the sovereign
I’m extremely optimistic about the technology for many reasons. The biggest reason: it’s your money and no one can take it away from you. You may think that your money is safe because it’s stored at a bank, but that’s far from the truth. Banks can easily limit access to your money for a number of reasons.
When I visited Ukraine a few years ago, my US bank blocked my complete account access because US imposed financial sanctions on Crimea. Even though I wasn’t anywhere near Crimea and had no intention of ever going there (I was in the capital, Kiev), my bank simply didn’t care and wasn’t willing to allow me access to my own money. Thankfully, I had access to other funds that I could use for my duration of my stay in the country.
If I had bitcoins, I could’ve easily exchanged them for the local currency. I have the private key, which means I have complete control to my money. No governments or corporations can tell me whether I can access the money or not. As long as bitcoin network is available (and it will be), I have access to my funds.
Another cool thing about the technology is that sending money to someone is easy and fast. I can send you any amount of money and you will receive it almost instantly. (Although, with the congestion on the network, you may have to pay a bit more in transaction fees for speed, the fees are still very affordable.)
Bitcoins can be exchanged into national currencies (dollars, euros, yen, etc) called “fiat” through exchanges. As of the time of this writing, 1 bitcoin is worth approximately $4,300. This is done via online or offline exchanges around the world.
The pillar of stability
When I tell people about bitcoin, their first reaction is usually indifference. They wonder the point of having another currency or get paid in another currency when it’s not backed by anything or sanctioned by the state. And, additionally, when you must always trade your bitcoins into government-issued fiat anyway.
First of all, contrary to what many people think, the dollar is not backed by anything either. It was taken off the gold standard back in 1971 after the spending and the printing of the dollar as a result of the Vietnam War made the fixed exchange unattainable.
As more dollars were printed and flooded the economy, and no additional gold was mined, each quantity of gold automatically commanded more dollars, more than the US government was willing to exchange them for. So, to solve the problem, the central bank broke the dollar/gold peg, which resulted in the dollar being worth whatever people thought it was worth in terms of gold or other currencies. Naturally, other currencies and gold gained value in terms of dollars.
Dollars aren’t printed by the US government. They’re printed by a quasi-government part-public/part-private central bank (The Federal Reserve) whose interests are closely aligned with private banks. Entire national economies expand and contract depending on how much money is printed and the central bank’s lending rate. Furthermore, during the height of the European debt crisis, most of the bailouts to foreign countries were actually governments bailing out failed banks so that those are able to pay back what they owe to the banks in the countries that they were bailing them out.
Because bitcoins aren’t controlled by a central authority, they can’t be printed at whim and used for bailing out failing institutions. Bitcoins enter the economy in a predicted fashion as a reward to “miners” who’ve solved difficult mathematical problems. In this way, Bitcoin represents a hedge against the inflationary risks of the dollar.
As Yuval Harari explains in the Sapiens: A Brief History of Mankind, currencies are no more than belief systems. Why is everyone willing to accept dollars for their goods and services? It’s because everyone in the world believes the dollar is worth something now and will be worth something tomorrow thanks to the economic might and political stability of the US—and, most importantly, because a dollar is truly a worldwide currency: a shoe repairer in Tajikistan or wine cellar in Argentina will still accept it in lieu of their national currencies.
In countries where the governments continuously abuse their currencies such as Argentina, Venezuela, Zimbabwe and others, the belief in the currency has all but eroded. For large ticket items, people choose to only transact in dollars (or euros). The existence of the currency black market in the country means the official rate set by the government is completely out of touch with reality that it should be ignored.
But even hard currencies such as dollars aren’t without their faults. They’re inextricably tied to politics and the elites. They’re used as weapons in currency wars (by being devalued to strengthen the country’s exports on the world markets). They’re also inherently inflationary in order to benefit the spenders/investors at the expense of the savers. They shape entire national economies and even influence international economies by controlling their demand and supply by setting the interest rates that stipulate the cost of money.
In the same way that dollars keep corrupt currencies honest, bitcoin is keeping the dollar honest. Similarly to gold, which cannot be mined at whim or easily transportable from one place to another, bitcoin represents a safer and more secure way to store value. Assuming the network’s technical implementation continues to support increased transactions, the rising value of bitcoin vis-a-vis to the dollar represents the stronger belief in the cryptocurrency.
Markets keep governments honest. The collapse of the Soviet Union was in many ways the triumph of decentralized capitalistic markets over centralized government planning. When a country’s currency is being heavily debased by corrupt officials resulting in a decreased purchasing power and culminating in the complete loss of confidence (e.g., Venezuela), the demand for dollars goes up and exchange rate adjusts to reflect that. If the government tries to intervene with the inflow of dollars (capital controls) or outright abolishing of local exchanges, the exchange doesn’t simply disappear into thin air—it goes underground.
In the end, it comes down to having a choice. Let the people decide. Let the markets decide. This is why I’m super bullish on cryptocurrencies and their potential to completely disrupt traditional systems that exist today. If people lose faith in the dollar because they feel the central banks are manipulating it to serve their narrow needs, they’ll store their funds elsewhere and cryptocurrencies like bitcoin will go up in value. On the other hand, If people lose faith in cryptocurrencies and prefer the security and stability of the dollar, they’ll sell bitcoins and buy the dollars. The freedom to choose.
Ultimately, there’s simply no feeling out there like knowing that you have a wallet of funds that only you can access and spend as you wish, anywhere and anytime without banks or governments getting in the way.
Let’s try a small experiment. If you enjoyed this article, send me a small donation to 1MKHTkZhJGxSCaRw9N8W3oChHbTzUS5igu. In exchange, I’ll send you a rough table of contents of a new book that I’m working on plus I’ll get your personal input about future topic ideas for the site. (After sending bitcoins, send me an email, specifying the exact bitcoin amount that you sent so I know it was you.)
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