Most people have already heard of Bitcoin. However, very few know what it is or how it originated. Many people know that it is some form of “cryptocurrency” but only a few know what that term means. Those of us that spend time on the Internet are familiar with the term but do not know that Bitcoin is just one form of cryptocurrency – there are others. Also, a lot of people are familiar with PayPal and other online payment platforms but do not associate cryptocurrencies in the same way. There is a lot of controversy but there is also a sign that cryptocurrencies may be here to stay.
Let us begin by attempting to define cryptocurrencies. One could say that cryptocurrencies are a new asset class that enables decentralized applications. Others define it as an anonymous digital currency, untraceable and unhackable that operates without the need of centralized banks or government regulation. Yet, like other asset classes, it acts as a mechanism to divide resources to specific forms, organizations or populations and is like other asset classes in that they serve as a form of “bearer instrument.” For example, corporate equities serve companies; government bonds serves nations, mortgages serve banks and property owners – cryptocurrencies serve decentralized applications. So what do we mean by decentralized? Well, a decentralized application is a way to create a service that no single entity operates or controls. Since it first came into existence in 2009 (created by a anonymous internet entity know as Satoshi Nakomoto in 2008), people are apprehensive and fearful of its potential.
Without going into a long, technical explanation of the process, let us just outline some of the more important features. Unlike most currencies whose purchasing power decreases over time, Bitcoin was designed to be deflationary. In other words, there are a limited number of Bitcoins and new ones are sparingly added to the Bitcoin market. As a result, the price goes up when more people show up hoping to buy the existing coins, thereby bidding up their value. Now, on the down side, Bitcoins are very volatile and its “wild” volatility can be stressful for Bitcoin investors. Besides, Bitcoin investors do not need an existing banking system because the currency exists in cyberspace where investors (i.e., “miners”) use the power of their computers. During the process, these investors solve complex algorithms that serve as verification for Bitcoin transactions. Try to think of commercial airlines. Most airlines offer travelers reward miles enabling members to purchase plane tickets, hotel rooms, and other items using accumulated airline miles as virtual currency. Now, Bitcoin created by an anonymous computer programmer or programmers there is no tangible asset that you can touch or hold. For this reason, its value fluctuates in a highly volatile manner. But, it seems that virtual currency is becoming acceptable and that virtual currencies are being used to make purchases at retail stores such as Overstock.com, Tigerdirect.com, Home Depot, Kmart, and Amazon.com. (However it must be remembered, that Bitcoin is not a “fiat” currency with legal tender or status in any jurisdiction in the world. Moreover, the regulatory and enforcement actions of major governments including the US and Russia will not likely accepted is as such in the near future.)
Now, there are a lot of banks and governments uneasy about the growth of cryptocurrency. These currencies claim to be decentralized, peer-to-peer payments networks that are powered by users with no central authority or middleman*. This is the primary reason governments are frightened by cryptocurrency – no central authority. Also, fiat currencies are used by governments and they use banks to issue or destroy them using monetary policy to exert economic influence. In addition, governments dictate how fiat currencies can be transferred, that enables them to track currency movement, dictate who profits from that movement, collect taxes on that movement, and trace criminal activity. Control over a country’s currency has many downstream impacts, most notably a country’s fiscal policy, business environment, and efforts to control crime. Since governments “intentionally” increase or restrict the amount of currency circulating in an economy in an effort to stimulate investment and spending, generate jobs, and avoid out-of-control inflation and recession, control over currency is enormously important. When we consider the fiasco of the mortgage market of 2008-2009 in the US, dissatisfied customers everywhere began to question their support of such a system. Bitcoin users do not need the existing banking system. The currency is created in cyberspace and cyber payment is stored digitally and passed between buyers and sellers without the need of an intermediary.
Still, there is controversy concerning Bitcoin use and the “Dark Web.” There is considerable concern about cryptocurrency being used for purposes of terrorism. Unfortunately, links between organized crime and terrorism have been well-documented. Moreover, Bitcoin has become the prominent currency often used to purchase illegal goods on line such as weapons and drugs. The inter-connection between Bitcoin and the Dark Web popularized by organized criminals and terrorist organizations poses the most significant threat. However, in order for a cryptocurrency to become a mainstream financial system, it would have to be decentralized with adequate consumer safeguards and protections, preserve user anonymity without being a conduit for tax evasion, money laundering, and other nefarious activities, and gain widespread acceptance among consumers worldwide.
*Other cryptocurrency: Filecoin, Coinbase, and LocalBitcoins.
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