Bitcoin, Cryptocurrencies, Blockchain… What are these? Should you care?

March 19, 2021

Lately, there has been a lot of noise on Bitcoin and other cryptocurrencies such as Ehtereum, XRP, Dogecoin, and Blockchain. Let's take a look at them one at a time.

Blockchain Technology:

I am starting with this because, this is the underlying technology on which all crypto-assets (including Bitcoin and other cryptocurrencies) are built upon. It is essentially a digital ledger of transactions that is replicated across the entire network of computer systems by so called “miners”. Because the transactions are entered in so many computer systems, it is very hard to tamper with, making it extremely secure.

This technology has promising use-cases from recording financial, property, art and many other forms of asset transaction details. This could be the foundational block for future digital currencies backed by regulatory authorities like Federal Reserve System (‘Fed”) in US, RBI in India, Bank of England in UK and other central banks in different countries.

However, one of the most important aspects of this technology worth noting is that, it is “Open Source” i.e, anyone can spin off another crypto-coin (just like bitcoin) if they chose to, there is little barrier to entry.

Now let's get to the main point of focus today, cryptocurrencies.

Cryptocurrencies: Bitcoin, Dogecoin, and twenty other popular ones:

Cryptocurrencies are not much about technology, but are more a medium of exchange for money. They are not backed by any regulatory authorities, with this in mind,

Cryptocurrencies have two main utilities:

1. Efficient currency converter: That is if you want to send some money from US to someone in Japan, you can do so very efficiently with a very low cost of transaction. Today it goes through several banks and uses infrastructure by companies like MasterCard and Visa.

2. Stored value in countries with highly unstable governments/currencies: In the past, in countries where the government and/or currencies are so unstable, generally, people would store their wealth in land or precious metals like gold. Here cryptocurrency may have a role to play. However, it won't have a major role in stable countries like the US. That said, in US right now it trying to evolve from exchange for niche goods to mainstream, for that it needs to be stable and the wallets must be connected to real people (otherwise it could end up in facilitating money laundering, which governments won't be thrilled about!).

If you look at the market size for the first use case, it is similar to that of Visa or MasterCard, which we are all very familiar with.

On the second use case, the main issue with this is that there is no barrier to entry for any one cryptocurrency to dominate, i.e, a new player can spinout a new coin anytime they want as the blockchain technology is open source. As it is you can see there are many popular coins. There is absolutely no scarcity!

This shows it is a commodity! Especially when so much money is involved it is bound to attract many more coins. Therefore it would lead to the creation of many more new coins till it settles to the lowest cost network; and at some point these coins may trade with each other, which would again breakdown the monopoly position of any one coin. Therefore the value the coin must collapse to the lowest cost provider as per the free market rules!

Lastly, as of now, it has no intrinsic value, and its price can go up only when someone else pays more for it.

With this in mind, if you take current Bitcoins value ~$1T, you must ask what does it take to build several networks equivalent to this, it would be much less than $1T, the collective realization of this fact would result in a significant decline in its value. Hence as of now, cryptocurrencies is a pure speculation and NOT an investment, however blockchain technologies can be investments!