The rise of cryptocurrencies — Why do they exist in the first place?

The concept of cryptocurrency as one of the most important use cases of blockchain technology was created in 2009. Ever since it was conceptualized, it has taken over like wildfire as people believed that cryptocurrency could solve many problems associated with today’s financial system. In order to really understand what difference can cryptocurrencies make, we just need to really understand the concept of money again in a way we have not thought about it before.

Concept of Money

Gold has historically been the most trusted means for exchange of value for goods and services. People were comfortable with gold as it is a finite resource and the more gold is mined, the more scarce it becomes. This helped gold retain and appreciate in value. As time progressed, carrying gold for transactions became cumbersome. This was when governments would exchange gold for paper currency that could be easily carried and spent (much better than breaking a gold bar into thousand pieces to buy apples, right?). The paper currency acted as a proxy to gold with people beginning to trade in paper currency knowing that gold was the underlying. If you ever wanted your gold back, simply take your paper currency back to the bank and claim your gold. This led to a transfer of trust from gold to paper bills as a valid tender.

With rapid macroeconomic changes, governments slowly transitioned from backing paper currency with nothing but a promise. Simply put, the value of the currency held by people now depended on the economic progress of the country. Realisation crept when slowly the currency trust model built on a strong underlying has now shifted to a central authority. This type of money is called fiat money. Fiat is a Latin word which translates to by decree — means giving legal status to paper currency by a central authority, in this case the government. If you trust your government, you can trust their currency.

Drawbacks of Fiat money

Now that you are wiser about fiat money, you should know that it comes with its fair share of drawbacks as listed below.

1. Centralized control — The value of money depends on the economic performance of the country issuing it. Venezuela and Greece are examples which show that when macros worsen for their governments, the currency lost value. Moreover, during the 2008 crisis, the US Fed printed $700 billion to bail out most of the banks, regardless of monetary demand-supply situation. In 2016, India decided to withdraw legal status of Rs. 500 and Rs. 1000 notes overnight making money inaccessible to millions of people.
2. Unlimited supply — Governments can print as much currency as they want if they want to increase the money supply in the economy. When excess currency floods the market, the value of each unit currency drops. We commonly feel that prices rise with time but in reality, it is the purchasing power of each unit of currency that keeps dropping, making you spend more money to buy the same thing.
3. Double spend problem — With technological advances, we have more and more digital money in circulation by way of credit cards, online bank accounts, wire transfers, etc. The amount of physical money in the world is decreasing at a rapid pace. Now how does digital money work? Banks maintain a ledger that records who owns how much. You trust the bank and the bank trusts its computer. This arises a risk of double spending, which means spending the same digital money twice. A digital transaction is nothing but a file or a record which can be reproduced multiple times by savvy individuals who can manipulate systems. In 2017, Wells Fargo unearthed 1.4 million fake bank and credit card accounts created by employees that were used to form a network of duplicate transactions to inorganically boost revenues without their customers knowing about it for years. Now something like this is not possible with physical currency: if you spend $20 at a grocery store, the notes are locked with the cashier making it impossible for the same $20 to be spent again unless one decides to steal it somehow. But with digital currencies and our reliance on banks and their systems, this problem persists.

All of the above problems,especially the 2008 financial crisis, called out for a need of a system for issuing and banking of currency without the need for an centralized intermediary. Then finally, in October 2009, a man or a group of people under the name Satoshi Nakamoto floated a white paper that talked about a peer-to-peer decentralized system that can substitute the current financial system using blockchain and cryptography to eliminate problems such as double spending. They called it Bitcoin.

Bitcoin vs Bank — A comparison on how Bitcoins are superior

• Bitcoin is transparent

Since most money nowadays is digital, the bank manages a ledger of transactions. The ledger is not transparent and is stored on a central computer, making it inaccessible for anyone. Bitcoin on the other hand has a transparent ledger, one can literally see a record of transactions that have taken place. The only thing you cannot determine is who made these transactions making it pseudo anonymous. The first ever transaction made using Bitcoins was in 2010 when a man named Laszlo Hanyecz purchased two pizzas by spending 10000 Bitcoins. This is how the transaction appeared in the Bitcoin ledger.

The transaction at the bottom was made to buy two pizzas in 2010. Those Bitcoins are worth $500 million today.

• Bitcoin is Decentralized

Unlike a bank which uses centralized servers to manage transactions, there is no one computer that holds the ledger in case of a Bitcoin. There are multiple computers or nodes that participate in the system, each storing a copy of the ledger. Hence, if someone decides to take down the system or hack it, they will have to target thousands of computers which are participating in the network. Banks meanwhile spend millions of dollars annualy on cyber security and are still vulnerable to data leaks or ransom attacks.

• Bitcoin is digital and cheaper to use

You cannot touch or hold Bitcoins, in fact there are no actual coins. They are merely rows of transactions and balances. “Owning” a Bitcoin means having the right to access a specific Bitcoin address in the ledger and using it to send funds to another address. These transactions cost lesser than a wire transfer, thereby cutting the middlemen (banks).

All this means that we now have an alternative to the traditional financial system that no bank or government can control. Moreover, Bitcoin or any other cryptocurrency gives 2.5 billion people in the world access to digital commerce who currently do not have access to banking.

Congratulations! If you have reached the bottom of the article, you now know and understand cryptocurrencies more than 99% of the people. As you can see, above all Bitcoin was designed with one thing in mind: To provide you a secure and private way to gain back control over your money.

Happy learning!