Trying to Understand Cryptocurrency
Over the last decade plus, there has been an emergence of a technology that has very interesting long-term prospects. As of today though, the technology has created a very divisive social atmosphere around it. Some live to invest in this tech, other choose to hate it. Now in this article, I will NOT say which side I think is right but I will attempt to explain how a crypto works in layman’s terms. This is NOT a solicitation to buy or sell crypto, think of it more as a article attempting to identify some of the interesting developments and drawbacks of this asset class.
First off, what is a cryptocurrency? They are essentially digital “tokens” you could say that have Cryptography built into it. Well, what is Cryptography? Cryptography is the study of secure communication techniques that only allow sender and recipient to view the message. The idea of cryptography is used via email daily, and is the basis of Security Companies operations. The companies work on ways to “encrypt” data so others can’t access it.
When we get into the cryptography of crypto is when things get interesting. For example, we will look at Ethereum (1). The Ethereum network does NOT run on a central database, but thousands of computers around the world (creates less risk of environmental threats to the network, so think of this as insurance for no downtime). So, think of the database as a link of all the computers. The database is where all the transactions are processed and verified. To access the database, you are given two things. 1. a private key (TO BE KEPT PRIVATE). and 2. a public key so the codes verifying transactions can see who did the transactions. Think of the public key as your signature & private as maybe like a password. The signature generates a long line of code (256 bits) that is UNIQUE and is generated by entering your private key. Basically, this is your encryption. No one can access your wallet through math, they have to literally guess the private key. The math of guessing it is 2^256. This is a number with 77 digits behind the first. For reference 1 trillion has 9 digits behind it. I would say this is a secure strategy. The drawback of this is if you lose that private key, you can never access the funds. So basically crypto is relying on the individual taking responsibility over a company or other structure. Now how could someone verify the transaction was me without getting my private key? Because the combination of your private key being right is what generates the proper public key for your account. To learn about this, take a look at the video in the references section below (2).
Now who or what is verifying these transactions? In the etherium network, people will “stake” their coins onto the market. Think of this as a deposit. Once you deposit enough capital, you can be vetted & then allowed to help verify the transactions being done. In a well-managed crypto, this pool of people expands. The more unique individuals verifying transactions, the less of a chance for someone to gain control of this process to manipulate it. To have a transaction verified, 2/3’s or more of the people verifying the transactions have to approve of it. If you have 1,000 unique verifiers, then the network would require 667 or more of them to agree on the outcome.
The most influential idea behind people investing within crypto is the idea of “decentralization”. How is crypto decentralized? Think of what I said in the last paragraph. Now do you think that our currencies today work like this? Far from it. Also, the number of coins that exist on good cryptos seems to be based on an algorithm not a person or country. While a government has the power to create currency whenever the “need” for it arises, a well-managed crypto has no centralized power to do so. One thing to keep in mind is some of these currencies have a supply that is theoretically unlimited. Keep an eye on this if you are thinking of investing. This is one of the most interesting traits of bitcoin, there literally is only a certain amount that can ever be created (as far as my understanding goes). A drawback of bitcoin in the future could be its simplicity. Although, it could end up being the opposite as well (meaning maybe Bitcoin will benefit because of how simple the workings of it are).
A HUGE drawback within crypto today is the people creating cryptos with no ethics involved, and this is running rampant. I read a fact a few years ago that there are more crypto’s trading than there are stocks on the New York Stock Exchange. Now you could say that some of them could be fun to mess around with, but to be quite frank with you I believe almost all of these will be worthless. Why? because of the actors who created them. All of these cryptos market themselves as “decentralized”. But how can something be decentralized when the creators own the bulk of supply? It’s because they are not decentralized, just centralized by a private individual. This is a great sign of a pump and dump scheme. They market themselves for example as the “Bitcoin Killer” but in reality, they are just destroying peoples’ wealth by putting it in their own pocket. When this ends, I believe that the good cryptos will also decline in value but the best ones will outlast it.
This is not the only negative, the costs are too. As crypto markets have developed, the demand has outstripped the buildout in computing power to verify the volume of transactions. This has led to the costs of each transaction increasing immensely. Think of a pipe, there is only so much liquids that can be forced into the pipe in a given second. Our Stock Markets work like this too, although the Crypto Market has felt more pressure due to it having a smaller pipe today. People are working on expanding this theoretical pipe, but it will take time.
Another drawback is the current culture around the cryptos. This point is more directed to developed nations than developing nations. Some argue these cryptos as inflation hedges, but the phycological story shows something completely different. For example, in the US, I have yet to hear someone in conversation discuss their thoughts on why they own crypto besides some statement like the following:
“Blank” cryto is going to “blank” price in “blank” MONTHS (not years)
Dogecoin is GOING TO HIT $1 (Bitcoin $100K by end of 2021)
NFT’s are the BEST WAY TO INVEST IN THE FUTURE
Now when I hear someone say they knooowww what will happen probably means they know next to nothing. When someone is basically “praying” for the price to rise, then what is everyone else doing? Probably something similar. When someone says a drawing of this ape is worth hundreds of thousands of dollars, others get jealous that they don’t own it and try to find the next “great crypto rise”. These are all signs of people just wanting to sell something for a higher price than they bought it for. This is not an investment, this is gambling. Now there are fundamentals on the scalability in the Long-Term, but today the market of cryptos is not looking for the signs of fundamentals developing. Most look at only the price.
Now these are not even close to all the positives and negatives, just some that have stood out to me. I am far from an expert in this field, but I am trying my best to understand it. Overtime, I am sure my grasp of the concept will expand. My understanding today is crypto (if executed correctly) could be the most influential change in the economics of money in human history. If the crypto is truly decentralized and is adopted by a large majority, it could lead to something that not only people in one country trust, but most if not all countries. Out of the box, but maybe the foreign exchange market changes from a centralized currency being the reserve currency (USD today) to a decentralized one so other countries are not as effected by another’s Monetary Policy (think of the COVID printing machine effect playing out today). Instead, the country executing their monetary policy would have to be more careful because the demand for their local currency is not propped up by forcing Zimbabwe to buy oil or another commodity from let’s say Saudi Arabia in US Dollars like how the world runs today.
Thank you for taking the time to read through this article, I hope you can take something with you or if you want, I am always willing to have an open discussion. All the best to you readers and I look forward to hearing what your thoughts on these ideas are as well.
Riley Sisson
Branch Manager, RJFS
Any opinions are those of Riley Sisson and not necessarily those of Raymond James.
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(1)- https://ethereum.org/en/eth/
