Friday, 1 December 2017

Cryptocurrency

Cryptocurrency is the term used to described new forms of digital currency that can be traded on the Internet. The most popular of these is Bitcoin, which was founded in 2008. Other popular cryptocurrencies are Ethereum and Litecoin. The underpinning technology is called blockchain. This allows for transactions to be made using a ledger style system. All transactions can be viewed on the ledger, making it a transparent system. Each transaction has a digital fingerprint that can't be faked, and thereby making it a trustworthy system. Blockchain relies on decentralised processing by multiple computers using a peer to peer network, in much the same way that bittorrent shares files between computers. To perform a transaction using bitcoin, you will need a digital wallet. This is used to store your transactions and the private key, which is used to encrypt your transactions and verify your digital identity. It is the encryption that creates the trustworthy part of the system and is why these are called cryptocurrencies.

When a transaction is made, it is added to a block of transactions. Miners will mathematically verify this block and ensure it is consistent with the previous block in the chain (hence the term blockchain). The blockchain (or ledger) is verified through a mathematical fingerprint (hash). Each transaction has to be mathematically proven in order for it to be verified. This is called mining. Computers that perform the mining calculations are rewarded with bitcoins. The difficulty of the calculations (and as a result, the processing effort) increases as more transactions are made. This means more power is required to verify a block of the blockchain as the number of transactions increases. So mining was a lot easier a few years ago, but requires more processing today and is therefore a more expensive process.

You may have seen in the news that Bitcoin has been reaching an all time high value. Currently it is sitting over US $10,000 per bitcoin. The cryptocurrency has gone through an exponential increase in value since 2016 when it was sitting at around US$500 per bitcoin (https://www.investing.com/currencies/btc-usd). This rapid rise can lead to swings in value as investors seek to profit and others are driven by FOMO (fear of missing out). Economists have seen this behaviour before (in the dotcom craze) and warn that this can lead to a bubble in the market. As more investors seek to buy the cryptocurrency, its value will rise, as there are only 21 million bitcoins that can be traded. The fundamental value of using a cryptocurrency is yet to be proven and only when there is mainstream support for using the cryptocurrency can it become truly useful. Some retailers are starting to offer payment with bitcoin (or other cryptocurrencies) but this is limited to a small part of the market. There is history of bitcoin trading sites getting hacked or the founders embezzling the funds. As usual it pays to be cautious when dealing with your hard earned cash. The largest trading site is coinbase.com

There are clear benefits in using a distributed transparent and trustworthy ledger system. From a banking perspective this could simplify and minimise the cost of interbank transfers. Currently it can take days for money to transfer between banks, with a block chain system this could be completed in a matter of seconds. This leads to benefits in time for the customer and cuts down on fees for the bank. There is no doubt banks are looking to use this technology but it can also be a digital disruptor to their way of working as the threat of cryptocurrencies becoming legitimised grows. For more information about cryptocurrencies take a look at the articles at www.coindesk.com/information/

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