School of PE Blog

Cryptocurrencies and blockchain technology represent a major evolution in modern financial systems and digital transactions. In just over a decade, cryptocurrency has elevated its status from an obscure anarcho-capitalist experiment to a disruptive force shaping the future of money and finance. While blockchain has become the buzzword and future of data encryption and communication. This blog aims to do a deep dive into cryptocurrencies and blockchain, explaining their underpinning technology, origins, applications, and potential impacts on the financial landscape.

What are Cryptocurrencies and How Do They Work?

Cryptocurrencies are digital or virtual currencies secured through encryption, currently operating independently of governments or central banks. Unlike traditional fiat money, cryptocurrencies are decentralized across a distributed public ledger called the blockchain. They enable direct transactions between users without third-party financial institutions through a peer-to-peer network (Federal Trade Commission, 2022).

The first and most infamous cryptocurrency, Bitcoin, was created in 2009 by the pseudonymous Satoshi Nakamoto. It pioneered the use of cryptography and blockchain to facilitate currency transactions without intermediaries. Here’s a quick look at how it works:

• New Bitcoins are generated through a process called mining, which involves computers solving complex math problems to verify transactions on the blockchain. This verifies legitimacy and adds new blocks to the chain.
• Users store and transact Bitcoin through digital wallets. Wallets have unique addresses composed of letters and numbers to send or receive coins.
• Advanced encryption techniques like public-private key pairs, hashing functions, and digital signatures encode transactions in a secure, permanent way. This ensures anonymity and eliminates double-spending.
• The blockchain contains an incorruptible record of all transactions across a decentralized network of computers. This replaces centralized ledgers maintained by banks.

From the success of Bitcoin, thousands of cryptocurrencies now exist; the most popular are Ethereum, Monero, Cardano, and Stellar. Built upon the same underpinning blockchain technology as Bitcoin, these newer competitors have also introduced innovations in areas like speed, scalability, transaction fees, and energy use to further the technology and create greater accessibility. Still, Bitcoin, being the grandfather of cryptocurrency, maintains the largest market capitalization at over $571 billion, followed by Ethereum at $221 billion (CoinMarketCap, n.d.).

Evolution of Blockchain Technology

Blockchain, the heart of decentralization in technology, arose to notoriety as the digital framework to support Bitcoin, but now the technology has evolved for a much wider use case. At its core, blockchain is a distributed ledger maintained by a peer-to-peer computer network rather than a single centralized entity. Every transaction is recorded as an immutable “block” with a timestamp and unique cryptographic signature.

The distributed and transparent nature of the blockchain builds trust, accountability, and security into its very structure, eliminating the need for third-party verification and placing control back on the user. Beyond cryptocurrencies, blockchain has spawned innovations such as smart contracts, supply chain tracking, voting systems, real estate processing, and more. Major corporations across finance, logistics, technology, and other sectors are exploring blockchain-based systems.

Advancements such as smart contracts allow pure peer-to-peer transactions. Embedding programs into each block that executes when predetermined conditions are met, automating the execution of agreements, ensuring that both parties are immediately satisfied; in addition, because these contracts are embedded into the blockchain, it eliminates future disputes and possible retroactive changes to the agreements.

Drivers of Mainstream Adoption

Despite volatility and skepticism, cryptocurrency adoption has accelerated rapidly. In 2021, the crypto market surpassed $3 trillion in value, demonstrating tremendous growth in the financial space. Here are some key factors driving mainstream acceptance:

• Increased digitization of finance, especially among younger users becoming increasingly comfortable with digital mediums of exchange and decentralized systems
• Realization of strengths like cheaper fees, faster settlements, and accessibility to anyone with an internet connection, all reducing barriers to entry into digital transactions
• Major institutional investments from banks, hedge funds, companies adding crypto to balance sheets
• High-profile tech industry support from the likes of Jack Dorsey, Elon Musk, and Mark Zuckerberg
• The growing ecosystem around cryptocurrencies - exchanges, wallets, dApps, NFTs, metaverse spaces
• Platforms making cryptocurrency easier to purchase, hold, and spend via credit cards and mobile apps.
• Recognition of energy-efficient protocols and transition to proof-of-stake models versus the more taxing proof-of-work model, like Ethereum 2.0
• Advances making blockchains scalable, interoperable, and usable for more practical applications, removing any cryptocurrency stigma and normalizing the technology

There remains much uncertainty and risk around cryptocurrency investing. Prudent regulation can provide oversight without stifling innovation. But the overall momentum and maturation suggest cryptocurrencies are here to stay as a disruptive financial force.

Broader Impacts and Challenges

Crypto advocates argue decentralized digital currencies make financial transactions more free and democratic. Without central control, cryptocurrencies facilitate private, secure, low-cost transactions across borders, and enable the freedom for customers to choose with currency or system they prefer, instead of being forced to use the fiat enforced by their nation. This promotes financial inclusion for the underbanked worldwide. Some currencies also promote a direct democracy, where its users can vote on changes to their policies to reflect the wishes and vision of the people. This transparency and close user base of blockchains also enable new business models, financial services, and anti-corruption capabilities.

However, cryptocurrencies still face many challenges for mainstream viability as a fully competitive monetary system. Pressing concerns include known issues around volatility, potential security flaws, lack of recourse and accountability, environmental impacts, and usage for crime/tax evasion. The vast majority of countries still lack comprehensive regulations to detect abuse while safely fostering innovation and implementation. The major news of financial fraud from FTX raises many concerns about the very real possibility of people losing all their money/investments without any Federal Deposit Insurance Corporation (FDIC) like insurance and protection. Not only against massive fraud, but users also require protection against hacking and predatory investment schemes. Ongoing technological improvements around scalability, privacy, and sustainability may address some criticisms, however, decentralization continues to pose a safety concern.

Looking Ahead

The cryptocurrency landscape keeps evolving at a dizzying pace. Prices, technologies, applications, and regulations remain highly dynamic. Upcoming developments like proof-of-stake consensus, asset-backed stablecoins, decentralized finance (DeFi), and central bank digital currencies could drive greater stability and mainstream adoption. While risks and skepticism persist, cryptocurrency clearly impacts future visions of money, finance, governance, and society.

References

CoinMarketCap. (n.d.). CoinMarketCap: Cryptocurrency Prices, Charts And Market Capitalizations. Retrieved August 11, 2023, from https://coinmarketcap.com/

Federal Trade Commission. (2022, May). What To Know About Cryptocurrency and Scams. Federal Trade Commission. Retrieved August 11, 2023, from https://consumer.ftc.gov/articles/what-know-about-cryptocurrency-and-scams