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Image credits: the Geostrata graphics team
CRYPTOCURRENCIES MAKING HEADLINES
On March 14th, 2021, Bitcoin surged to the $60,000 mark. The News over some years has been dominated by the ginormous rise in prices and popularity of cryptocurrencies like Bitcoin and Ethereum. Even some of the top billionaires are divided over their utility. While Elon Musk’s Tesla invested a whopping 1.5 billion dollars in Bitcoin, Charlie Munger, the legendary billionaire investor and Vice-Chairman of Berkshire Hathaway, stated: “Bitcoin is worthless artificial gold”. These two cases reflect two extreme camps, one where people are hailing crypto-currencies as revolutionary in fundamentally changing our concept of currencies-fiat currencies being the prevalent one.
Some see it as a bubble-citing some problems like cryptocurrencies having no inherent value in themselves as such. Both these extremes hold some truth, and the canvas of cryptocurrencies is still being painted. Between these two extremes exists most people who see the happenings from afar and adjust and develop their actions as things progress. What are cryptocurrencies, and why are they becoming so popular? Where do they fit in the broader picture, and what does it all teach us about human psychology?
BACKGROUND STORY OF CRYPTOCURRENCIES
Cryptocurrencies are a form of digital currency, blockchain technology being the foundational basis, but more on that later. To better understand the phenomenon of cryptocurrencies, first, we need to look at the broader picture. It is essential to dive down into the concept of money and the problems and fears about the modern idea of money, which boosts cryptocurrencies. Money is essentially a medium of exchange. We value things in terms of money which represents the value we attribute to the labour that went into producing that commodity (plus profits obviously: the reward). The modern economy is nothing but the human civilisation exchanging values on a ginormous scale per second, day in and day out, years after years. Money, in that sense, is the enabling factor.
We live in the era of fiat currencies- paper currencies. Unlike the gold and silver coins that were prevalent centuries ago, fiat currencies have no inherent value. Until 1971, all major currencies were pegged to the American dollar, which again was pegged to gold. This system provided stability to the post-world war economies for decades. However, as economies grew, it became tough to peg the dollar with gold constantly, and therefore, this relationship was broken under the Nixon administration. Now all of these major currencies are free-floating in the foreign exchange market. Their prices are driven by their demand and supply, which is determined by how much belief the people have in the economies of their origin. With this background in place, we are better equipped to understand the world of cryptocurrencies and how it matters to us.
BLOCKCHAIN-THE FOUNDATION FOR CRYPTOCURRENCIES
Cryptocurrencies and Blockchain technology work side by side. In simple terms, blockchain technology is a form of database- where’s the catch? A decentralised structure of a database. Let us further explore that. Consider the internet, which is essentially the transfer of data when reduced to its fundamental principles. Gazillions of the quantity of data being transferred worldwide per second, day in and day out. Blockchain makes sense when we consider how exactly this transfer takes place. Servers. Yes, this transfer of data takes place through servers, and these servers are highly centralised. Now, although this system has served us for decades, it is not perfect.
Centralisation comes with its problems: authorities in control of the servers tend to accumulate a lot of influence and power, which leaves most of us at their mercy. For example, the US Congress and even the European Union called the CEOs of big tech companies like Facebook, Alphabet, and Twitter over privacy concerns. A classic case of centralisation of the database. Also, centralisation allows the choking of the whole apparatus. Say- malicious viruses hack Google’s servers, this could lead to a literal meltdown worldwide, say what if the stock markets become inaccessible for a while. Billions of dollars could be lost this way.
What Blockchain provides is the decentralisation of databases. Imagine what if our data, instead of being stored onto certain crucial servers, is shared across millions of computers working round the clock, constantly making calculations and updating their records. There are a lot of concerns with that. To list a few would be that these small units of servers or computers need energy- lots of energy. For these servers to work as efficiently as required-incentives need to be created, we don’t know how to tackle that, and with incentives comes the question of accountability. Who is to be held accountable when discrepancies occur: an organisation? Well, that completely goes against the idea of blockchain technology decentralisation. Blockchain is thought towards eliminating the centralised form of the economy into a peer-to-peer form of economy. This is a process still in its early phase, but one thing for sure, it is here to stay.
CRYPTO-CURRENCIES
Remember we talked about incentives for the millions and millions of server-computers that blockchain requires, cryptocurrencies, and initially bitcoin was created for the same purpose. Cryptocurrencies aim to decentralise our currency apparatus. Currencies around the world are highly regulated and rightly so. We need a credible organisation with extreme powers to manage and regulate any currency-which forms the blood of an economy. This centralisation is not just limited to maintaining stability in demand and supply of a currency-which essentially translates to that of an economy, however, it also assists in maintaining political stability. Why do we then need decentralisation? Currencies over time have been depreciating.
Gone are the days when we could buy groceries for cents, a classic case of inflation at work. This is still fine- economic growth needs some inflation. However, there has been this fear of inflation going over the limits. That is why more and more people are entering the stock market or several other investment avenues to try and beat inflation. Investing is a sign of financial literacy, however, the sudden rise in participation in these avenues is a sign of the inflationary pressures as well. One important thing to understand is that credit drives an economy. Sometimes during extensive economic growth, an economy absorbs so much credit that it becomes difficult to pay it later. Corporations go bankrupt, and the market corrects itself. For example, the 2008 Financial Crisis.
Sometimes, even the corporations deemed too fatal to fail also reach the edge of bankruptcy. Governments cannot let that happen, so they try to rescue them by pumping billions and sometimes even trillions-US stimulus packages into the economy. The central authorities can create money out of thin air and pump it into the economy. This sort of behaviour-although saved our economies from collapsing has put the fear of inflation crossing all limits in the coming future. Here comes human psychology. Money is hard-earned; no one wants to see the reward for their work-money devalue into a worthless piece of paper or anything close to that. Hence, cryptocurrencies have been perceived to be a hedge against this devaluation of our fiat currencies, and as a result, their prices have been sky-rocketing.
SHOULD SOMEONE INVEST?
Should you invest in Cryptocurrencies? For quite a significant amount of time, they have been outperforming many assets and stocks in the market money. That makes up a satisfactory enough argument for putting in your money. But cryptocurrencies come with a price, and that is that they are volatile, highly volatile. Therefore, one shouldn’t invest what they cannot afford to lose. Yes, there is a chance it might go up and quite significantly, but if it goes down, it can cost you badly.
Therefore, a safer option remains only to invest that portion, which won’t affect you much if it even goes down in the short run. As things progress and cryptocurrencies and blockchain become more regular, I believe they can become a promising investment avenue with massive returns in the long run.
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BY PRATYAKSH KUMAR
CO-FOUNDER THE GEOSTRATA
thegeostrata@gmail.com