My Thoughts on Crypto-currencies

As I stared at the wallet balance on my Bundle app, I couldn’t help wondering what was going on. Date: May 13, 2021. My crypto portfolio had lost over 20% value in 24 hours. It was a bloodbath. From Bitcoin to Ethereum, Cardano, BNB. All were in the red. What manner of fuckery?? The crypto market was witnessing a massive sell-off. Price crash in real-time.

It wasn’t the first time we had witnessed such a crash though. Crypto has been around for a while, and coins have generally gone through boom and bust cycles. But, there were several reasons for the recent crash.

Two weeks prior, Elon Musk put out a tweet. It was a statement that Tesla would stop accepting Bitcoin payments because apparently, the technology behind coin mining is bad for the environment. Shortly after Elon’s tweet, the price of Bitcoin began to plummet. Now Elon, though he isn’t a crypto expert, seems to wield a lot of influence in the crypto space. A large number of investors who don’t really understand the technology behind crypto are swayed by Elon’s tweets and opinions.

Bitcoin fell 12% after Elon’s tweet. Not long after, there were reports of measures by Chinese officials looking to deter institutions from accepting crypto as payment. General investor sentiments towards crypto turned negative. And because cryptos are purely speculative assets, there was more plunging. Over the course of 2 weeks, the price of bitcoin fell by over 40%. 

I know we have touted cryptocurrencies as a good store of value, but in light of these recent events, we have really pushed the limit. If an asset can casually dump 40% of its value in 2 weeks, can it qualify as a store of value?
Over the past year, I have been looking into cryptocurrencies, researching intermittently from afar. With the recent crash, I decided to consolidate my notes and really make sense of this technology that is supposed to usher in a better financial system.

First, there’s Blockchain

The blockchain is a distributed database/ledger shared by all the participants on a network. Each participant maintains a copy of the ledger. The blockchain implements protocols to ensure that writing to the ledger is based on some form of consensus; meaning the majority of participants agree to the write. Moreover, each block entry contains the hash of the previous block, hence tampering with one block invalidates every single block after it. In this sense, a blockchain can be regarded as tamper-proof. 

Blockchains are run by peer-to-peer networks that are completely trustless. There is no need for a designated central authority to enforce the transaction rules. The rules are inherently baked into the network’s protocol. This concept was introduced in 2009 by Satoshi Nakamato and has formed the basis of all cryptocurrencies in existence today. 

What really is Cryptocurrency?

Bitcoin was the first cryptocurrency released in 2009, and since then, other cryptos have sprung into existence. Before we can appreciate what crypto is about, we need to have a high-level understanding of banking. 
Traditional Banking is centered around a number of activities: creating value, storing value, transferring value, receiving value, etc. In most countries, rules around traditional banking are exercised by centralized authorities. More often than not, these centralized authorities may act with goodwill to the greater benefit of the populace. But, what happens when these authorities become corrupted? What happens when they implement policies that don’t favor the public?

Cryptocurrencies differ from traditional fiat currencies by achieving decentralization through blockchain technology. Removing the need for central authorities by allowing distributed consensus. Distributed Consensus protocols employ Proof of Work or Proof of Stake algorithms although proof of stake is largely more scalable. 

Why the sudden interest in cryptocurrencies?

Four to five years ago, there weren’t many people talking about crypto, myself included. At the time, I just thought of crypto as some internet fad, one that seemed like a get-rich-quick scheme. Social media has done a lot to fuel the rising popularity of cryptocurrencies. Turns out people don’t pay attention to something until there’s a lot of noise around it. Underneath all that buzz is a truly revolutionary technology that has barely reached its full potential. For now, it qualifies as a financial asset.

Crypto as a Financial Asset

Would you invest in an asset class that endures wild price swings at short intervals with sporadic boom and bust cycles? Cryptocurrencies as an asset class are still widely speculative. Driven purely by fundamental laws of supply and demand. And while they have performed better than other asset classes in recent years, they have earned a reputation as volatile. 

I think the major reason for bitcoin’s volatility stems from the fact that it’s still primarily in price discovery mode. It’s hard to pin a value on crypto when it has no intrinsic value. Most people who own crypto either HODL it, or sell it for cash. Hence, until an economy starts to evolve around crypto, it will probably be in price discovery mode for a long time. People need to be able to do stuff with their crypto, not just buy and sell it for the dollar. 

But, there’s a chicken and egg problem here, more Institutions and big companies need to embrace crypto for the price to become more stable. But the current price instability discourages large institutions and investors from adopting it in the first place. 
As far as crypto is concerned, there are 2 types of people: 

  1. Those who invest to make a quick buck.
  2. Those who invest for the long term.

The first group of people makes their money in day-to-day trading. What they are doing is somewhat akin to gambling; placing bets that crypto prices will rise or fall in the near term.
The second group of people views crypto as a stake in a possible financial future that is just starting to materialize.  If crypto is to survive the long term and become an asset to reckon with, it will need more people, institutions, investors with a long-term view.

As for me, I do not think crypto is going anywhere. At least not any time soon. It is built on an ingenious technology, which though imperfect, is still poised to usher in a new financial system. If you ask me, the old one was overdue for a rethink.