Have you ever wondered what makes the money in your pocket worth the things you spend it on? I know I have. The answer is trust. We trust the government that has issued the currency, as does the person who is accepting the money. This mutual trust makes the piece of plastic worth its value and is what is making cryptocurrencies like Bitcoin so useful today.
Back in the day, all federal reserves needed to have a certain amount of gold to back the currency notes that it issued. So, if you print $x worth of notes and have 10 kilograms of gold, each note is worth 10/x amount of gold. Therefore, the more money you print, the lesser the value of each note. But, somewhere along the way, the world decided that gold is in short supply. So, instead, we will base our currencies on oil. Still alright, I guess, since oil is a tangible resource. Since then, however, the United States has used its might to make a new rule: that all oil will be traded, and thereby valued, in US dollars (USD). What this means is that all any currency that is based on oil will be valued in USD only. As a result, the USD is inexplicably tied to all currencies.
But, what is the USD tied to? It is now a fiat currency, meaning that it has no tangible worth in gold or any other resource. The US Federal Reserve can simply print money into existence. Its value is denoted by how much someone is ready to pay for it. And the same is true for all the currencies of the world because they are all linked to the value of oil, and therefore the USD. If you aren’t alarmed yet, think about this: all the money in your pocket and all the money in the bank is valued by a currency that is under the control of Donald Trump.
Here’s how cryptocurrencies can help. A cryptocurrency, e.g. Bitcoin, has a few things that make it different from all other currencies. Other notable cryptocurrencies include Ether by Ethereum, which is gaining traction in transactions made on the Internet. Cryptocurrencies have no physical or tangible form: no notes and no coins. This is immensely helpful because it’s much easier, and cheaper, to make something secure in the virtual world than the real world. Central banks spend vast amounts of resources on printing money to prevent forgery. Cryptocurrencies like Bitcoin avoid this by using a highly encrypted key on a computer, so all it takes to make and securely store Bitcoin is a few bytes of data.
A cryptocurrency is like a global currency. It is not backed, regulated or controlled by any country or federal reserve. And, its value is decided by the demand and supply – like a global stock market where everyone can have a say and where everyone is a shareholder. It is highly non-inflationary. Moreover, it has no borders or jurisdiction. Because it lies within the realm of the Internet, it has the same value in any country – at least, any country with a good internet connection.
Bitcoin is open, meaning that everyone on the network helps run the network itself. You don’t have to pay a commission to transfer money. Nor will you be charged any service or maintenance fees. There is a vast network of computers that help keep the network running. In return, they get a small amount of Bitcoin for donating their computational capacity. But, this Bitcoin doesn’t come from your kitty. We pay this Bitcoin in such a way that everyone’s currency is equally depreciated, making the impact negligible to any particular user.
A hallmark quality that defines Bitcoin’s utility is that Bitcoin is extremely secure, thanks to the technology behind it: Blockchain. The Blockchain is what is truly marvellous about Bitcoin or almost any other cryptocurrency today. It works by using the power of democracy, handing control to the users themselves through its open and distributed nature. The Bitcoin Blockchain is a ledger that records all the transactions of all the Bitcoins ever transferred. A pretty big ledger, right?
Well, Blockchain handles this by dividing all transactions into sets or blocks. These blocks are securely locked and then tied together in a chain such that if any single block were tampered with, then the whole chain is invalidated. This helps because, as long as the most recent blocks are valid, you needn’t concern yourself with all the blocks before them.
Here’s a simple analogy to help illustrate the mechanism of Blockchain. Imagine that you are the person in charge of keeping track of all these Bitcoin transactions. You have a pen and paper, and you start taking notes. Soon the papers pile up, so you take a cord and tie a bunch of them together, and you lock them using a number as the key. But, soon you have another bunch, and another, and another. So, rather than remembering all the keys for every group, you use a special method where every block’s key is contained in the block before it. Now, every time you add a new block, you just find the secret number in the current block and use that as the key for the next block. This way, all you must do is remember the key for the first block and then go on unlocking all the blocks sequentially.
That’s exactly how Blockchain works. The important thing is that the key isn’t just any random number. It is a fixed combination of the data contained within the current block itself, for example, a sum of all the transacted amounts in that block. Now, if somebody were to tamper with the accounts to give themselves some additional money, you would know because the key, computed now, would not unlock the next block and then all blocks after that would remain locked too.
To tamper with the records, they would have to change each transaction and each block. But, say someone is hell bent on cracking the Blockchain, so much so that they are ready to change the entire set of records, from the start to end. This would be fairly easy if someone had access to all the records at once, but you – the creator of the Blockchain – are smart. You anticipated this, so you keep multiple copies of the chain in various places, locked and secure. If something were to happen to any single chain, maybe even a natural disaster or accident, there remain hundreds and thousands of Blockchain backups that spell the truth.
This is another amazing thing about the Blockchain: it is distributed. Globally, thousands of computers and servers maintain the Blockchain, so if anyone had Bitcoin larceny on their minds, they’d have to hack not just the whole Blockchain sequence, but all the Blockchains around the world, simultaneously! Impossible is a strong word, but this comes pretty close.
Bitcoin is just one manifestation of the Blockchain. There are many more applications for this technology, and Blockchain is no doubt something to watch out for in the future. Cryptocurrencies are something that will disrupt the financial world. But this also puts control of the world’s money in the hands of the world instead of glorified, grandiose bureaucrats or the elite that control them. Ultimately, it is the genius of the Blockchain and the trust that it affords to a currency that fuels the cryptocurrency revolution we are witnessing today.