Economics of cryptocurrency

In 2008, the mysterious Satoshi Nakamoto founded the first cryptocurrency, Bitcoin, hoping that it would one day be used for daily transactions and also a way for investors to work around the traditional banking infrastructure after the Economic Crash. Since then, Bitcoin and other cryptocurrencies have surged in popularity in the economic world, reaching and ultimately surpassing the goals that their creators had envisioned them to meet. This article will detail the timeline of cryptocurrency’s rise to economic relevance and how cryptocurrencies function.

Background

Even before Bitcoin’s inception in 2008, there were attempts to establish online currencies that could be securely encrypted by the use of ledgers – a unique string of alphanumeric characters given to each account within a finance system. However, these online currencies, namely B-Money and Bit Gold, remained nothing more than developmental projects. Several years later, in 2008, an individual using the pseudonym Satoshi Nakamoto, proposed to advance the concept of an online currency integrated with elements of cryptography. Subsequently, in 2009, the Bitcoin software was made available to the public, allowing people to begin to harvest the cryptocurrency via ‘mining’.

In 2010, the first Bitcoin transaction was completed, in which a man traded 10,000 Bitcoin for two pizzas (an amount that would be worth over £350 million), assigning Bitcoin its first monetary value. A year later, alternative cryptocurrencies began to be released, such as Namecoin and Litecoin, and tried to develop on Bitcoin’s advantages such as anonymity and speed. In 2013, however, Bitcoin experienced its first price crash, falling from over $1,000 to $300. 2014 was also a negative year for Bitcoin and cryptocurrencies, with 850,000 going missing in the largest Bitcoin exchange up to that point, suggesting that cryptocurrencies were hotbeds for scams and theft. Two years later, cryptocurrency was subjected to further criticism of encouraging scams and other criminal economic acts through the emergence of Ethereum and ICOs, which, although initially gained much traction and excitement from the word, was dubbed as facilitating Ponzi schemes by the SEC, and furthermore was banned by China. However, from 2017 onwards, Bitcoin and other currencies have had very positive trend rates of growth, albeit with a volatile label characterized by their dramatic crashes and surges in price, with Bitcoin eventually reaching a record price of over £50,000 per coin as recently as early November this year.

Cryptocurrencies are fundamentally decentralised encrypted currencies allowing for online transactions to take place, and they have numerous features in place which allow them to do this whilst maximising security and appreciation in value. One main component of cryptocurrencies is a ‘blockchain’, or in other words, a single chain of chronologically arranged blocks of information, which ultimately removes the need for a third party to get involved with transactions between two parties, thus “circumventing the traditional banking infrastructure”. These blockchains, or distributed ledgers, are made available to the public, and are created and verified by users themselves. Another key feature of cryptocurrencies is mining, which is essentially a “proof of work” cryptographic technique which limits a cryptocurrency network to creating a fixed amount of blockchains within a fixed time frame (for instance, Bitcoin allows for up to 1 megabyte of blockchains per 10 minutes). Thus, ‘mining’ ensures that cryptocurrency networks aren’t overloaded with blocks of transactions, whilst simultaneously preventing fraudulent financial activity by allowing for the digestion and verification of the blockchains themselves.

Miners, the ones who verify and digest the blockchains, are compensated for mining the cryptocurrency, and ‘halving’ is the system of compensation that many cryptocurrencies employ, which, as the name suggests, halves the compensation earned by miners for every fixed amount of currency mined (210,000 in the case of Bitcoin). This acts as a deflationary system for the rate in which cryptocurrency is released into circulation. A tool in which many ‘miners’ use to check the validity of blockchains are hashes, which are strings of numbers and letters unique to a blockchain. This means that any minute change to a blockchain will result in a change in the hash, which can be registered by a miner through imputing the blockchain into a hash calculator, thus allowing for the identification of fraudulent activity.

Finally, cryptocurrencies often make use of ‘keys’ and ‘wallets’ to ensure that users can complete transactions safely. There are two types of ‘keys’, ‘public keys’, which effectively are the hashes unique to each blockchain, and ‘private keys’, which are hashes between users so that the transactions can take place. Users can access their cryptocurrencies through ‘wallets’, which are a set of keys. These keys can range from debit cards to hashes to QR codes, and must be imputed correctly to access an account. This specificity of detail required to access ones account ensures that the accounts themselves are secure and as invulnerable as possible to fraudulent activity, although ‘hot wallets’, which are comprised of keys connected to the internet, are more vulnerable to hacking than ‘cold keys’, which have no connection online.

In 2010, Bitcoin would’ve barely bought you three meals. Thus, it is a gross understatement to say that Bitcoin and other cryptocurrencies have come along way, seemingly breaking price records every year and becoming increasingly involved in economic activity. However, without several meticulously designed and programmed features, such as mining and blockchains, cryptocurrencies might still be no more than a developmental project.