Understanding Cryptocurrencies, their Current Trends, and Future Potential

Six months ago I had no idea what a “bitcoin” was outside of just hearing about it – let alone the block chain technology that forms the backbone of these digital currencies – otherwise known as cryptocurrencies.

The world of cryptocurrencies, the investment market that has exploded around them, and the technology that enables them is an intimidating one to get into at first glance. Covering each and every intricacy of this technology is beyond the scope of this article but I hope to give a solid foundation on which to understand and further explore what cryptocurrencies are and the potential they have to transform the way we use digital networks to perform economic transactions.

To help explain all this, I contacted Marshall Swatt, an expert in digital currencies and block chain technology, consultant to companies like Citibank and Deutsche Bank, and founder of startups such as Coinsetter, to ask a few questions about the trends, challenges, and conceptions in this industry. But before we get into that, we need to understand a few terms and concepts on exactly how block chain technology functions.

Cryptocurrencies run on block chains, which are essentially distributed digital ledgers that record a group of transactions in “blocks” that connect to each other using digital keys to verify the transactions. The transactions are done using the cryptocurrency that the block chain runs and are extremely difficult, if not impossible, to alter once recorded. These “blocks” don’t exist in some giant server farm – instead they are actively and independently mined, which is the process of running the computations that verify the block chain keys. The more “miners” (people that host the hardware/software that run the computations) that mine a given block chain, verify the transactions with one another, and keep expanding it as new transactions occur, the more secure and credible the block chain is, and subsequently, the cryptocurrency that runs off it.

Cryptocurrencies themselves function more like foreign currencies than say stocks or bonds, relying on speculation on their supply and demand to determine value more than anything else.

The tricky part is in understanding their demand, because what’s the point of seemingly complicating the process of running financial transactions when we already have a global banking system doing it for us? Well that’s the issue: centralized banking. Proponents and investors of crypto currencies want to see our finances decentralized, or out of the hands of a central power like a bank, and make transactions more transparent, efficient, and less prone to manipulation.

Instead of having our entire financial infrastructure exist under a few centralized “nodes” (i.e. banks and the stock market), the idea is that individuals can have the power of verifying and securing transactions peer to peer (directly between each other) through thousands of “nodes” (i.e. the many thousands of miners that verify each block of transactions) in a block chain network such that the information in each block is verified by multiple sources, encrypted (safer from hacks), and transparent to everyone part of the transaction block.

Block chain technology is a completely new area of computer science that Swatt likened to the early days of the internet.

“I think block chain has the same potential to impact people’s lives that the internet had in the early nineties,” but Swatt also clarified that “This technology in many respects can stand on its own without necessarily being part of the internet or being viewed as an extension of the internet.”

Alright great, that sounds amazing on paper so why haven’t we implemented this already? There are many factors that make widespread implementation hard, the first and foremost being that this is all relatively new.

“It’s still in the very early stages of adoption and development of practical applications and services that are going to add real value,” Swatt states. “But the long term trend, no question –we’re going to see some very significant growth over the long term, I’m very optimistic.”

This optimism across the community comes from cryptocurrencies opening up into new markets and becoming increasingly accessible thanks to businesses beginning to accept and trust the credibility of cryptocurrency transactions, on top of its increasing popularity for investors. Companies such as Microsoft, Subway, Wikipedia, Dell, and Steam (to name a few) have already started accepting bitcoin to different degrees as a form of payment.

“We’re seeing a lot of early steps in that direction and there’s a lot of talk about business models and ideas around that, but we haven’t seen a lot demonstrations yet.” In order to really enter the mainstream, Swatt argues that developers need to create products and services that appeal to the average consumer.

“No one has created a killer consumer app, right? And it’s not even clear what that would look like, there’s different possibilities but it’s more of an exploration stage at this point.”

Bitcoin is arguably the most popular, successful, and probably only digital currency many have heard of – but it’s only one of thousands of different cryptocurrencies out there. Altcoins, digital currencies that aren’t Bitcoin, function similarly to Bitcoin at a fundamental level in that they run on block chain technology, but differ greatly at a practical level in terms of use.

Lower tier cryptocurrencies come and go by the dozens on a weekly basis, numbering in the hundreds as new currencies are introduced, established currencies fork (more on this later), or just die out. What are considered top tier cryptocurrencies aren’t immune to these fluctuations either but are relatively more stable in that they have yet to fail or lose significant trade volume, even if their values roller coaster. It’s important to note that every cryptocurrency does not share the same purpose as a financial transaction system nor do they use block chain technology in the same way.

The second biggest cryptocurrency in both value and trade volume is Ethereum, which separates itself from Bitcoin by marketing its platform to create block chain applications and implementing a variety of features that Bitcoin doesn’t have such as smart contracts, which are contracts that remove the middleman by automatically fulfilling themselves independently of the parties that set them up once the parameters of the contract have been meet or voided. Its currency, the “ether,” is used in facilitating transactions within these smart contracts and decentralized applications on the Ethereum block chain network.

Other digital currencies like Litecoin and Ripple act as direct competitors to Bitcoin by using different versions of block chain technology and adding features that Bitcoin is currently unable implement in order to facilitate financial transactions in a more efficient or different way.

When asked about the point of all these currencies, Swatt explained that “you have a bunch of other digital currencies as well that are adding features or nuances that Ether doesn’t have, that Bitcoin doesn’t have, and so essentially these different currencies are carving out a niche and staking a claim and saying hey, we’re different because we implement these sets of features or we implement them in this way and that differentiates us from these other currencies and therefore we believe it gives our currency or this platform some kind of unique intrinsic value vis a vis the competitor currencies.”

Perhaps the biggest issue regarding digital currencies is that of governance in a decentralized system, an issue that Swatt believes isn’t getting enough attention.

“To say that the block chain technology inherently solves governance issues I think is a mistake,” adding that “It is definitely one of the most critical elements that needs to be addressed and it’s really not being addressed, it’s largely being ignored.”

Despite the drive to create decentralized networks where the only formal governance is the community as a whole, the actual direction a community decides they want to take their block chain isn’t always clear and sometimes messy. What happens when the community disagrees? That can lead to a hard fork which happened to Ehtereum in the past year and much more recently to Bitcoin.

In this scenario, the block chain gets split into two by miners who support and implement some type of new functionality or protocol. At the point where the block chain forks, miners who favor implementation begin adding new updated blocks to the block chain separately from miners who oppose implementation by continue adding non-updated blocks. Two block chains now exist and record transactions independently of each other, only sharing transaction history up until the fork.

It’s up to the miners and subsequently the consumers who actually make transactions to determine which one survives, which is in some cases both as seen in both the Ethereum and Bitcoin hard forks. In both cases, the updated versions are the ones that have stayed on top, but not without controversy and friction within their communities.

Citing the recent Bitcoin fork, Swatt calls the nature of these forks “political” stating that “It raises a great point because it shows that one huge aspect of block chain technology and specifically public block chain decentralized networks is that there really hasn’t been a mature discussion or resolution about how these networks are going to be governed.”

Even with these key issues, the popularity in digital currencies has significantly increased in the past year as have their values. At the time this article is being written, the total market value of all cryptocurrencies is over one hundred forty billion US dollars, approximately 87% of which belongs to the top ten cryptocurrencies that value together at over one hundred nineteen billion US dollars, and around 50% of which belongs solely to Bitcoin at over seventy billion US dollars. The top five traded cryptocurrencies account for over 75% of total transaction volume.

These numbers could very well be completely different by the time you read this article, or could be the same. The only thing certain in this stage is that while the markets are volatile at all times in the short term, the long term trend has been upward since inception, with total market value increasing over 1000% in the past year alone – the fastest year of growth so far.

Cryptocurrencies are becoming a bigger deal by the minute. Whether or not they disrupt the financial industry or revolutionize the tech industry is yet to be seen, but many would say the answer isn’t if, but when. Block chain technology is ripe with potential and yet to be truly utilized, and it may very well be the platform the next generation connects to and communicates with. The most promising aspect of these technologies is that you – as an individual – can be a part of them today, and perhaps reap their success tomorrow.

 

For more information on tracking and following the digital currency market and trends:

Websites to explore if interested in cryptocurrencies:

For more information on Bitcoin:

For more information on Ethereum:

For more information on block chain technology:

For more information on investing in and the application of digital currencies:

 

As a college student majoring in engineering, I love learning how the world around us works. As a writer, I love exploring why the world around us works. My philosophy is that before we can make any change in our world, we first need to thoroughly understand it.
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