In a matter of weeks in November 2017, bitcoin
surged from a fringe investment to a global sensation.
In mid-November, the price was around $3,000 for a
single bitcoin; on December 6, 2017, it surpassed
$19,000 . At the time of publication, the value was
hovering around $15,000.
Bitcoin is having a moment — really, it’s had a year.
No matter if you think it’s a bubble about to burst, or
hope your investments will pay back big in the long
run, there is one clear takeaway: Cryptocurrency is
changing the future of finance. What’s not yet clear is
how the technology behind bitcoin, and
cryptocurrencies like it, will alter our national and
global financial systems.
Back on the Blockchain
Bitcoin, like all cryptocurrencies, relies on a
technology called blockchain that makes its
transactions so secure that experts consider them to
be virtually unhackable. And because the transactions
are assured, the cost of verifying transactions is less
than in a central bank though, admittedly, the cost of
verifying bitcoin transactions has become fairly
expensive.
Cryptocurrency transactions happen directly between
individuals instead of through a bank. Every time a
person makes a transaction using a cryptocurrency —
for example, using funds stored in his or her crypto
wallet to send bitcoin to someone else — the
transaction is recorded on a digital ledger called a
blockchain. Every cryptocurrency has its own
blockchain, and computers doing complex math in a
large network maintain it.
Once users make a specific number of transactions
using a cryptocurrency, the computers group these
transactions into a “block.” In order to send a block,
adding transactions to the blockchain and winning a
monetary reward, a computer has to solve a complex
math problem called a cryptographic function.
Basically, the cryptographic equation is throwing a
pumpkin (the block) off a building and telling you
what the splatter pattern looked like. The only way
users can match the splatter pattern — and send the
block — is to hurl a bunch of pumpkins off a building
themselves. So people who “mine” cryptocurrency are
actually just using their computers to smash billions
of pumpkins in order to find the winning pumpkin
with the right splatter, which validates their block.
In other words, the first computer that can solve a
complex math problem gets to add its block of
transactions to the blockchain and receive a
monetary reward for doing so (this is what people
mean by “mining” crypto). Every computer in the
network adds the new block to its copy of the digital
ledger, and the process continues.
Although bitcoin was created to avoid centralized
banking and government money, the technology can
be used as a national, centrally banked currency. In
fact, the blockchain is so secure that it reduces the
cost of verifying transactions, so banks are already
looking into it, says David Yermack , chairman of the
finance department at New York University’s Stern
School of Business. In 50 years, Yermack says,
cryptocurrencies could be used as national
currencies.
Will Our Future Be In Bitcoin?
Bitcoin was created to work outside national
currencies, which is a draw to people who don’t trust
central banks, says Yermack.
Those who are hopeful about the rise of bitcoin may
have noticed its popularity in countries like
Zimbabwe and Venezuela, where it is being used as a
major means of exchange when government-issued
currencies have failed because of hyperinflation.
Bitcoin and other means of exchange have become
popular in these countries because transactions can
be performed on cell phones, and their value is more
stable than the hyper-inflated national currency.
But others believe that bitcoin is too riddled with
problems to be the cryptocurrency upon which the
future is built. First, it likely can’t be used on a
national scale because of how few transactions per
minute bitcoin supports. Bitcoin’s framework can
only make seven transactions per second, says Ari
Juels , computer science professor at Cornell
University who studies cryptography and computer
security. VISA’s credit card network, for comparison,
can handle 65,000 transactions per second .
Issues of privacy also stop it from becoming the
future of money, says Phillipa Ryan , commercial
equity lawyer and lecturer at the University of
Technology Sydney. “Bitcoin is problematic in that it
provides too much privacy and not enough privacy,”
says Juels. “Too much privacy in that it provides
enough to give criminals the opportunity to
perpetrate a lot of mischief, from ransomware to the
Silk Road. Not enough in that transactions are actually
traceable by pseudonym.”
Its value also fluctuates too much to provide a stable,
functional currency. Unlike traditional currencies,
which have a value that is set by the central banking
system, the value of bitcoin is driven by speculation
about its worth like a stock, says Yermack. So it
doesn’t make the cut as a currency. “Traditionally,
we think of money as a kind of means of exchange
and a store of value,” says Harold James , an
economic historian at Princeton. “[Bitcoin] is very
good at the means of exchange, but not very good at
the store of value.”
The future likely won’t be based on bitcoin.
That’s not to say that the future won’t be
based on other cryptocurrencies.
If you have a dollar bill, it’s pretty safe to assume it’s
worth about a candy bar from day to day. One
bitcoin, on the other hand, could be worth a candy
bar one day, a car the day after, then next to nothing
the day after that. It’s more like a stock than a stable
national currency. James says that, based on the
historical precedents he studies, bitcoin looks like the
highly unstable private currencies created in Eastern
Europe after the First World War. When speculation
about the value of bitcoin is substantially more than
its worth in the real world, bitcoin will burst, like the
stock market crashed.
Economists studying cryptocurrency and computer
security experts agree: The future likely won’t be
based on bitcoin. Of course, that’s not to say that the
future won’t be based on other cryptocurrencies.
In the meantime, bitcoin will remain as a grand test
of the blockchain technology, says Ryan. Its value will
continue to fluctuate, but Ryan is convinced it’s
already a bubble. “I think that bubble will burst. It’s
fun to watch though, it’s been a great ride,” says
Ryan. “When bitcoin finally fails, I think we will look
back on it as a really important, valuable experiment
in which more lessons will be learned than there will
be loss.”
A Shift In The Financial System
Bitcoin offers something groundbreaking, and a
growing number of national banks, including the
Federal Reserve, are interested in using blockchain
technology to power a centralized national
currency. Most experts agree that, in the future,
countries will turn to cryptocurrency, as money is
already moving from the physical to the digital realm.
So a method that secures digital transactions is a
necessary investment, and the blockchain technology
used in cryptocurrencies is a top contender.
“I think the whole idea is probably horrifying to the
bitcoin people, but it’s the ultimate harbinger of
success when the person you’re trying to defeat co-
opts your own plans and turns them against you,”
says Yermack. “The ultimate victory is where the
central bank co-opts their technology and makes it
the basis of their own operation. And I can see it
very clearly play out that way,” Yermack says.
“Monetary policy and financial stability — I think
those problems will be exactly the same in 50 years.”
But in 50 years, a nationally backed cryptocurrency
could replace the paper dollar, he says.
When it comes to the future of money,
cryptocurrency’s influence will be felt in its improved
ability to avoid technological problems like hacking, Ryan says. Based on the issues of cybersecurity
looming ahead, Ryan thinks that the blockchain will
be the technology to transform the money of the
future.
Blockchain could make its way into the mainstream
in two primary different ways. One option is to
switch from physical to digital currency. A dollar
would still be a dollar, but transactions would use
blockchain to make them more secure. The second
way would be to move your bank account from
something like CitiBank and transform it into an
account in the Federal Reserve itself. If all of a
nation’s money were centralized, it would make the
Federal Reserve more efficient at its job of stabilizing
and regulating the economy, says Christian Catalini ,
assistant professor at MIT’s Sloan School of
Management who studies the economics of
cryptocurrency.
Some institutions are beginning to try it. Estonia is
working to create an e-Residency program , and part
of their plan includes launching the estcoin, the
world’s first national cryptocurrency. The Bank of
England is working to create its own cryptocurrency
and has created an experimental cryptocurrency
framework called RSCoin that would use a centralized
system. To go crypto, the Bank of England would
create digital money as if it was printing physical
notes. For example, in 2017, there were 73.2 billion
British pounds in circulation . A British economy using
only cryptocurrency would have the same fixed
number of pounds, just represented by a digital
“coin” instead of a physical note. Since the value of
the British pound is based on how many are in
circulation, exchanging a physical note for a digital
one has no economic significance — that is, a pound
is still a pound, says Yermack. Like bitcoin, RSCoin
would use a public ledger and the cryptographic
system to distribute money.
In their paper on the RSCoin model, the authors write
that a cryptocurrency backed by a national bank
should help make cryptocurrency usable on a larger
scale, since the central bank could employ other
institutions to do the computations to verify
transactions. In a model with one central bank and
only 30 commercial banks, RSCoin could make 2,000
transactions per second — not quite up to VISA’s
speed, but certainly fast enough for British citizens to
move about their financial lives quickly and securely.
For a consumer, a centralized cryptocurrency won’t
change much, says Catalini. “[Consumers] will just
see cheaper prices in the denomination they’re
familiar with, and blockchain technology may be
used in the background to offer new or better types
of financial and payment services.” So with a
national cryptocurrency, bank fees would likely drop,
and money transfers would happen faster.
And with national cryptocurrencies, it will be more
difficult to conduct illegal activity. Even with the
anonymous ledgers used today, governments can
track users and financial information, says Aniket
Kate , a computer scientist at Purdue University. Since
all transactions on the blockchain are recorded on
every connected computer, it would be difficult to
hide financial indiscretions from the government,
Kate says.
Over the next fifty years, Yermack thinks that law-
abiding citizens, banks, and governments alike could
benefit from moving to some form of digital
currency. “There is a huge opportunity cost in not
making the central bank more efficient,” says
Yermack. “I think what you’re really going to need in
the long run is a reorganization of the branches of
government and probably more levels of political
control over the central bank.”
As countries creep closer to creating their own
cryptocurrency, they will have to decide just how
private they want transactions to be. Bitcoin’s famous
openness might not be so appealing for all
transactions — you might not like it if your neighbor
could see that you’re buying vibrators and cat food in
bulk (of course, you could also find all their weird
purchases). However, cryptocurrencies can protect
user privacy in varying degrees, Kate says; a future
system could inhibit your neighbor’s prying eyes.
But the issue of privacy is potentially more of a social
problem than a technical one. In Norway, all tax
records are public knowledge. In other parts of
Scandinavia, electronic banking is also on the public
record, says James. Citizens of Denmark, Sweden,
Norway, Greenland, and Iceland rarely use their
physical currencies, James says, making those
countries a microcosm for a possible future of digital-
only currency.
“The only question that seems to be open is: would it
be the kind of Scandinavian system we talked about,
where every transaction can be monitored [and] that
lends itself to a surveillance state?” James asks. “Or
will it be a kind of Bitcoin-like system, where there is
an anonymity built in?” As countries start to make
the switch to digital currencies, their societies, along
with the governments themselves and the economies
upon which all rely, will have to figure out how to
adapt.
