ELI5: What is Cryptocurrency
TLDR
Cryptocurrency is digital currency with its transactions recorded on an excel sheet that is shared by everyone.
If you want to learn more about blockchain you can read this article.
Crypto is enabled by blockchain
Blockchain is the “excel sheet” that is shared by everyone, which is also the technology that enables the existence of cryptocurrency.
Can we see crypto?
Nope, we can’t see it, there is no tangible “Crypto note” or “Crypto coin”.
It’s transactions are recorded on blockchain and we can own it by purchasing and keeping it with an exchange platform or in our own wallets.
Crypto vs Traditional money
Traditional money has three primary functions:
- Medium of Exchange
Before money existed, there was the Barter economy, where people directly exchange goods or services for other goods or services. However it only works when both parties have something that the other party wants.
Even then, it works only when both parties agree on the value of the goods. Is one pizza worth two hamburgers, or three? There would be endless bargaining.
Money serves as an instrument to facilitate the exchange of goods and services.
Crypto can be used to purchase goods and services from vendors who accept them, and can also be traded for other currencies (fiat or crypto). However, the acceptance of cryptocurrencies as a medium of exchange is still limited compared to traditional fiat currencies.
2. Unit of Account
A unit of account is a standard monetary unit of measurement for goods and services. It is divisible, fungible, and countable.
Divisible: each unit of account can be subdivided into smaller units.
Fungible: each unit has the same value and is indifferent to other units
Countable: can be counted mathematically
While cryptocurrencies have units, their high volatility makes them less reliable as a unit of account.
3. Store of Value
Money should retain its purchasing power over time, so people can save and use it in the future.
Cryptocurrencies like Bitcoin are often considered to have store of value, similar to gold, because of its limited supply. However. their extreme volatility and the relatively short history of cryptocurrencies make them a risky store of value compared to traditional assets.
Considering the above functions of money, the effectiveness of crypto fulfilling the functions vary depending on the specific cryptocurrency as well as the context in which it is used. While cryptocurrencies have the potential to fulfil the functions of money, it is not yet at the position to be seen and served as money.
Characteristics of Crypto
- Decentralised
Cryptocurrencies are operated on blockchains, which are decentralised network of computers, they are not controlled by any single entity like government or organisation.
This fundamental aspect allows them to exist outside the control of governments and central authorities. This means transferring value online can be done without the need for middleman such as banks.
2. Scarcity
Fiat currencies have an unlimited supply, as the central banks can issue and/or print as much fiat currencies as they want, in order to influence the value of the currencies as part of their economic policies.
On the other hand, most cryptocurrencies have limited supply that is pre-determinded when it is created. (eg. Bitcoin has a supply of 21 million)
The scarcity of cryptocurrency is important for its ability to potentially fulfil the functions of money, for its deflationary tendencies and perceived value, which is crucial for its long-term stability and growth.
Although scarcity can be a desirable trait for a cryptocurrency, it is not the only factor that determines its value.
3. Irreversible
Since blockchain is immutable, once a transaction is recorded on the blockchain, it cannot be modified or deleted, which means if a transaction is done it cannot be reversed.
This is because there is no longer a central entity that is trusted to perform transactions, therefore transaction records are made public and unchangeable.
4. Anonymity
Since there is no central entity, we do not have to identify ourselves like how we have to do when opening an account with the bank. Every user can have multiple wallets to do transactions without identifying themselves.
5. Divisibility
Cryptocurrency is capable to be divided into small units, it allows crypto to be used in precise transactions, especially small payments and micro-transactions, making it more accessible and usable.
Most crypto are highly divisible, often much more so than traditional fiat currencies. For example, one bitcoin can be divided into 100 million satoshis.
Divisibility is an important feature of crypto, it can make crypto accessible to people who cannot buy a whole unit of high value crypto such as Bitcoin. It also allows more efficient use of crypto since small transactions are allowed.
6. No geographical and time limitation
Cryptocurrencies are accessible globally and operate 24/7.
They can be sent and received anywhere in the world, as long as there is an internet connection. This makes them accessible to people in different parts of the world without the need for traditional banking infrastructure.
Unlike traditional stock markets, cryptocurrency markets operate 24/7, which means that trading can occur at any time, and prices can fluctuate continuously.
7. Volatility
Highly volatile cryptocurrencies can experience huge price swings in very short periods, which can lead to both significant gains and losses for investors.
The volatility is due to various factors like market demand, regulatory news, and technological developments.
Final Thoughts
The emergence of Cryptocurrencies has brought significant disruption to the concept of money with its decentralised nature. They have the potential to reshape the financial landscape, offering new avenues for investment, payment, and even societal organisation.
However they are not without their own challenges, such as being perceived as tools for illegal activities or mere speculative assets, and navigating regulatory uncertainties.
As the world adapts to digital revolution, it’s clear that cryptocurrencies are here to stay, although their ultimate role in the global economy is yet to be determined.
It’s essential for individuals and institutions to educate themselves and consider their implications for the future of finance.
neko x
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