The Shape(lessness) of Crypto
This is part 4 in the Fundamentals of Crypto series. To start at the beginning, visit our Intro to the series.
In Part 3: The Birth of Bitcoin, we saw how bitcoin emerged out of the ashes of a crisis, and how it’s basic protocols were fashioned in direct response, and as an intended antidote, to some of the perceived shortcomings of fiat currencies. In part 4 we’ll try to get a deeper understanding of how bitcoin functions as a currency.
With a very basic understanding of Bitcoin (the system) as a peer-to-peer payment network that’s programmed with specific rules and conditions that cannot be manipulated — we can turn our focus to the “other” bitcoin — the thing people are buying and selling, the thing people are saying you should HODL (hold on for dear life) because it’s value is going to the freaking moon! (hyperbole much?)
As we covered in Part 1 — the color of money, money is the underlying accounting system and currency is the unit used to denominate and exchange value. The same applies in the world of crypto. bitcoin (the token) is the latter. It’s the newest form in the ongoing legacy of currency, a modification, a digital update to the way we record, represent and express transactions and values within our money system.
By definition, bitcoin falls into the larger category of digital currency. In the same way that most of your US dollars are merely a line item on the virtual ledger of a bank somewhere — bitcoin, and other cryptocurrencies, are similarly an electronic representation with no physical or material existence. There are no actual coins (insert gasping emoji). Your “coins” are a metaphorical token, an abstract representation for the balance (the credits and debts) accrued to you and recorded on the digital ledger. And the value of those tokens, like other forms of currency, can similarly fluctuate, as things like confidence and demand for those using it increases or declines.
On the macro level then, cryptocurrencies are not so startlingly different than other forms of currency. They too seek to accomplish the three basic functions of a currency: a unit of account, a medium of exchange, and a store of value. The real revelatory aspect of bitcoin and cryptocurrency is to be found in how and to what degree they achieve said functionality. It is their programmability, the fact that they can be constructed and engineered in ways to enhance their utility as a currency, that makes them so unprecedented and so damn exciting. Unlike fiat or commodity currencies, whose rules, properties and conditions of usage exist and are enforced for the most part extraneously, the programmability of cryptocurrencies, and their connection to the underlying accounting system, is embedded into their very DNA. To illustrate this, let’s try to deconstruct an actual bitcoin token, and see just what the hell we are dealing with when we talk about cryptocurrency.
The preface crypto is a reference to cryptography. Literally translating to something like “hidden writing” it’s the practice of protecting information and securing communication through the use of codes. Sensitive information (eg. credit card info, email messages, personal records, etc.) is encrypted into a format that is unreadable for any unauthorized recipient.
In the case of cryptocurrencies, cryptography is actually built into the architectural framework of both the system and the token. Take bitcoin. Each bitcoin is actually a chain of digital time-stamped transactions (grouped together in blocks — hence the term blockchain). When a coin is transferred between parties, both the previous owner and the new owner “sign off” using keys. The inputs — the amount being transferred, the payee and payer addresses, and the timestamp are then hashed (an advanced form of encryption) and recorded onto the next block in chain. This means that each bitcoin has its entire history, and the entire history of the whole network, encoded and etched into it. Each bitcoin is a detailed, verifiable, ongoing record of all transactions processed by the network.
This is strikingly different than say, dollars. It would be like if your dollar knew everywhere it had been, and knew every where every other dollar had been as well. It’s an astounding amount of information that is baked into the fabric of the currency, and a major reason why it provides an unprecedented amount of security and protection from tampering. It’s the reason why you can’t just invent or duplicate bitcoins. It would be immediately obvious to the network that your bitcoin (your record of transactions) was bogus, that its story didn’t line up with the story everyone else had (aka “consensus”). This a major part of the brilliance of bitcoin. Both the network and the currency are built in such a way that they signify to each other their legitimacy. Bitcoin uses digital technology to merge and synthesize its currency with the underlying accounting ledger in a very direct way — creating a new kind of integrated self-regulating money system.
Our coverage of bitcoin, both here and in part 3: The Birth of Bitcoin, is far from exhaustive, but it provides a decent baseline context from which we can zoom out and make some generalizations about cryptocurrency.
- Cryptocurrencies operate on a decentralized network. They are peer to peer. They have no controlling central authority that can change the protocol or the rules of the game on a whim.
- They have cryptography built into the very fabric of the currency, and the architecture of the network upon which the ledger operates.
- They are digital, and therefore they are programmable. The tokens, and the networks upon which they run, can be imbued with specific attributes and designed with certain protocols, many of which allow them to transcend various physical limitations (eg. speed, distance, memory, etc.) or combat particular problems (eg. inflation, manipulation, etc.).
At this point it’s useful to go back to our list from Part 2 . If we measure bitcoin (as a general stand in for cryptocurrencies) against our list of key attributes, we can come to a better conclusion about it’s fitness as an effective currency.
- Durability. bitcoins are digital. As such they’re not subject to physical decay. They don’t degrade or wear out. They will continue to exist as long as the network continues to run.
- Portability. Again, bitcoins are digital. They are borderless. They can be sent anywhere there’s an internet connection, with the speed and ease of sending a text message.
- Divisibilty. bitcoins are insanely divisible. You can break them down into smaller units, down to the eighth decimal — aka a hundred millionth of a bitcoin, called a satoshi. This creates opportunities for much more nuanced pricing structures and a whole new economy of micro-transactions — making cryptocurrency a great denominator of value in extremely complex and varied markets.
- Fungibility. In theory all bitcoin and respective cryptocurrencies are identical and interchangeable, just as dollars or ounces of gold. There is however, a bit of a wrinkle. Because the history of each transaction and exchange of bitcoin is embedded into the coin and the ongoing ledger, it’s possible to distinguish where they have been used. Hypothetically, if bitcoins were used to say — finance a terrorist organization, drug trade, or other illegal activity, the coins used could be flagged in some way and might be viewed as carrying some type of risk. We’ll run further with this idea in another series (chinks in the crypto armor)
- Credibility. Bitcoin has been around for 10 years now. From inception it’s value and adoption has been on a general upward trend. As of writing this, 1 bitcoin (btc) today is worth around $8K (USD) and the market cap for all bitcoin is approximately $130 billion. It’s popularity and perceived value is certainly growing, however, its volatility remains high. Price fluctuations are frequent and sometimes dramatic. This instability has discouraged its usage for everyday payments, but faith in bitcoin as a store of value, as something to hold on to for the future, appears to be high though it still has a long way to go to garner the same trust and faith as dollars or gold.
- Liquidity. Today’s volume, the amount of btc exchanged in the last 24 hours, is upwards of $17 billion in USD. That means if you’re looking to exchange your bitcoin you’ll have no trouble finding buyers or sellers. But if you’re running out to the store to buy a bottle of wine, you’d better bring cash or a card. When it comes to usage for everyday payments, as a practical medium of exchange, bitcoin has not yet reached mass adoption.
- Scarcity. The supply of bitcoin is truly limited. Only 21 million will ever be produced. No more, no less. And there’s no central authority to manipulate the supply. Unlike with fiat currencies, you can’t just print more, or pull coins from circulation to exercise economic levers to influence the market.This has obvious implications on the long term value proposition of bitcoin and cryptocurrencies and gives weight to the claim that bitcoin has the ability to replace gold as a better long term store of value.
Not bad eh? Looking at the above list it’s not hard to fathom why cryptocurrencies could be poised to rise up and assume the position of dominant currency. That said, there is no perfect system, and it’s necessary, as with any serious discussion, to take a critical viewpoint and explore the potential issues and problems with cryptocurrencies. In succeeding posts we’ll offer some counter-arguments from the skeptics, and apply pressure to the claims made above in an effort to test their validity.
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