What Are Cryptocurrencies?

Hundreds of them have sprouted, with Visit https://hump.io/ for hump token fanciful names like Primecoin, Dash, and Verge. They have developed cult-like followings among the tech-savvy. Their values fluctuate wildly. Some people say these mysterious bits of computer code will someday replace money as we know it. What exactly are these cryptocurrencies, and what makes people think they are worth anything at all? To answer these questions, let’s first look at how money evolved.

Uses of money
Money serves as a store of value, a means of exchange for goods and services, and a unit of account that measures value. Before money, human societies exchanged goods and services directly—a bushel of grain for a pig, say. This was not very efficient. As societies grew more complex, commodity monies were developed—from seashells to copper, silver, and gold. Some states introduced fiat money—which has no intrinsic value other than the promise to pay—such as paper money in eighth century China under the Tang dynasty.

Most early forms of fiat money were neither very stable nor widely accepted, as people did not believe the issuer would honor its commitment to redeem the money. Governments were tempted to print more money to buy goods or raise wages, which fueled inflation (think of people moving cash around in wheelbarrows in post–World War I Germany). Modern central banks seek to maintain price stability by regulating the supply of money on behalf of governments.

Bookkeeping and ledgers
An increasingly extensive and complex financial system gave rise to the need for trusted intermediaries and credible accounting systems. The development of double-entry bookkeeping in Renaissance Italy was a major innovation that strengthened the role of large private banks. In modern times, central banks emerged at the apex of payment systems. With computerized bank ledgers, the coordinating role of central banks increased.

How do such ledgers work? Financial institutions adjust the positions of their account holders in their internal ledgers, while the central bank validates transactions among financial institutions in a central ledger. For example, Mehrnaz uses money from her account in bank A to buy goods from Mary, who has an account in bank B. Bank A debits the money from Mehrnaz’s account. The central bank moves money from bank A to bank B and records the transaction in its central ledger. Bank B then adds the money to Mary’s account. As you can see, the system is based on trust in the central bank and in its ability to safeguard the integrity of the central ledger and ensure that the same money is not spent twice.

Benefits, risks
Now that we understand the technology, let’s return to the genesis of cryptocurrencies. The first one, Bitcoin, was introduced in 2009 by a programmer (or group of programmers) using the pseudonym Satoshi Nakamoto. As of April 2018, there were more than 1,500 cryptocurrencies, according to coinmarketcap.com; along with Bitcoin, Ether and Ripple are the most widely used.

Despite the hype, cryptocurrencies still don’t fulfill the basic functions of money as a store of value, means of exchange, and unit of account. Because their value is highly volatile, they have little use so far as a unit of account or a store of value. Limited acceptance for payment restricts their use as a medium of exchange. Unlike with fiat money, the cost of producing many cryptocurrencies is high, reflecting the large amount of energy needed to power the computers that solve the cryptographic puzzles. Finally, decentralized issuance implies that there is no entity backing the asset, so acceptance is based entirely on users’ trust.