Friday, January 17, 2014

Cryptocurrencies: The future of Bitcoin and its peers

The Bitcoin logo
Bitcoin is a name that most people have heard of. You might not have heard the term "cryptocurrency" or the names of other examples such as Litecoin, Peercoin or Dogecoin. Cryptocurrency refers to any currency type that uses cryptography to ensure the verifiability and in most cases, anonymity of all transactions. Bitcoin was the first modern cryptocurrency, but there have been many others. In fact, creating a new cryptocurrency is so easy that the proliferation of them is getting a bit out of control. A new currency introduced this month, for example, only has 42 possible coins that can be mined--an homage to Douglas Adams' Hitchhiker's Guide to the Galaxy comedy / science fiction series of novels. These vanity and joke currencies began after an Internet meme was turned into the only semi-serious cryptocurrency, "Dogecoin," which refers to the misspelling of "dog" often used on Web sites such as reddit.com.

So, is this just a silly and short-lived flurry of activity? Will Bitcoin and all it's silly ilk die off?


No.

Bitcoin is here to stay for a few simple reasons:

  1. There is no central organizational structure to Bitcoin or most other cryptocurrencies, so even if most people were to lose interest, the currency itself will continue on.
  2. Cryptocurrencies are durable. A wallet can be lost, permanently leaving a chunk of the currency unavailable, but it is never actually destroyed.
  3. There are too many people in the world who want to transact in a currency that isn't centralized.
This last item has been interpreted as a signal that cryptocurrencies are a vehicle for crime, and certainly crime has been a big consumer of Bitcoin and, to a lesser extent, other cryptocurrencies. But the value proposition is much larger than that. Sometimes perfectly legal activities in one area are constrained, financially, because of regulations in another. For example, right now in Colorado, marijuana is legal to sell, according to the state, but retailers can't deposit that money in banks because of Federal regulations. They can, however, transact in Bitcoins and transfer their holdings instantly, anywhere in the world: to an exchange like Mt. Gox or BTC-e or to a wholesaler for more product. Or they can simply hold the coins themselves (running much the same risk as holding cash, of course).

The real question is: how much value can a cryptocurrency have when anyone can create one? This question is important, not because it spells the end of cryptocurrency, but because it might be the beginning. What if, for example, the US Federal Reserve and Treasury Department announced tomorrow that they were minting their own form of cryptocurrency and that it would enjoy the full faith and credit of the US Federal Government? I think Bitcoin's value in USD would fall through the floor. In this way, cryptocurrency is just a new kind of paper to print money on. Eventually governments will get involved, and how they get involved will be very interesting to watch. I doubt that we'll see any one nation successfully introduce their own cryptocurrency, but I could see one with a very shaky economy decide to pin their physical currency to a cryptocurrency... That would be interesting. There are already some people pointing out that, in these weak economies, the transactional value of BTC (or B⃦) is massive to those parts of the world.

On the side of the lesser currencies, I think that the momentum of Bitcoin will continue to propel it forward, but alternatives like Litecoin and Peercoin will continue to have as much value as they introduce through innovation. Newer currencies will have a harder time getting established, but hat doesn't mean they're valueless. Essentially, we're in the land-grab stage of cryptocurrency development, and the real estate that these other currencies have carved out for themselves will only become more significant over time.