There is so much buzz about crypto currencies and its underlying technology Blockchain.
However, for an average Joe it is rather difficult to grasp what exactly all this means and where is the world headed for; whats in it for Individuals, Companies, and the country's regulators. Here I try to simplify what I have understood regarding crypto currencies, blockchain, its use-cases, whats good and whats not so good, and what the future may behold.
To simply put, cryptocurrency is a store of value; similar to fiat currencies such as US Dollar, Indian Rupee, or the Japanese Yen. Just that the crypto currency is not printed on paper by a central authority such as the Reserve Bank of India. The crypto currency can be exchanged online and every record of transfer of crypto currency is recorded on a public register called as a block chain. Today there are hundreds of crypto currencies with top currency such as Bitcoin, Ethereum, Cardano, XRP, Polkadot among others traded on crypto exchanges all over the world. The combined market capitalization of all crypto currencies is about 1.7 trillion US dollars as of January 2022; that is 1.6 times the GDP of Mexico !
2. Why and How cryptocurrencies were born ?
Crypto currencies are kind of peoples money - No centralized authority or control to print and distribute !
Central banks print currency, control inflation, interest rates through their monetary and fiscal policies. During the Global Financial Crisis of 2008, the common man felt helpless. Interest rates increased, housing prices collapsed, creditworthiness of individuals and companies deteriorated, the world financial system was brought down to its knees. Large companies were bailed out by governments using public tax money but the common man suffered heavily - loss of jobs, loss of property, and wealth destruction as world markets collapsed. Post this crisis, there was an idea of creating a currency independent of the central banks of the world - kind of taking matters in public’s own hands ! Bitcoin was the first crypto currency to be born; a brainchild of an “untraceable” hypothetical Japanese person called Mr. Satoshi Nakamoto.
3. What is a Blockchain ?
Crypto currencies are “exchanged” on a public record or register called as Blockchain. A block can be thought of as a packet of data or information. This block passes from one node to another node forming a chain. There can be many nodes in a single chain. Important point to Note is all Nodes are kept up-to-date about all transactions happening in the chain.
Let me give an example of How blockchain works by giving an example of a Housing Society.
Assume there are 100 members in the housing society. Now if a member, say Mr. Nadkarni, wants to do a house renovation work, then he needs to apply to and get approval from all other 99 members of the society. Let’s say Mr. Nadkarni wants to paint his house in Blue. Then he submits an application to all 99 members. All members will review and approve the application and keep a permanent record with them stating “Mr. Nadkarni has painted his house in Blue”. This record is permanent and cannot be altered so easily. For e.g. if 3 years later, a member of the society or an outside member claims that Mr. Nadkarni has painted his house Red then this statement will be verified by each member and will be rejected because each member has a record which states that “Mr. Nadkarni has painted his house in Blue”.
Instead of taking approval from each member of the society, what if Mr. Nadkarni took approval only from a central authority (such as the society secretary or chairman) ? Then there is a risk that if only 1 record (one with the secretary or chairman) could be tampered with, the history can be distorted; there is a danger of the truth being lost. On the other hand, it will be very difficult if not impossible to tamper the records held by all 99 members of the society in a block chain environment.
As we can see, the Blockchain methodology is more effective (99 people can attest to the “truth”) but also inefficient (need to ask all 99 people to reveal the “truth” instead of record from 1 central authority).
4. What are the practical uses of Blockchains ?
Crypto currencies such as Bitcoin mentioned above are a practical use case of Blockchain.
As we can see, the concept of block chain is much wider and can be used in real life. Extending on the example of housing society, let’s consider the case of property ownership.
For example a person holding a title on a parcel of land has a record of land registration with him. This same record is held by the central authority such as the municipality. Occasionally, there are cases in India and elsewhere in the world where property rights are under dispute. Although a person is holding the title paper, there could be claims on the same property showing ownership rights and thus the title will be under dispute.
Blockchain offers a solution to this problem. If the property is registered on the block chain (called as a smart contract), then all members in the chain have a record that the parcel of land is owned let’s say by Mr A only. It is not possible to change the record unless all members agree to it. Later, if some other person Mr. B claims ownership on the title, the claim will be instantly refuted as it does not agree with the “truth” held by all nodes (members) of the chain. This trust-less, de-centralized nature of block-chain creates more transparency, and also reduces frictional costs - dispute resolution is quick as “truth” is known to All. Potential to save time and court and lawyer fees !
Blockchain technology is also used today to transfer money across the globe - using ripple’s platform via the XRP cryptocurrency - the transaction is done at a fraction of what it would cost through the traditional SWIFT channel and also completed in seconds as against few hours to couple days taken in traditional remittance procedures. As of this writing, 100+ financial institutions world over have partnered with ripple for cross border payment solutions.
5. What is the future of Blockchain ?
Similar to managing the property rights example given above, the block chain technology can be used in protecting copyrights, patents, securing medical records, validating and processing insurance claims. The solutions are endless and can span across industries.
There are concerns and challenges around blockchains such as the security of blockchain against cyber attacks, use by anti-social forces for money laundering and extortion activities among others. Also, the global regulatory landscape is not yet clear, and taxation rules on income earned through trading cryptocurrencies is yet to fully develop in several countries. Additionally, the mining activity associated with cryptocurrencies is power intensive though we have seen renewable energy sources being increasingly used for mining purposes - bitcoin mining today consumes 0.5% of the worlds energy needs !
So what are the central banks doing amid an increasing interest in crypto currencies - they are developing their own crypto currency! termed as CBDC (Central Bank Digital Currencies). The role of Central banks around the world is to maintain a well functioning financial environment, aid economic growth while keeping inflation under control. Central banks are developing use-cases for their own digital Crypto currencies - the purpose is multi-fold; from payments monitoring to taxation monitoring, payment of social security benefits to its citizens among others. As of 2022, more than 100 countries in the world have researched into CBDC and are either in the Research, testing the Proof of concept, or close to the Launching stage of a CBDC. A digital Yuan, Digital Yen, e-Krona, Project Atom of Australia are some of the CBDCs under consideration by their respective central banks.
As with any emerging technologies, there are bound to be opportunities and challenges, pluses and minuses and crypto is no exception. These are still early stages and block-chain technology and use-cases continue to evolve. It would be interesting to see if mass adoption of cryptocurrencies by individuals and institutions can become a reality or not in the future. However, it is becoming increasingly clear that the potential of block-chain if used for the right purposes has immense practical applications, and only time will tell if they become a main-stream adoption and integrate into business and society.
