Blockchain vs Bitcoin vs The Stock Market
With the recent uptick in Bitcoin’s price, there’s been a ton of interest about how to get into the cryptocurrency market. Some people think it’s all a scam, some people think it’s the future, and some just want to make a quick buck. For cryptocurrency as it stands right now, I fall into a mix of the three opinions, and figured I’d throw my two cents into the ring. I’ll go ahead and preface this entire post with I know only a small amount about cryptocurrencies, so don’t take what I say as the absolute truth. Feel free to leave comments telling me why I’m wrong about what, and I’ll try to update this if I’m not feeling too lazy. I’m mostly using this post as a place to post about my observations and thoughts.
For starters, let’s do a quick check on what exactly blockchain is. This is my explanation of it, so it’s prone to error, but I think overall it’s accurate (comment below if you think otherwise though and again, I’ll try to update this if I’m way off base). Essentially, blockchain is a way to make a ledger of transactions that is 100% public yet not hosted in one central place (i.e. decentralized). At the same time, the transactions on it are “pseudonymous” (every transaction has an address, but you don’t necessarily know who actually owns the address).
This is an incredible technology, as it allows for any system that is normally kept by a single entity to be put out to the public, without needing everyone to post their private details. As a quick example: Imagine an election system, where you need people to track the votes, and a way to verify the votes. In a normal election system today, you place your vote to a central authority, who counts your vote with others, and then reports back the results. If you want to check what your vote was, you can ask them, and that is how you can verify your vote. But in order to validate the entire election, you would need to re-gather everyone else’s votes and count them yourself, and then validate each persons vote against the original system. This is tedious, requires a lot of private information about others, and is generally not feasible in any election.
With a blockchain voting system, everyone could cast their vote, and verify their vote on the public ledger. Your vote would be private unless you shared it, and everyone could count every vote that comes through the ledger. There are other challenges of course, such as ensuring that every person votes just once, ensuring there are no “fake people”, and other things, but blockchain handles a lot of other potential issues on its own. For example, with blockchain, it is just about impossible to modify other people’s votes, as you would need complete control of the entire system (and would need to maintain that control until the election is over). There’s a lot to be worked out with this, but several folks are already hard at work on this at least.
So that’s how blockchain works, but how does bitcoin utilize this? Well with bitcoin we effectively have a public ledger with all transactions that have ever occurred with the cryptocurrency. For example, if Alice wants to send Bob 5 bitcoins, Alice creates a transaction via the blockchain. This transaction is then verified by someone else to ensure that Alice has a valid address with 5 bitcoins and that Bob has a valid address to receive these 5 bitcoins. It also creates what is called a Nonce, which identifies this unique transaction. The Nonce is very hard to generate however, and this is where the majority of “mining” a bitcoin comes from. Once someone has verified the transaction and generated the Nonce, they are awarded a new bitcoin in the system. An entire Medium post could be dedicated to explaining this, and I don’t 100% understand all of the exact details, so I’ll leave that to you guys to read more into.
What makes blockchain so appealing is the fact that transactions can be done with anonymity and without a central authority. When Alice sends Bob 5 bitcoins, they use their Bitcoin Wallet addresses to do so, which if they haven’t shared with anyone else will mean that no one else will know who they are. On top of this, you don’t have to worry about waiting for a middleman to handle the transaction. This of course has led to shady uses such as for illegal drugs, but does have legitimate uses too (such as in countries where what should be legitimate transactions are blocked for political reasons). The big thing that I question about this however is does this make Bitcoin a currency? While yes, you can buy many things with Bitcoin, it is still very hard to purchase every day items in the U.S. with Bitcoin (or other cryptocurrencies for that matter), meaning that I personally do not have a big use for it in my daily life. That said, many people predict that in the future, as more places begin to accept cryptocurrencies, they could rise in value.
This has led a large amount of folks to start trading these coins as an investment. The idea is that right now, Bitcoins can’t be used for a lot of things, but in the future you will be able to use them for everything. If you have a lot of them in the future, and they can be used in the majority of places, then of course you would be very rich. This led to the value of a Bitcoin to begin changing in price as folks attempted to figure out what the value would convert to in other currencies (such as the U.S. Dollar). The result of this has been almost a stock market made of various cryptocurrencies, complete with exchanges and all. This has started to turn Bitcoin and others into investments, rather than currencies. The volatility especially has made them especially desired by those who want to (and have successfully) make millions over night. This leads to the question: Is Bitcoin an investment like the stock market, or a currency like the Japanese Yen?
In my personal opinion on this matter: I do not think it is either an investment, nor a currency. Part of what makes many currencies valuable is their backing by a central authority. Whether that is gold, a government, or some other entity, and how valuable they really are, is up for debate. But the ultimate point is that if I gave you a piece of paper and told you it was a currency, you would probably not take my word on it. On top of this, the actual ability to use Bitcoin out in the physical world is still very lacking. It is incredibly difficult for me to go to my local grocery store and buy my groceries in Bitcoin. While companies are looking to solve this, I don’t think there is an easy solution to this, especially as companies like Valve begin to stop accepting Bitcoins at all.
As far as using Bitcoin as an investment, I think Bitcoin falls flat here too. The idea of an investment is that you put your money into something with the expectation that it will be worth more money later. This idea however is usually based on some set of factors that are generally reliable. For example, if you invest your money into your own company, you generally have the belief that the company is doing something that is worthwhile enough to make it more valuable later on. Many people say that Bitcoin trading is like the stock market in that both could go to a worth of 0, but thanks to Market Makers this isn’t exactly the case with the stock market. Similarly, I don’t see Bitcoin going to exactly 0 (someone will always value it I believe), but I do think it’s drop can be much more severe. The bigger issue is that with Bitcoin, you are purely speculating what will happen with it based on how other people feel about it. With companies, many pay dividends that are based on how much money they make, meaning that you can get a good estimate as to its value based on its earnings, which are much more solid than how someone feels about a virtual currency.
With all of this said, it sounds like I am completely dismissing crytpocurrencies as a whole, but I do think they are incredibly valuable. I just don’t think we should view them as either a currency nor an investment. Cryptocurrencies like Bitcoin are something entirely new, a third category that has solid properties of both. I think even calling them cryptocurrencies is a bit bad, and we should figure out what this new category actually is. What this new name should be, I have no idea. What I do know is that treating them like either an investment or a currency will more than likely lead to trouble, and I do think cryptocurrencies are headed towards this. It’s important to remain levelheaded and really figure out what they actually are to move past what is coming.