There is a lot of talk going on today about how Bitcoin and other cryptocurrencies are an option for investing or not. Those who have invested in Bitcoin a year ago have seen the value of their BTC soar beyond expectations late in the last year, then fall to a much lower level a few weeks later – the increase is still massive (today, one BTC trades as about $8,000 compared to just above $1,000 one year ago).
I have been writing about cryptocurrencies lately. I think I need to post something very basic about them, here. Let’s not think of Bitcoin, or any other currencies as investment options right now, but as a payment system, and look at the way it works compared to banks.
How banks work
Banks are, first and foremost, businesses. They offer their customers an account where they can hold their money, from where they can transfer it to other accounts as a form of payment, and pay a fee in exchange for this service.
Their payment methods are secured using the latest digital technology but they are the same as they were before – actually, the same things could be done, only much slower, by using pen, paper, and carrier pigeons.
Their activity is strongly regulated by the authorities – but even with this strict oversight, there are cases when manipulation, tampering with exchange rates and other forms of foul play find their way in the world of banking (not to mention government bailouts and such).
Banks rely not on deposits but on loans to make profits – and they depend on profits to survive.
Banks have their advantages, like their long history, the widespread acceptance of bank cards, their fraud protection measures and the fact that they do not rely on the internet for money transfers, but they also have their share of shortcomings, like their vulnerability to manipulation, to inflation,
How the blockchain works
Unlike traditional financial systems, cryptocurrencies are completely decentralized – each block in the blockchain, the distributed database on which they rely, holds a full copy of the entire ledger.
And the majority – currently 51% – of all the nodes (each one holding the blocks) must agree that any transaction is valid before it can be completed.
This makes the blockchain tamper-proof and gets more secure as more nodes (more processing power) are added to the system.
Unlike fiat currencies, cryptocurrencies can’t be issued as central banks please – they are available in a limited supply.
Cryptocurrencies have the advantage of being manipulation-proof (or is it?), cheap, and global, with an ever-increasing grade of acceptance.
They do have shortcomings, though – they are still not accepted widely enough to truly matter, they are under a lot of pressure from central banks and other institutions, and the exclusive reliance on computers to function.