Cryptocurrency - Future of Money Part-I

Nowadays more often one comes across terms like Bitcoin/Cryptocurrency/DeFi in business news. Bitcoin is making headlines worldwide as its price reaches US$55,000 per Bitcoin. A little more interest in such news would reveal that a group of computer geeks are relentlessly trying to disrupt the world of finance with DeFi - Decentralized Finance.

The central piece of DeFi is cryptocurrency - digital money. Money unlike issued by the Government or Central Bank but created by a computer program based on Blockchain technology. In a very very simplistic definition, a blockchain is a growing list of records, called blocks, that are linked together using cryptography. It is managed by a peer-to-peer network for use as a publicly distributed ledger, where nodes collectively adhere to a protocol to communicate and validate new blocks.

The system we use now for managing exchanges of currency and assets dates back to 1397 when the Medici family first established a bank in Florence. The invention of the bank made it possible for two strangers to do business as the bank acted as middleman and provided the necessary trust. Thus the banks created rent-seeking businesses, positioning themselves as fee charging gatekeepers. Anyone who needed to send or receive money had no choice but to deal with a bank. As this new finance business grew and became more complex, other rent-seeking intermediaries such as securities brokers, insurance agents, financial lawyers, payment processors and credit card companies of modern day installed themselves to provide intermediate trust. As it currently works our highly interconnected global economic system would collapse if these middlemen stopped working. All this has made us wholly dependent on the banks for our monetary exchanges. This is what gave rise to the behemoths of Wall Street, which ultimately took the world to the brink of disaster in 2008.

On 15 September 2008 the collapse of Lehman Brothers - the fourth largest bank in the USA triggered the 2008 financial meltdown. There was a good chance that the banks may not be able to fulfill their obligations had the US Government not bailed them out that cost the taxpayers US$498 billion. This translated into a loss of trust in the middlemen. Into this world of broken trust the hitherto unidentifiable mysterious figure pseudonym Satoshi Nakamoto placed his bitcoin project, just one month after the Lahman collapse. On 31 October 2008, several hundred members of an obscure mailing list comprising cryptography experts and enthusiasts received an email from somebody calling himself Satoshi Nakamoto, “What is needed is an electronic payment system based on cryptographic proof instead of trust. I have been working on a new electronic cash system that’s fully peer-to-peer, with no trusted third party.” His brief text directs them to a nine page white paper posted at a new website that he had registered two months earlier, which describes a currency system he calls bitcoin.

The simple genius of cryptocurrency is that it cuts away the middleman yet maintains an infrastructure that allows strangers to deal with each other. It does this by taking the all important role of ledger keeping away from centralized financial institutions and handing it over to a network of autonomous computers, creating a decentralized system of trust that operates outside the control of any one institution.  At their core, cryptocurrencies are built around the principle of a universal, inviolable ledger, one that is made fully public and is constantly being verified by these high-powered computers, each essentially acting independently of each other. In theory, that means we don’t need banks and other financial intermediaries to form bonds of trust on our behalf. The network based ledger - which in the case of most cryptocurrencies is called a blockchain - works as a stand-in for the middlemen since it can just as effectively tell us whether the counterparty to a transaction is good for his money.

Cryptocurrency promises to reduce costs of doing business and to mitigate corruption inside those intermediating institutions as well as from the politicians who are their indirect beneficiaries. Since cryptocurrency works on digital wallet technology, therefore, transactions can be done from a smart phone in your pocket. The biggest promise of cryptocurrency is that it can bring the unbanked people into its orbit thereby enabling them to take active part in the economy, since you don’t need a bank to transfer money. All this can be done with a smart phone in your pocket. There are estimates that about 2.5 Billion to 2.0 Billion people in the world are unbanked.