Cryptocurrency – money or madness?
Well, to work that one out, you need to understand the nature of the beast. And while cryptocurrency might sound futuristic and out of this world, the reality is that it’s very much a 21st century invention.
In short, cryptocurrency is a decentralised digital currency – a currency that isn’t controlled by any one single person, bank, group or government.
How is cryptocurrency made? If you’re picturing the jingling coins in your pocket, you can let that go. Technically cryptocurrency is not made of anything; it only exists digitally and there are no physical coins or notes. (Except for fun keepsakes that crypto fans have made along the way).
The ‘crypto’ part of the name comes from ‘cryptography’, which is a way of making information secret and serves as the backbone to all cryptocurrencies.
Cryptocurrencies by their very nature, are highly technical and Bitcoin (the most well-established cryptocurrency) is no less complicated. Luckily, you won’t need a PhD in algorithmic maths to understand the explanation that follows, which aims to make the whole thing accessible and just a teeny bit fun. If you actually want to geek out and revel in the full technical specs, one way you can do that is with the original Bitcoin white paper written by its inventor, the mysterious Satoshi Nakamoto (whose true identity remains unknown to this day).
With that, here goes…
Bitcoin, is made by mining. And before you start thinking picks, shovels and dark caves, it’s not mining like digging for coal – it’s more akin to searching in cyberspace for buried treasure.
To earn this Bitcoin treasure, ‘miners’ need to complete two jobs: the first is to authenticate Bitcoin transactions, and the second is to solve a puzzle (or ‘hash’ as it’s known in crypto-lingo).
How does Bitcoin mining work? To answer this, we need to go deeper into the wormhole.
The technology that allows Bitcoin to exist is called ‘blockchain’. The blockchain is a record of how Bitcoins have been spent (like a ginormous spreadsheet, but made of blocks sort of like a game of Tetris).
Using a network of computers, miners analyse every Bitcoin transaction to make sure it’s genuine. Among other things, this ensures nobody spends more than they have.
Miners all have to agree that the transaction happened in the way the data says it did before it can be rubber stamped. When it’s verified, all that data gets put into a block. When that block is filled with data, it joins all the other blocks, which increases the length of the chain.
This verification process is essentially a way of making sure all transactions are ‘true’ and keeps the blockchain error free. Any transactions that cannot be authenticated simply aren’t recorded. Crucially, this means the currency cannot be controlled, fixed, faked or inflated easily by any one person or group.
After a miner has confirmed a certain number of transactions, they can then try to solve the puzzle. You can think of the puzzle like a quest to find a really, really long string of numbers and letters (or a ‘hexadecimal number’ if you want its official name). The first miner to get closest to this number wins and is rewarded in Bitcoin. At that point, you can say they’ve successfully mined some Bitcoin.
If you were to say it all sounds a bit 80s arcade game, you wouldn’t be far off. But there is some serious tech behind it all. Miners aren’t sitting in darkened rooms with pencil in hand furiously having a go at some twisted Sudoku game. They’re actually mining and authenticating transactions with hugely powerful computers that take up significant amounts of energy — indeed, enough to power the whole of the Czech Republic.
Of course, you don’t have to toil away as a Bitcoin miner to earn your cryptocurrency; you can simply buy some from a digital wallet service. Just remember, cryptocurrencies are volatile and while savings might rocket to the moon, they might also crash and burn.
How can Bitcoin be worth anything if it doesn’t really exist? Why is £1 sterling worth £1? Because the Bank of England says it is and the rest of us have agreed to go along with it. As crazy as that sounds, that’s how the concept of money really works. A large proportion of society value money and participate in the quest to earn it. Bitcoin isn’t so different, except for one thing: the quantity of Bitcoin in the world is finite, whereas if the Bank of England wanted to print more money it could.
The number of Bitcoins in existence will max out at a small fraction shy of 21 million, and around 17 million of them have already been mined. After that, that’s it: no more new Bitcoin.
Looking at it from this perspective, Bitcoin is likely to hold its value so long as people keep buying into the idea. And for now, they do.
Although there’s no rolling record of how many miners there are, estimates put numbers in the region of hundreds of thousands. If you’re wondering whether the pot of gold is worth chasing, a single Bitcoin is currently valued at just over £9,000. And at its peak in 2017, one Bitcoin was worth nearly £13,500.
Is it ‘‘real money’? If you mean real as in, can you buy stuff with Bitcoin, then yes, it’s real.
A handful of places accept Bitcoin as payment, including Expedia (NASDAQ:EXPE) and Microsoft (NASDAQ:MSFT). Back in 2018, KFC Canada trialled crypto payments, and for one week you could even get your fried chicken fix with the ‘Bitcoin Bucket’. If that doesn’t make it real, what does?
The final frontier? Bitcoin is just one of many cryptocurrencies, but, for enthusiasts, they all represent a truer, incorruptible form of currency that can’t be manipulated by any person or government.
So, is cryptocurrency money, madness or the future of finance? Only time will tell.
MyWalletHero, Fool and The Motley Fool are all trading names of The Motley Fool Ltd. The Motley Fool Ltd is an appointed representative of Richdale Brokers & Financial Services Ltd who are authorised and regulated by the FCA, and we are permitted in this capacity to act as a credit-broker, not a lender, for consumer credit products (our FRN is 422737). The Motley Fool Ltd does not have permissions for, and does not advise on, investment products and services, but may provide information on investment products and services.
The Motley Fool receives compensation from some advertisers who provide products and services that may be covered by our editorial team. It’s one way we make money. But know that our editorial integrity and transparency matters most and our ratings aren’t influenced by compensation. The statements above are The Motley Fool’s alone and have not been provided or endorsed by bank advertisers. The Motley Fool has recommended shares in Lloyds (LON:LLOY), Tesco (LON:TSCO) and Barclays (LON:BARC).
Motley Fool UK 2019