The value of cryptocurrencies is rising fast. But is it sustainable? And how does it work, anyway? These questions, and many more, answered…
The money has become too much to ignore and so bitcoin and cryptocurrencies are back in the news. You may have heard about Ethereum, a cryptocurrency that has risen in value by more than 2,500% over the course of 2017. Or maybe you’ve heard about one of the many smaller cryptocurrencies that raised hundreds of millions of dollars in the first few days they were on sale, during their “initial coin offering”. Or you’ve just spotted that bitcoin, which made headlines in 2013 for hitting a high of $200, is now worth nearly $7,000 (£5,250), making a lot of people very rich in the process.
Are these cryptocurrencies simply speculative bubbles or will they actually transform our financial system? It’s time to answer a few common questions about this new technology – and assess whether a lot of people have just pulled off the investment of their lifetime or made a huge mistake.
What actually is bitcoin?
Bitcoin is a cryptocurrency, the first and still the biggest example of its type. At its core, it’s a new form of digital asset, created through a canny combination of encryption (the same technology that protects WhatsApp from eavesdropping) and peer-to-peer networking (which allowed music piracy to blossom in the 00s through services such as Kazaa).
If you own a bitcoin, what you actually control is a secret digital key you can use to prove to anyone on the network that a certain amount of bitcoin is yours.
If you spend that bitcoin, you tell the entire network that you have transferred ownership of it and use the same key to prove that you are really you. In that respect, your key is similar to a password that allows you access to your money, except with no possibility of resetting your key if you lose it. Anyone else who manages to discover your key would gain total, irreversible control over your cash. The history of all the transactions made is a lasting record of who owns which bitcoin: that record is called the “blockchain”.
What are its advantages over money created by central banks?
Bitcoin advocates will point to a number of possible advantages, from the ability to use the blockchain to track things other than simple money to the built-in support for “smart contracts”, which execute automatically when certain conditions are met.
But the biggest advantage, and the only one everybody agrees on, is that bitcoin is decentralised and so extremely resistant to censorship.
Although it’s possible to observe a bitcoin payment in process, it’s not practicably possible to stop it. That makes it radically different from conventional banking, where banks can, and do, intervene to freeze accounts, vet payments for money laundering or enforce regulations. That has made it a haven for activities from cybercrime and drug trading to enabling international payments to closed economies and supporting radically off-grid living.