2010 was a great year to make $75 million with less than you spend at Starbucks in a month. Although at the time, neither of us knew why.
A while back, I wrote about the incredible innovative impact that blockchain will have on not only business but the underpinnings of virtually every aspect of commerce. Notably, the most visible impact of blockchain, so far, has been in the rising value of cryptocurrencies such as bitcoin. How much of a rise? According to CNBC, $100 in 2010 bitcoin value would have translated into $75 million today--probably more by the time you read this.
While my earlier article delved into the guts of how blockchain innovations will rock commerce, here I'd like to look at what the future of cryptocurrency might look like and the likely scenarios for the value it will create.
1,000 Cryptocurrencies, and Counting...
A cryptocurrency, such as bitcoin, is a unit of value that can be used for online transactions. There are about 1,000 different cryptocurrencies in circulation today. Among the more popular are bitcoin, Ethereum, Ripple, NEM, and Litecoin. While not all of these are not strictly cryptocurrencies--for example Ethereum is an actual platform for distributed applications--they all have a cryptocurrency component.
Just to give you some scale: The total market cap of the cryptocurrencies I just listed is about $75 billion as of today. That may be a rounding error in comparison to the $1.5 trillion of U.S. currency estimated to be in circulation, but it's nothing to turn a blind eye to.
It's called a "crypto" currency because various encryption mechanisms such as blockchain are used to assure its validity, ownership, and value. The last of these, value, is actually determined by both demand and an algorithm that caps the number of units that can be issued. In the case of bitcoin, the number is 21 million.
The blockchain algorithm gets increasingly more complex as the number of units approaches the maximum that can be issued. Computers called miners are actually used to apply the extraordinary computing power required to mine or record new bitcoin transactions. To give you an idea of just how much horsepower is required, even the most powerful laptop with a graphics card would require over 500 years to mine a single bitcoin. By the way I'm using the term "mining" as it applies to a bitcoin, but in fact the bitcoin is just a reward for creating a block in the blockchain.
But the real issue of interest is not the algorithm but rather the impact cryptocurrency will have on so many aspect of how we use and manage money.
Old Money Versus New Money
A few years back, I was invited to speak at a Federal Reserve meeting in Chicago. At the time, bitcoin and a small cadre of cryptocurrencies had already caught the attention of many in the financial industry. But the Fed had a specific concern about the future of currency as it entered the cyber realm, namely that, as it stands now, there is no way to use monetary policy to manage cryptocurrency.
But wait, you're thinking, "If bitcoins are only worth what people who use them say they're worth then are they worth anything at all?" Great question. After all, although the dollar is a fiat currency (meaning it's not based on a gold standard or any other commodity), the U.S. government still stands behind it. Good point. But if a cryptocurrency is used by enough people, then won't it have value because of all of the people who stand behind it? Well, only as long as they all agree it has value.
Now, granted, you can make a case that because it is scarce, transferrable, and backed by a global network of nodes that secure the blockchain it has some inherent value. But ultimately, the value will hinge on how widely used and accepted the currency is. And that only seems to be accelerating.
For example, you can actually get a Visa card that is funded by bitcoins or Ethereum which you can use to buy just about anything you could with any traditional currency.
However, here's another take on cryptocurrency that's worth considering. Until now, currencies have only been issued by governments. Although I can store that value in digital form or even as gold bullion in a safe, I have to ultimately convert my value into currency in order to conduct virtually every transaction. That has some interesting repercussions. First, it provides an auditable trail of my transactions, which is critical to how I am taxed, deemed to be credit worthy, limited in how easily I can transport currency across international borders, and ultimately how I transfer and pass wealth on to my heirs.
That sounds as though cryptocurrency is primarily a way to circumvent the regulations and legal restrictions on how I transact. But let's not forget that the ultimate anonymous currency was paper money, which is slowly going away. So, there is one overwhelmingly non-illicit reason I may want the anonymity of a cryptocurrency, namely that it is quickly becoming the only form of anonymity I have on the internet. In an age of increasingly transparent transactional behaviors, cryptocurrency is totally bucking the trend.
In some ways, it may be our last hope of actually protecting our identity, at least our economic identity. But wait, there's more.
Another cryptocurrency, Ethereum, has just started auctioning off names that you can use to create a crypto identity for your wallet to use your cryptocurrency. Deposits on some of these names have reached $1 million using an obscure type of auction process (Vickrey auction) that is somewhat reminiscent of the rush to buy domain names in the late '90s. Yeah, you're starting to see the possibilities of where this might be going.
Fascinating as this all is, the question remains, "Will we continue to see the sorts of gains over the next seven years that we've seen over the past seven?" OK, seriously now, if you're expecting a crystal ball to emerge on this one I'll be there first to admit that I don't have it. If I did, I'd have used it seven years ago and be writing this from the secluded island my mega yacht would be docked at.
The Future of Cryptocurrencies
What I can say with certainty is that this is clearly a hedge bet if ever there was one. But don't expect it to be a smooth uphill climb. After an initial run-up, all cryptocurrencies take you on a nauseating roller coaster ride. The likely scenarios are, in order of probability:
- It all goes bust because of speculation and irrational exuberance. (Read dot-com 2001). Then it comes back in a decade or so with more substantial prospects for the future, which may be an existing or yet to be created cryptocurrency.
- Regulators step in and start to, or at least attempt to, impose restrictions on cyber currency and its use. Investors cool off, some panic, prices plummet.
- Breaches occur (either architected by nation states or by nefarious criminal interests) which undermine trust in crypto currency. Again, leading to the downfall of one, some, or all of the current players before a more trusted alternative is created.
- You buy into a cryptocurrency using a service such as Coinbase. You end up sitting on a small fortune and you send a generous donation to my cryptowallet to thank me for my foresight in helping you add a few more zeros to your legacy.
Note, however, that in each of the above scenarios, and pretty much any other one that I can come up with, cryptocurrencies are not going away. That doesn't mean bitcoin or Ethereum or any other currently existing cryptocurrency will be here 10 years from now (although, in full disclosure, I am betting they will be), but the idea of a new form of currency that redefines the notion of monetary value, economic transactions, contracts, and even identity, and how we use and protect all of these, is something that is clearly here to stay.
The only question now is how to go back in time to 2010?