When will banks and governments feel it?

The painful reality of cryptocurrency

If [the American] people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their Fathers conquered…. I believe that banking institutions are more dangerous to our liberties than standing armies…. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.t ~Thomas Jefferson

An unprecedented revolution is in progress, in case you haven’t noticed.

Like all revolutions, this one, too, is different. It’s not that its arrival was never foretold. Quite the contrary, it was predicted years ago. It’s just that nobody really cared all that much. And revolutions usually come unannounced.

Bitcoin, Litecoin, Ethereum, etc. These are just some names of the same announced revolution that will disrupt the world of finance and — before that — the way people manage and exchange their financial assets, whether it’s a house, a car, bonds, apples or pears.

Some of the most important technological aspects of current cryptocurrencies have yet to reach the point of perfection. But the stage is set for the unstoppable army to steamroller the world into submission. Yes, we are at war, but not a single rocket needs to be launched.

So how does this new wave of crypto money work and how will it affect our life?

Let’s start with Bitcoin, a cryptocurrency that many don’t like to label as such. Created more than a decade ago, it will stop being mined by 2140, after which miners will be forced to find a new form of incentive as mining will become more expensive than the block reward itself.

The technology behind the Proof-of-Work, the heavy computation required to maintain the blockchain consistent yet decentralised, is consuming as much energy as a country like Ecuador and is doomed to increase if more and more people and organisations decide to join the “bitcoin revolution”. This in turn is raising some legitimate questions regarding how efficient such a network would be and how bad for the environment it actually is. Paradoxically, the higher the number of users, the slower the network, since more activity means more transactions to be processed and more pending transactions to deal with. In fact, from a computer scientist’s perspective, the Bitcoin protocol is neither efficient nor scalable. But please do not panic nor be surprised: no decentralised protocol can be as efficient as the centralised equivalent. Remember this when someone is comparing the throughput of Bitcoin to that of Visa next time.

Two major schools of thought have issued their verdict for this crypto-craziness. Some are counting the days till the imminent crash of Bitcoin, because a currency increasing its value by 145% a month smacks of a bubble. Some others — and I am including myself — are drawing deeper conclusions that tell a slightly different story.

To start with, Bitcoin — or any other cryptocurrency widely recognised and accepted by a community — has properties similar to those of gold and fiat currency. Like gold, Bitcoin can be stored but is not used for daily payments. It increases in value as it becomes rare, while resisting inflation. And though this comparison may sound somewhat superficial, does this automatically render it crazy? Maybe.

As a matter of fact, the cryptocurrency aficionados want to dismantle the traditional financial system, first by integrating crypto assets into it and then making sure that everyone appreciates the ease of transferring and managing assets without fees and intermediaries. On the other hand, traditional banks are still capable of playing the role that is instrumental for guaranteeing reliability, customer identification, and preventing money laundering as well as unethical financial transactions (e.g., arms dealer, drug traffickers and terrorists). We still need to find a mechanism that performs such a role within the cryptocurrency world. After all, crypto financial transactions live on the human substrate of the traditional transactions.

As for the 1–1 comparison, with the financial instruments we are all used to, Bitcoin in particular is closer to the concept of gold rather than currency. While resistant to counterfeit, it can be divided, easily stored and exchanged almost instantly (with respect to international transfers between any two traditional banks), Bitcoin is still very unstable to be considered a viable financial instrument to pay salaries, take out a mortgage, or represent the value of any good in the long term. Evidently, this extremely high volatility is due to the fact that the supply is completely detached from the demand and does not adapt accordingly (to be more specific, Bitcoin non-elastic supply is deterministically fixed). Hence, higher variations in the demand will reflect almost instantly in the market, dramatically changing the price of the coin and pleasing speculators, much like the dot com bubble and unregulated markets. Any improvement in this direction would accelerate the adoption of cryptocurrency in the current financial world. Just a hint.

But the biggest benefit of crypto currency comes when it is regarded as a rare asset like gold. Currency is an instrument that a community has agreed on in order to exchange goods and assets, to handle and generate value outside the pure financial ecosystem.
The Romans came up with the wonderful idea of taking an element that is rare in nature, that requires effort to be mined, that cannot be duplicated, in order to make items that can stay in a pocket and be exchanged by people. Sorry Mr. Nakamoto, you’re late, 2000 years late.

It was only later that gold was replaced by certificates that could be converted into gold and exchanged at a finer resolution. Such certificates, called banknotes, were guaranteed by private individuals and only at a later stage by governments and institutions like banks. The fact that transactions with banknotes were clearly easier than those with gold is the number one reason why gold has been entirely replaced by banknotes. Those in turn became just a certificate that represents the value of a rare asset. Does all this sound familiar?

Today we almost always use fiat money (“fiat lux et lux fuit”), based on the social contract that determines the legality and the exchange value in a community of people across nations. The role of the banks has always been to guarantee stability and to prevent governments from abusing it by controlling the currency.

With blockchain technology, and Bitcoin in particular, we are basically experiencing The Roman Monetary System 2.0, except that no bank nor Emperor needs to be involved in the process. How crazy does it sound now?

Introducing banknotes as the certificate that represents an asset in any monetary system opens the door to other phenomena that institutions can take advantage of: seignorage. The term comes from seigneur (lord in french) and indicates the right of the lord to mint money. In fact, producing banknotes can be extremely convenient, if not regulated.
The 100 dollar bill is just a coloured paper that costs less than a cent of a dollar to produce. Still it represents a value of $100. The difference between the value of money and the cost to produce it goes under the name of seignorage. When this number is positive the government or the financial institution involved in the minting process will profit. Otherwise the operation will result in an economic loss. Needless to say, seigniorage is one of the many forms of revenue for a government to finance expenditures without the need to collect additional taxes. Smart, right?

With blockchain this will change. In fact, anyone can mint new money and profit the value it represents (provided the minting effort contributes to maintain consistency of the blockchain a.k.a. if consensus in block verification is achieved). Sooner rather than later, governments will have to face the fact that minting money is no longer necessary nor convenient. Moreover, joining the blockchain revolution, a decision that would be taken as soon as governments realise stopping it is impossible, will not secure to any government nor institution an advantageous or monopolistic position with respect to any other miner on the platform.

This is Bitcoin. And that’s one of the most limited of the cryptocurrencies. The power of technologies like Ethereum knows no limit other than the fecundity of the imagination: they are paving the way for a plethora of applications to be executed in a fully decentralised way and without the need for intermediaries and institutions.

As a matter of fact, there is a very active community who is decentralising services with blockchain technology and cryptocurrency. One attempt to decentralise machine learning is fitchain. Check it out at fitchain.io

Written by

Managing Director @ amethix.com Chief Software Engineer & Host @datascienceathome.com

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store