An Introduction to Crypto
It seems that every time I delve deeper into cryptocurrency, I come up with more questions than answers. In an environment that is seeing unprecedented influxes of new investors due to information being peddled across social media, the idea of cryptocurrency and the blockchain is having its day in the sun. This creates an obvious problem — people flooding to the market are not educated about the risks and rewards of investing in crypto, and there is a lot of potential to both win and lose huge sums of money with a purely speculative approach. Ask the millions of novice investors who found r/Wallstreetbets.
So, let’s take a deeper dive into some terms and acronyms that you may come across in your journey into the future of finance.
DeFi
The first term that you may come across is DeFi, which is an acronym that stands for ‘Decentralized Finance.” Essentially, DeFi represents the general thesis of how the monetary system will run in the future. It is the inverse of the current system, which is controlled primarily by big banks, global consortiums like the International Monetary Fund (IMF), and, in the US, the Federal Reserve.
This means that no one entity is in control of the assets on the blockchain, a key distinction that many proponents of crypto believe to be the path to a more-transparent and equitable system.
By creating monetary policy, and adjusting key financial measurements like interest rates, our mostly centralized banking system means that, in general, our currency remains stable. However, this system has come into question in recent years as abuse has continuously been revealed, inflation continues to be a risk, and wages have remained stagnant. This is not to mention the system failure that caused the system that banks use to make wire transfers to go down, raising concerns that a centralized system may be susceptible to technological attacks and outages moving forward. Furthermore, the impact of the introduction of trillions of dollars via the stimulus initiatives by the US government to mitigate financial disasters caused by COVID remains to be seen, and most don’t think that it will end well.
This is where DeFi steps in to save the day. Essentially, the idea of having an entirely digital financial system relies on one of the primary advantages of the blockchain, which is having a global database supported by users of a massive peer-to-peer network. This means that no one entity is in control of the assets on the blockchain, a key distinction that many proponents of crypto believe to be the path to a more-transparent and equitable system. Moreover, all transactions on the blockchain are recorded, and accessible to anyone, meaning that the risk of market manipulation is reduced. To learn more about market manipulation in our current system, check out my article here.
Mining and Staking
DeFi can be achieved due to the advent of crypto mining, or the system that rewards people for supporting the blockchain with their own computer hardware. Essentially, people who mine crypto are using computers to solve complex problems that “verify” transactions on the blockchain. It can be thought of as renting these computers in exchange for cryptocurrency. These mining activities maintain the general ledger, which ensures that all transactions are recorded, and remain immutable after completion. This is in contrast to the current system of transferring money, which is done through banks and other financial institutions. Waiting 3–4 days for a wire transfer may become a thing of the past, and some say that it is a way to dramatically reduce the processing costs on remittance globally, just one of the ways in which cryptocurrency benefits financially underserved demographics.
Finally, with the introduction of de facto crypto banks, like BlockFi or Ledger, cryptocurrency investors have even more incentive to dump their funds into digital currency. These organizations allow what is called “staking,” a term for when a user deposits their crypto in exchange for accrued interest on that asset.
The rates offered by these companies far outpace those of the traditional financial market, and even so-called “high-yield” accounts — on BlockFi, I earn 8.6% interest on my “staked” Bitcoin (BTC), more than 14x the amount I would earn on a high-yield account with 0.60% APY. Naturally, staking cryptocurrency comes with an assortment of risks, and the entirely new concept of depositing a piece of software using real money doesn’t track with traditional investors (yet).
Any investor worth their salt knows the power of compound interest, and that is what staking does exceptionally well. Essentially, in the current Bull Market, crypto will continue to rise this year, and that boosts your value held in crypto. Some might argue that putting all of your money into crypto is the opposite of liquidity, because you can’t spend your Bitcoin or Cardano (ADA) anywhere. However, this is quickly being resolved by BlockFi, which is set to offer its Visa Rewards card, a way to earn crypto in lieu of cash back on purchases. This has now provided a third stream of income from crypto, joining appreciation in value and higher, compounded APY. Larger investors will be able to take advantage of this, and generate significant passive income, which is quickly becoming the primary means of accumulating wealth in an era of debt, stagnant wages, and automation.
Blockchain
Many analysts in the space of crypto believe that Bitcoin was just the beginning of a massive change that is going to wash over our society in the coming years. The underlying technology of Bitcoin is outdated when compared to other cryptos that are truly implementing the concepts of blockchain, like Ethereum and ADA. To reiterate, the beauty of cryptocurrency rests in its ability to decentralize financial frameworks and its disruption of the way in which we currently interact with each other. The aforementioned companies are two of the top players who are working to implement new advancements on the blockchain, like Smart Contracts, which I will discuss below. Some have compared Bitcoin to a PC, and Ethereum to the Internet. Ethereum couldn’t have been built without Bitcoin, but its technology has the potential to implement the theses that Nakamoto intended in the creation of Bitcoin.
Smart Contracts
Leaders in the space have quickly come to the determination that Blockchain will cause a shift in how we perceive each other, as the ecosystem of crypto is built upon rewarding for contribution, and punishing for fraud or misbehavior. Everyone who engages in the system of Blockchain has a copy of every transaction that happens on a distributed ledger, and for this reason, it is very difficult to hack. Each transaction includes key information about the previous transaction, as well as information about the current transaction, a process reminiscent of a Linked List in computer science. Thus, someone looking to defraud the system would have to have enough computing power to solve the algorithms and change the ledgers on every node on the network, which is virtually impossible.
One fun example that I thought about is one that we all may encounter at some point. As everyone knows, it is common for people to share subscriptions now. The best example of this is streaming services — services like Netflix and HBO allow a customer to have multiple accounts, allowing people other than the original purchaser to use the service without increasing the cost. Naturally, people began to take advantage of this, and it became common practice for people to share with friends and family for free. This is slowly changing as subscription prices rise (my Prime subscription cost me close to $130 this year), and people want to mitigate the costs through sharing.
Say that you and 2 friends want to share a Netflix account, and split the cost each month. Currently, this entails a relatively lengthy process. First, you enter into an agreement with Netflix to use their service for a certain amount each month. Then, you have to wait until you receive that bill each month to split it with your friends. In turn, they send you money, which you collect and send back to Netflix to pay the bill. I have used this system, using Venmo as the intermediary between myself and my friends. Let’s see how a Smart Contract might make this a little easier.
Some of the terms of a Smart Contract to split the Netflix bill might be that each person is required to pay as soon as the bill comes due, and that payment is triggered when the bill is received. Additionally, the Smart Contract is not connected to one person, but rather seen as one subscription by Netflix. So, this Smart Contract can then be set to have a conditional that will trigger a payment from this subscription to Netflix once each of you and your friends complete the transaction to send money for your respective part of the bill. Once these conditions are implemented, the process becomes entirely automated.
Moreover, it can be a way of enforcing certain rules, such as the consequences of not paying. Perhaps there could be a non-payment clause in your Smart Contract with your friends and Netflix that removes a user who fails to pay for more than 2 months. This contract could then penalize that person, remove them from the subscription, and adjust the process to accommodate the 2 remaining people in the Smart Contract without interrupting payment.
Some have theorized that this system could also create a certain rating system, akin to credit scores, where users of Smart Contracts would gain trustworthiness with each successful transaction or the meeting of an obligation. Thus, people would be rewarded and incentivized to do the right thing, and make good on their promises. No longer will we need third parties, like the credit bureaus, to tell us the history of each person’s financial life.
Further Implementations
Smart contracts go well beyond what I mentioned above. One of the most-interesting use cases for blockchain and Smart Contracts is the concept of ownership of an asset. Blockchain allows us to create an indelible record of the genesis of a given asset or transaction. Check out my article on NFTs to find out more about how blockchain can change our understanding of digital scarcity and ownership.
Every Bitcoin from the beginning of time has a record that is reflected on the distributed ledger, which can be used to trace it back to its creation. Unlike individual currency notes, each Bitcoin is traded directly to someone, rather than via a proxy, such as a bank. For example, when you retrieve cash from the ATM, you are crediting your account for that amount, but the serial numbers of the individual bills are not tracked, and there is no feasible way to track where this money had been before. Similarly, when you are paid via wire transfer, your account is simply credited that amount through the bank, rather than directly from the company to you; the money has to be processed before it is accessible, which can take time. This may be why illicit activities are generally transacted in cash — there is no proof of who owned each bank note before, and it is fast.
Imagine purchasing a house, and all of the difficulties that it entails. You have to find a mortgage, hire lawyers, go through closings, and pay expenses, like moving possessions or paying commission to the real estate agent. What would happen if we used a Smart Contract to solve that problem?
First, once the house is created on the blockchain, it can always be tracked to its original owner. Then, the owner could create a virtual Smart Contract with agreed upon conditions, moving the process along without continuous breaks. For instance, a Smart Contract might allow for the two parties to sign the agreement directly, without lawyers, based on the parameters of the desired outcome. An example might be that, once inspection has passed, the closing fees and such are automatically calculated and billed to each party, respectively. Maybe there would be an agreement that automatically pays the real estate agent’s commission once the seller receives money from the transaction. This ensures expeditious transfer of the house to the new owner, a transaction that would be processed on the blockchain, and stay with the owner until the house is sold again.
Final Thoughts
The above fails to scratch the surface of the true depth of how cryptocurrency will change our lives, and how to understand where these inevitabilities might take us. Once you can understand the foundational ideas of crypto and the blockchain, you can explore deeper the types of issues that each coin or organization is trying to solve. One surprising example is Ripple, which many believe has the potential to take over credit cards by speeding up transactions, namely removing the middle man or bank. DeFi is here, and it is quickly changing the world as we know it. Are you ready?
