From the course: Finance Foundations

Cryptocurrency

From the course: Finance Foundations

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Cryptocurrency

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- So, what exactly is cryptocurrency? I'm sure you've heard of it. And many, when they hear of it, nod their head like they know what it is. And then inside themselves, they say, "I don't know what it is." Well, let's see if we can take away some of the mystery. Cryptocurrency is a decentralized electronic currency whose existence and ownership are documented through cryptographically secured data in a blockchain. Now, here are three necessary characteristics of a reliable currency. Reasonable limit on supply of the currency, verifiable, and broadly accepted. Now, before we get to cryptocurrency, let's think about each of these three characteristics with respect to gold and to United States $100 bills. First, is there a reasonable limit on supply? Well, gold is tough to mine. I myself have been two miles down in a gold mine in South Africa. The world is not going to be suddenly flooded with extra gold. Now, with $100 bills and all other forms of US money, the supply is limited by the policies of the US Central Bank, the Federal Reserve. If we trust the Federal Reserve to set good policies, then US currency is a reliable currency. Next, verifiable. Now, there are chemical tests that can confirm the quality of a gold bar or a gold coin. US currency is created with several embedded security features. You may have seen a wary cashier hold your $100 bill up to an ultraviolet lamp. The UV lamp reveals ink visible only under UV light. Next, broadly accepted. Well, I know from personal experience, a crisp new $100 bill is accepted just about everywhere in the world. Now, I have never tried to buy anything with gold, but my brother, who has some experience with gold, tells me that reputable gold dealers are everywhere. Okay, now that brings us to cryptocurrency. Is there a reasonable limit on the supply? Is it verifiable? Is it broadly accepted? Well, my discussion here is based on my understanding of Bitcoin, which is the original and most widely used cryptocurrency. Bitcoin is verifiable because it's based on the blockchain technology that we discussed in the previous video. Starting with the first 50 Bitcoins created on January 3rd, 2009, the Bitcoin blockchain contains a record of every Bitcoin transaction since then. And 'cause this blockchain is duplicated in thousands of widely dispersed nodes, corrupting it is practically impossible. The sender and receiver of a Bitcoin transaction have private and public keys that allow them to securely exchange transaction information. With Bitcoin, these private and public keys are used with the SHA-256 algorithm to create easily decodable transaction data for those with the private keys. Note, detailed discussion of private keys, public keys, and secured transaction transmission are outside the scope of this course. Now, before a new transaction is added to the Bitcoin blockchain, it must be validated. The validators are called miners. A miner runs a fast computer program that uses the hash associated with the transaction to create a new hash having characteristics defined by the system. Creating the new hash involves very fast guessing. The miners have an incentive to do this because the first miner to generate an appropriate hash gets a reward, which is hundreds of thousands of dollars. So because of the cryptographic protection of a blockchain and because of competitive validation by the miners, Bitcoin and other cryptocurrencies are verifiable. Next, is there a reasonable limit on the supply of Bitcoin? Yep. The Bitcoin system is capped at 21 million Bitcoins, and as time goes by, the system is set up to make Bitcoin mining progressively more difficult. Finally, is Bitcoin widely accepted? Accepted, yes. Widely, not yet. So far, few regular businesses accept Bitcoin, but I read that McDonald's is experimenting with accepting Bitcoin at a few of its locations outside the United States, and you can even go today and pay for a luxury car purchase using Bitcoin. Cryptocurrencies, such as Bitcoin, are developing all the characteristics of a genuine currency. Verifiable, limited supply, and increasingly broad acceptance.

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