How crypto and digital currencies work
U.S. President Joe Biden on March 9 signed an executive order for government oversight on cryptocurrency that urges the Federal Reserve to explore whether the central bank should jump in and create its own digital currency. The order directs federal agencies, including the U.S. Department of the Treasury, to study the impact of cryptocurrency on financial stability and national security.
This action caused a big stir. According to reports from AP, following the announcement of the executive order, cryptocurrencies experienced an increase in price, including Bitcoin which went up 9.8 percent in value to $42,211. Digital payment platforms also experienced a rise in activity, including PayPal which reported an increase of 4.9 percent.
Coinmarketcap.com reports that as of March 11 the global crypto market cap was $1.73 trillion. Even long before Biden’s move, hedge funds have been trading bitcoin, PayPal let users buy crypto on its app, and Twitter allowed users to tip creators with bitcoin.
But what does it all mean? Is print money going to become worthless? Do we all have to enter the metaverse now?
Cryptocurrency is a type of digital currency that uses cryptography to secure transactions. Instead of relying on banks or financial institutions to verify transactions, each transaction is encrypted and verified via blockchain.
Imagine it like this: you go into a store to make a purchase. You bring your item to the cashier and take out a dollar bill. The dollar bill has a secret serial number and before the cashier can accept the bill and put it in the register, a team of people must figure out the secret serial number by decoding a puzzle.
Once everyone has decoded the puzzle and has the serial number, they all look it up in a ledger and review all the other transactions that were made with the same dollar in the past. They then agree that the dollar is legitimate because it has a record. Your transaction is added to the ledger and the payment is approved. The cashier can now put the dollar in the cash register, and you can take home your purchase.
This is how cryptocurrency works, except the process happens in a blink of an eye and is performed by people using powerful computers around the world.
Your transaction is a “block” added to the list or “chain” of transactions made with that unit— this is blockchain.
One way to obtain cryptocurrency is to purchase it from a broker or on a cryptocurrency exchange platform. Much of the interest in cryptocurrencies is to trade for profit. So, cryptocurrency is like the stock market, but instead of buying shares of a company, one is purchasing digital money. Like the stock market, there is volatility. The value of a cryptocurrency fluctuates and is affected by market predictions and other factors.
Another way to obtain cryptocurrency is by “mining.” Remember that group of people that had to decode the serial number on your dollar bill and check it on the ledger? Those are cryptocurrency miners. For their service, they receive cryptocurrency that is paid by those involved in the transaction. Miners compete against each other for the responsibility to validate the transaction.
At first, individuals were able to compete for blocks with a regular at-home personal computer, however, this is no longer the case because it has become more difficult to mine cryptocurrency over time. To keep the supply of cryptocurrency stable, the algorithm or the mathematical equation is adjusted to make it harder to solve.
The more mining occurs, the more difficult it becomes to mine.
As a result, mining now requires a huge amount of data processing power to make the necessary mathematical equations quickly.
Much of cryptocurrency mining is done by machines called application-specific integrated circuits (ASIC) that only perform a single function or set of related functions, which is to perform the mathematical computations to verify or create bitcoin.
It seems complicated, so why would anyone invest in cryptocurrency?
For many, the appeal of cryptocurrency is that it is decentralized. It’s peer-to-peer, eliminating the need for an intermediary and their fees.
Cryptocurrency is not connected to a government entity. A decentralized currency is free from traditional economic influences, such as inflation, taxation, and economic disasters. It can facilitate new types of economic activity, particularly quick international transactions.
The cryptocurrency boom has caught the attention of world leaders and the digital currency movement is picking up speed as governments launching or making plans to launch Central Bank Digital Currency (CBDC).
CBDC is digital currency that is backed and issued by a country’s central bank. Instead of print money, the government issues electronic coins or credits that are backed by the full faith and credit of the government.
Digital currencies are beneficial to governments because they have lower transaction costs, and it provides access to money for those who do not have a bank. Digital money can promote financial inclusion, especially for economically vulnerable households and communities. It will give individuals and businesses access to affordable financial products and services, such as credit, insurance, savings, transactions, and more.
According to the Atlantic Council, as of March this year, 87 countries are exploring CBDC. This is compared to only 35 that were considering it in May 2020.
In 2020, the Bahamas established CBDC, and Jamaica is set to roll out its digital currency in the first quarter of this year.
As reported in this publication, in January, Palau launched the world’s first digital residency program using blockchain.
In October 2020, the National Bank of Cambodia launched its digital currency called Bakong. It enables Cambodians to use a free mobile app to make payments and transfer money through any bank on the platform, even if they don't have a traditional account with the bank.
According to NBC, it provides a platform for more than a dozen banks and financial institutions and has reached about 5.9 million users, with transactions worth nearly $2 billion.
The Bahamas became the first country to launch a CBDC, the Sand Dollar, in October 2020, while Nigeria was the first African nation to launch a digital currency, the eNaira, in October this year.
Despite the growing interest in digital currency, there are still hurdles to overcome.
For CBDC to be successful there needs to be international standards and coordination to establish interoperability so that users can use their digital wallets everywhere and businesses can make transactions across borders.
Regulations need to be in place to combat money laundering and other illicit activity and to ensure consumer protection.
In addition, there are environmental factors to consider because the power needed to mine cryptocurrency may put a strain on the existing energy production infrastructure. This could result in the advancement of renewable energy sources.
With that in mind, although there have been exciting developments, I would not recommend spending your life savings to purchase cryptocurrency or start hoarding bills in the hopes they will become antiques.
Once the issues have been solved and nations have completed their research, the transition to CBDC could be slow, first the government would start with accepting both digital and traditional forms of currency. Then, slowly it will phase out traditional moneys.
In the future, transactions using a digital wallet on a mobile phone could become the norm around the world.
Jay R. Shedd is the executive vice president of CPL, the parent company of PTI Pacific Inc. which does business as IT&E, IP&E. He has more than 30 years of experience in the telecommunications industry, business development, sales and marketing. Send feedback to email@example.com