Cryptocurrencies: Workings and Value proposition
This post is part of a series. Checkout the previous chapter to understand how blockchain works — the technology upon which cryptocurrencies are built.
Cryptocurrency is a digital or virtual currency that is secured by cryptography. They are by design, nearly impossible to counterfeit or double-spend. They are generally not issued by any central authority, making them theoretically immune to interference by central banks or governments. Currently there are 100s of cryptocurrencies in circulation and new ones are being added on a regular basis as the barriers to deploying a cryptocurrency are lower than ever.
This post will cover the broader value proposition of cryptocurrencies and future posts in this chapter will selectively cover each of the top cryptocurrencies — how they work, their utility, and value creation.
Valuation
Cryptocurrencies are not widely accepted as a form of payment by highstreet vendors. The prices of food, clothing and other everyday utilities are quoted in fiat currencies so it easier to understand the value of a single unit of a fiat currency — in terms of the utility derived from products they can fetch. While progress is underway to facilitate transacting with high street vendors using cryptocurrencies, the prices are still quoted in fiat and generally a crypto-to-fiat conversion takes place at the point of sale. But for now, cryptocurrencies are not very ‘currency-like’ — hence they are often referred as “crypto assets”. The value asserted, in fiat terms, to a single cryptocurrency can vary widely from zero to some finite number depending on whom we ask. The valuations of cryptocurrencies are often highly volatile.
Beyond these volatile valuations there are cryptocurrencies that aim to offer meaningful utility. Utilities that could one day make their valuation more clear and justified — whatever that number might be. The general populous are still deeply divided on how to value cryptocurrencies, so we will focus on utility and let the audience decide how they value this utility.
Utility
Almost all public blockchains have at least one native cryptocurrency. The native currency is the ‘legal’ tender to pay for services offered on that blockchain — very similar to how countries have a fiat-currency as legal tender to pay for goods and services. Here are some popular blockchains and their native cryptocurrencies:
- Bitcoin — Bitcoin (BTC)
- Ethereum — Ether (ETH)
- RippleNet —Ripple (XRP)
- Zilliqa — ZIL Token (ZIL) and Governance ZIL (gZIL) — some blockchains have more than one native currency.
Let’s consider the top 2 public blockchains and the utility of their native currency, asset or token — also referred to as token economics.
Bitcoin is the first and by far the largest blockchain network in terms of allocated computational resources. At the time of this writing, the network is running at152 EH/s — that’s 152,000,000,000,000,000,000 hashes per second!* To put in plain terms, anyone aiming to undermine the security of the Bitcoin network would need to consistently compute more than 152 EH/s — that’s at least 150 times faster than the top 500 supercomputers in the world, combined!
*The importance of using hashes per second as a metric to measure Bitcoin network capacity will become clear in a Bitcoin specific post in future.
We are now living in a world where even the top technology companies and government organizations are falling victims to nation state sponsored cyber attacks.
Cyber security is paramount and truly scarce right now. Bitcoin offers, among other propositions, a secure network free of interference from anyone and resistant to cyber attacks by design. The security guarantees of transacting on the Bitcoin network using its native currency is a great utility for any transactions that could benefit from it — most likely high value transactions. There are more utilities atop the strong security benefits and this will be covered in a post exclusive to Bitcoin.
Ethereum, the second biggest blockchain by market capitalization, took the ideals established by Bitcoin and added functionality to support deploying smart contracts on the blockchain. This allows developers to build decentralized applications (DApps) that act as a interface between end users and the smart-contracts running on the Ethereum blockchain. Essentially, the Ethereum network aims to be the world computer.
A smart contract is a computer program or a transaction protocol which is intended to automatically execute, control or document legally relevant events and actions according to the terms of a contract or an agreement.
To understand the true potential of a programmable blockchain like Ethereum, we should look at how services like Google, Amazon, Netflix or any internet application for that matter work. These applications must be hosted somewhere and typically developers pay to cloud services such as AWS, Azure or Google Cloud, to rent the infrastructure. The availability of these applications is limited by the underlying infrastructure which can and has failed time and again, leading to outages of many services.
Ethereum smart contracts can run on any node on the Ethereum network and have virtually no down time. Whenever users interact with the blockchain using a DApp, they pay a fee for running the smart contract. These fee go to the node that executed the smart contract. Fees are denoted in Ether (ETH), the native currency of the Ethereum blockchain. This essentially gives utility to the cryptocurrency — a medium of payment for executing a contract on blockchain. Drawing a stark parallel to how developers pay cloud services in fiat-currencies for hosting their applications. This utility creates demand for Ether among the users of smart contracts.
There are many other blockchains and even more utilities for each of their native currencies. We will cover them in greater detail in dedicated articles. The goal of this post is to briefly discuss the utility of at least the top 2 cryptocurrencies and set the stage to talk about how different cryptocurrencies work.
The ideas discussed in this post are by no means an endorsement or disapproval of the financial valuations of any cryptocurrency.
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