Digital Currencies

by Titusz Pan

When we think about money we usually see piles of coins or banknotes in front of our inner eyes. In reality most of our money has become virtual quite some time ago. When we use our credit cards, make wire transfers or pay via paypal, we are using corporate digital payment systems to transact money. Behind the scenes this money is nothing but records of ownership in databases that are controlled by our banks. The base supply of this money is issued by central banks, which are generally independent of the government executive. The vast majority of our money is created by banks themselves through fractional reserve banking.

For some years now there are new and very different kinds of digital currencies available to us. These other kinds of digital currencies are also called crypto currencies or virtual currencies. The motivation to create these new decentralized currencies is what ultimately led to the invention of blockchain technology.

The rise of digital currencies began with the creation of the first data-block of the Bitcoin blockchain. This so called genesis block was established in January 2009 and contains the following encoded message as reference to a front page article of “The Times”:

The Times 03/Jan/2009 Chancellor on brink of second bailout for banks

In 2017, Bitcoin is already part of history. Original copies of the newspaper issue that was referenced by the first Bitcoin block are traded as collectibles at prices of over $10.000,- among enthusiasts. Hundreds of alternative digital currencies (altcoins) have spun off Bitcoin. They can be traded globally against each other and all major traditional fiat currencies on hundreds of exchanges – 24 hours a day. The total market capitalization of these currencies is currently at$63.383.000.000,- (May 18, 2017) and is rising rapidly. More and more dedicated  hardwaredevices are coming to market. They are purpose built to securely manage digital currencies. Digital currencies are still far from mass adoption, but it is not unlikely that one or several of them will become a major means of global exchange of value over the internet.

Digital currencies are the internet-native answer to the challenge of trusted and direct transfer of value without intermediaries. They differ from traditional money in several and essential ways. They are not issued or controlled by central banks. Instead, they are issued by computer networks according to publicly announced, predefined, transparent and mathematically guaranteed rules. Comparable to bank notes or coins owners can be in total control of their holdings. Transactions between two parties cannot be reversed or censored by third parties. Digital currencies are managed by decentralized communities and voluntary participation.

Compared to the size of our global financial markets these new currencies still only account for a very tiny percentage. Though legal in most countries they are currently highly speculative, quite unstable in value and surrounded by regulatory uncertainty. Speculators are betting on digital currencies as a safe haven that is uncorrelated to our traditional financial systems.

The key insight to take away from the young history of digital currencies is that the internet community is starting to embrace the idea that currency is nothing but a choice – an agreement between people. An agreement that can be forged by voluntary, decentralized consensus systems (blockchains). The community is executing on this insight – independently from banks and institutions. And by now it has proven to itself that digital currencies can work as “real” money that represents and transacts real value. So far, this went much more smoothly than anticipated by Henry Ford:

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning. (Henry Ford)

Traditional bank money did never really catch up with the dynamics of the internet and failed to become a native internet citizen. Everybody can send an email around the globe in seconds. So why does it have to be so expensive and complicated with money? Why isn’t it possible to easily and cheaply pay micro amounts of money directly to others over the internet? Not being able to do this, might even be one of the reasons why many internet businesses have to finance themselves via online advertising and excessive collection of user data. Digital currencies hold the promise to do away with the inefficiencies and security issues of our banking systems and transform the ways in which we exchange value with each other.