Bitcoin was created in 2009, proposed by Satoshi Nakamoto in his white paper, 'Bitcoin: A Peer-to-Peer Electronic Cash System' .
Since then, numerous cryptocurrencies have been following Bitcoin's footsteps. Recently, it has been getting a lot of media attention, and its total market value has reached billions and billions of dollars.
A number of central banks started to feel the threat and started diving deep into the adoption of cryptocurrency and blockchain technologies for retail and large-value payments.
Certain cryptocurrencies vow to replace the traditional fiat currency system. Nevertheless, there was too little research in economics and provided little insight into the economics of cryptocurrencies.
A field of economics that specifically researches about cryptocurrency - cryptonomics was born. They tried to build the most existing models of cryptocurrencies with the help of computer scientists that are able to understand the feasibility and security of these systems.
The economics researchers are focusing on the incentives of participants to cheat (game theory) and many more other key variables that affect the real value of a cryptocurrency in exchange. These considerations are extremely important for understanding the design and economic value of cryptocurrency as a means of payment whether cryptocurrency can survive in future, or go bust.
Economic definition of money
By economics definition, money serves three interrelated economic functions:
Money is :
a medium of exchange,
a unit of account,
a store of value.
Whether cryptocurrencies can serve those functions relative to the current existing money systems will be playing a large part in determining cryptocurrencies’ future value and importance.
Fans will often argue cryptocurrency can and will effectively serve those functions and will be widely adopted by the public. The main arguments they proposed are that a decentralized system using cryptocurrencies ultimately will be more efficient and secure than existing monetary and payment systems. Therefore, it is very important to first understand the problems that are existing in the current monetary system.
Problems of current monetary system
In the current era, money is widely exchanged electronically.
Electronic payments systems are always subject to certain difficulties related to lack of scarcity (a digital file can be copied many times over) and the overall lack of trust between parties.
These payments are subject to double spending. For starters, double spending is a scenario that can occur when a payer sends a digital file directly to a payee to transfer value. The problem occurs when the payee cannot himself confirm that the payer has not sent the same file to multiple other payees.
Money in the system could be double (or triple, quadruple) spent, the money would not retain its value but multiples of its original value.
Traditionally, this problem is solved by involving centralized, trusted intermediary. These intermediaries are private banks, government central banks, or other financial institutions.
The trusted intermediaries maintain private ledgers of accounts recording how much money each participant holds, which is the main point cryptocurrencies' adopters critics.
To make a payment, a message needs to be sent to the intermediary to make changes to its ledgers. The intermediary then will be validating the transaction. This ensures the payer has sufficient funds for the payment. Then, they will deduct the appropriate amount from the payer’s account, adding it to the payee’s account.
This however, proposes several hidden problems which we will discuss below.
Cryptocurrency as a means to replace money
Cryptocurrency proposes itself as the future money in a payment system in which a network of computers, validates transactions.
These electronic payment systems, unlike banks, use public ledgers that allow individuals to establish an account with a pseudonymous name known to the entire network. This pseudonymous name is called a public key. A private key, known only to the account holder will be paired to the public key.
In this system, a transaction can occur anytime two parties agree to transfer their cryptocurrency in exchange for any other assets or services.
The buying party will unlock the cryptocurrency with their private key and pay to the selling party's public key. This process can happen anytime and anywhere in the world without permission of a third party.
These protocols are therefore available to secure each transaction by using digital signatures to validate the identity of the two parties involved.
In this case, the entire ledger can be secured. Any changes in the ledger are visible to all parties although the parties do not know each other. Parties will not need trust to exchange value as the protocols to prevent double spending and invalid changes to the ledger.
This system incentivizes its users to perform the functions necessary for validation by awarding them newly created units of the currency.
Economics efficiency of cryptocurrencies
1) Cost-advantage
Cryptocurrency has a cost advantage over traditional payment systems for money transfers and payments especially internationally. Sending money internationally involves tons of intermediaries. Cryptocurrency supporters could avoid these particular unnecessary costs because cryptocurrency transactions take place over the internet globally and borderless.
2) Trust-free system
Traditional payment systems require that government and financial institutions be credible.
Although these institutions can be credible in a society, an institution may anytime misuse their assets and go bankrupt, losing his or her money without adequately apprising such a risk. . Without needing to trust any third parties, two parties can exchange value using the blockchain and can verify the transaction themselves.
3) Value preservation
Government’s ability to maintain a stable value of a fiat currency may be flawed as fiat currency does not have intrinsic value. There have been incidents of hyperinflation in certain countries. These government-backed currencies lose most oftheir value, leaving its users with nothing. Cryptocurrencies often have a limit amount coded into the system and therefore can make sure that their value is preserved well.
Finishing thoughts
Cryptocurrencies have the potential to overtake the current traditional monetary system. Given these benefits cryptocurrencies can offer, there are certain economic benefits that we can look deeper into. Nevertheless, the future of cryptocurrency depends on scalability and regulations. Many cryptocurrencies' interests are already peaking up with many corporations and individuals started adopting the monetary system. The future for cryptocurrencies are bright. In the near future, the best cryptocurrencies will stand out, replacing major industries, creating a whole new system for the globe.
