An Everyman's Guide To Understanding Cryptocurrencies

Tyler Durden's picture

Submitted by Charles Hugh-Smith via PeakProsperity.com,

When an asset rises by almost 30% in a few weeks, it tends to attract attention.  Recently, that asset was bitcoin (BTC). The price of BTC in dollars rose from $454 on May 23 to $590 on June 6th.

When an asset doubles in a matter of a few months, it tends to attract attention.  The cryptocurrency Ether (part of the Ethereum platform) doubled from around $7 in April to roughly $14 in early June.

Are these cryptocurrencies mere fads? Or are they potentially game-changing alternatives to the conventional currencies such as the U.S. dollar, Chinese RMB, Japanese yen or European Union euro?

There’s no lack of skeptics and critics of bitcoin and other cryptocurrencies. For example, “National currencies aren’t as Centralized, and Bitcoin isn’t as Decentralized, as you think.” (Source)

There are plenty of defenders of cryptocurrencies as well, for example this response to the article above. 

The controversy is understandable; bitcoin has had a difficult adolescence. After soaring from $15 in early 2013 to over $1,000 in December 2013, the cryptocurrency crashed to $215 in early 2015 in the wake of the bankruptcy of a major exchange (Mt. Gox) that cost bitcoin investors $470 million in losses.

Yet despite concerns about security, criminal use and volatility, cryptocurrencies have proliferated at a dizzying pace, and new models such as the “smart contracts” of Ethereum have been developed.

So what are those of us who can’t follow the technical arguments supposed to make of all this? For that audience, here's my stab at making sense of the potential global role of cryptocurrencies.

Cryptocurrencies Are Digital Currencies That Are Not Issued by Governments

What’s a cryptocurrency? Wikipedia’s definition is “a medium of exchange using cryptography to secure the transactions and to control the creation of new units.” Cryptocurrencies exist only in the digital realm; there are no physical coins or paper notes.

Cryptocurrencies have no intrinsic value. They share this characteristic with fiat currencies issued by governments/central banks:

“Fiat money is currency that a government has declared to be legal tender, but is not backed by a physical commodity. The value of fiat money is derived from the relationship between supply and demand rather than the value of the material that the money is made of. Historically, most currencies were based on physical commodities such as gold or silver, but fiat money is based solely on faith. Fiat is the Latin word for “it shall be.” (Source)

Though major central banks own gold, the currency they issue is not “backed by gold,” i.e. it cannot be converted into gold upon demand.

The value of fiat currency is a function of supply and demand. There are many sources of demand for currency: governments demand taxes be paid in their fiat currency, for example, and this creates demand for the currency.

There is however only two sources of supply: the central banks of nation-states (or regional unions like the Eurozone) and private banks in fractional reserve money systems that enable banks to create new money via issuing new loans.

In a fractional reserve banking system, if a bank has $10 in cash deposits (i.e. in reserve), it can issue a new loan of $100. This loan is new money that was created out of thin air. When the loan is paid in full, this new money disappears from the system.

When central banks or states issue new currency in excess of what the economy is actually producing, the supply overwhelms demand and the currency’s value (i.e. purchasing power) falls accordingly. Venezuela offers a present-day example: the official exchange rate of the Venezuelan bolivar is 10 to the U.S. dollar (USD), but the “street”/black market value is closer to 1,000 to 1 USD. (My correspondents in Venezuela report that it is illegal to post the black-market exchange rate on a website.)

Governments typically restrict alternative currencies to protect their monopoly on money issuance: residents must use the government-sanctified currency or face prosecution and prison.

The U.S. government has declared bitcoin is a commodity (i.e. property) rather than a currency. Other nations have banned bitcoin (presumably out of recognition that it is an alternative currency outside their control.)

Why does bitcoin have any value at all? There are two basic reasons:

  1. The supply is limited.  The design of bitcoin limits the total number of bitcoins to 21 million. (If you really want to know why this is so, you’ll need to understand the blockchain and bitcoin mining, topics that are beyond the scope of this article.) At present, there are over 15.5 million bitcoins in circulation, roughly three-quarters of the eventual issuance of 21 million.
  2. There is demand for bitcoin precisely because it is outside the control of governments/central banks and cannot be devalued at will by governments/central banks.

Why Fiat Currencies Are Being Devalued

Why are most governments/central banks trying to devalue/depreciate their fiat currencies? After all, devaluing the currency reduces the purchasing power of everyone who holds the currency, meaning that the currency buys fewer goods and services. This loss of purchasing power makes everyone who must use the currency poorer.

Why do governments/central banks pursue a policy that makes their citizens poorer?

There are two primary reasons why governments seek to devalue their currency:

  1. To make the nation’s exports cheaper, i.e. more competitive, in the belief that expanding exports will make the overall economy grow, despite the fact that devaluing the currency makes imports more expensive, hurting everyone who buys imports.
  2. To make it easier for debtors to service their loans. As our currency loses its value, we experience that loss of purchasing power as inflation: the prices of goods and services rises as the purchasing power of the currency declines. Governments/central banks presume that wages will rise along with the prices of goods and services. This rise in wages will make it easier for debtors to service their debts, i.e. make their monthly payments. In a system that depends on the expansion of debt to fuel consumption, making it easier to service existing debt is of critical importance: if debt becomes more difficult to service, debt expansion slows and so does consumption. As consumption slows, the economy slides into recession.

As their currency is devalued (by intention or by unintended consequences), the great problem for many people will be transferring their remaining financial wealth out of depreciating currencies into a more stable currency or into assets in a more stable nation.

The Role of Cryptocurrencies in Capital Preservation

This is where cryptocurrencies have a role that could increase as global currencies are devalued: if you can shift financial wealth out of a currency that is losing purchasing power into a cryptocurrency that is holding its own or even gaining in purchasing power, it would be irrational not to do so.

What advantage do cryptocurrencies have over other stores of value such as gold, silver or cash? All of these traditional stores of value have advantages—portability and universal recognition that they are money—but they cannot be transported across the globe quite as easily as digital currencies.

Though it is a topic of hot debate, many observers believe it is technically difficult to the point of impossibility to stop people from buying, selling and sending cryptocurrencies because currencies such as bitcoin live in a network that is scattered around the globe—a network that can be accessed by anyone with a web browser.

While local exchanges could be shut down by governments, and businesses could be prohibited from accepting cryptocurrencies, stopping people from logging onto servers sited elsewhere is a bigger challenge. (Many governments have outlawed cryptocurrencies, though their success rate in stopping their citizenry from owning/using cryptocurrencies is unknown.)

The rise in daily transactions in bitcoin suggests an expanding base of users globally.

In Part 2: Will Cryptocurrencies Soar As The Global Economy Falters? we explore the potential demand for cryptocurrencies as a means of transferring and preserving capital, and the potential impact of these capital flows on valuations of cryptocurrencies.

As governments actively devalue their currencies (thereby making everyone using the currency poorer), their citizenry with financial capital are forced to seek ways to move their at-risk wealth into other currencies or assets. And as the stability and valuations of cryptocurrencies increase, the potential for a self-reinforcing feedback loop increases: as the value of cryptocurrency rises, it attracts more capital, which pushes prices higher, and so on.

Are we in the infancy of a global stampede into cryptocurrencies?

Click here to read Part 2 of this report (free executive summary, enrollment required for full access)

 

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logicalman's picture

I'd be a bit wary of basing everythng on vapour whose 'value' can change as insanely as Bitcoin's.

I thought it was supposed to be an improvement on the crap we have now.

Doesn't really look like that to me right now.

Great concept, if it were truly secure and untraceable, but anything on-line is tracked.

Needs work.

 

Justin Case's picture

I concur, I just feel that if I don't hold it I don't own it. If the power grid goes out due to terrorist attack that's it for getting to yoar bitcoins. What happens when there is a selling panic and you need yoar bitcoins? You have to sell into that panic, then when it's cooled off it's too late for you to gain anything back.

Data loss due to component failure, worm, virus, hacker. You'll have vertually nothing.

I'll stick to the old fashion money. It has a 5000 yr. history for exchange to fiat or goods and is recognized in every nook and cranny on planet earth. 100%

Brekyrself's picture

Problem is this is also true of our current banking system.  Any power or network interruption can lead to chaos within the financial marketplace.  Cryptocurrnecy goes beyond bitcoin, even with the ability to hold phyiscal crypto!

Forget about simple bitcoin, there are various other projects that have been running succesfully for years.  One for example has the ability to shake up the business and financial marketplace with a distributed marketplace/options exchange.  The underlying asset called BitShares backs market pegged assets such as BitUSD, BitEuro, BitGold.  You can move in and out of these in under 3 seconds, with no questions asked.  These can not be confiscated physically, are more secure compared to current credit/debit card systems, and can be sent anywhere, anytime, at your fingertips.

Crypto will shake up the financial and business marketplace as we know it.  Will it be a current system or something not yet developed, we shall see.

wee-weed up's picture

 

 

Are these cryptocurrencies mere fads?

 

Uh no... they're merely perfect avenues for the shadow gov't (NSA, CIA, FBI, DHS, etc.) to steal your wealth.

wee-weed up's picture

 

 

"can be sent anywhere, anytime, at your fingertips"

 

Until... (but don't mind me... Mr Ostrich)

ali_baba's picture

Joos are ALWAYS thinking of ways to separate you from actual money. They themselves only value gold. It's in their religion. The goy are easily duped into thinking otherwise.

Brekyrself's picture

Please let us know how they can steal our wealth via crypto technology.  Can't freeze your account, no capital controls, can transfer anywhere in the world with a click of the mouse...

Golden Phoenix's picture

Transactions are stored in the blockchain. If you run a bitcoin client your wallet can be stored as a string of characters on a piece of paper. The entire blockchain can be stored on a thumbdrive. This means if the entire internet failed wiping every server hard drive in the process once it was back up and running the entire blockchain could be restored from that one thumbdrive. If one wanted to be extra cautious the thumbdrive could be stored in a Faraday cage making it EMP proof.

 

In some ways this is safer than say a standard bank account. Imagine an EMP attack in New York or a solar EMP burst takes out your bank's servers. The only guarantee your account will be restored with the correct balance is their word. With bitcoin you have a copy of not just your wallet but the entire system. As long as one individual maintains a copy the entire thing can be restored verbatim.

 

In some ways this is safer than gold. Muggers and intruders always look for gold. A piece of paper with a backup of your bitcoin wallet can be shoved into one of hundreds of books in a bookcase, slid under the refrigerator, etc..

 

Not saying any of these are best. For utmost flexibility and diversification a little of everything is always a good idea. Whether a bank account, gold, or bitcoin, no one should invest in any one of these more than they are prepared to lose.

nmewn's picture

Money doesn't need a blockchain or ledger to express itself as money or where it's been or who has used it last to "authenticate it" and you better hope your ISP power provider has Farraday Cages wrapped around their internet gateways & power substations or in reality what you have is a useless piece of plastic called a thumb drive. 

 

 

Not even a decent cocktail swizzle stick ;-)

Golden Phoenix's picture

How much cash do people use on 'The Walking Dead'? How much gold? If society collapsing is what you're preparing for stock up on ammunition, cigarettes, booze, and antibiotics. If you offer cash or credit after the apocalypse people will laugh in your face. Now if there isn't an apocalypse bitcoin turns out to be quite handy and getting handier all the time.

 

You think you're clever but we've heard almost all the same arguments in the early adoption days of Paypal. Among other things bitcoin is a Paypal fee killer.

GRDguy's picture

I remember the days when promised software didn't exist: We called it "vaporware."  Thanks for bringing that up.

nuubee's picture

It is only capable of changing in value by that much because it's total market cap is small relative to the paper world. Keep that in mind when passing judgement.

44_shooter's picture

try getting a hold of your shitcoin when they shut down the internet.  

ebworthen's picture

Listen, the South Seas Company has exclusive trading rights to the New World, you can't lose!  Here is a piece of paper.

 

 Black Tulips are extremely rare; everyone will want one forever, I'll trade your house for one.  Here is a piece of paper.

 

Bitcoin is the new currency!  It is better than tangible Gold or Silver!  It will never be worthless!  Here are some 1's and 0's on the Ethernet.

vega113's picture

About 5000 years ago: gold?! this is not money as it has no intrinsic value!!! You cannot eat gold or make a knife out of it! 

AND this is right, but gold has the chemical/physical values that make it valuable. Same with bitcoin - it is like gold, but digital. It is based on real technological innovation. It does need internet to function, but aside of it - a lot easier and more convenient to buy and hold compared to physical gold. Maybe, just in case if the world with internet will still exist - you need have some.

wildbad's picture

I'm wary of the volatility of bitcoin et al so do not use it to store wealth.  Its a good play though.

The real value of it is to cross borders invisibly without a tax.  If you own an income property in country "A" and live in country "B"; to acess that ca$h you need to lose at least 5% just to use your money.  A crypto xfer is essentially free.  One can then buy the hard asset of ones choice in country "B".

No more federal clearing, no more currency exchange fees, no more capital controls.

This is one (additional) reason that governments want to go digital.  They want to oversee ALL traditional digital transactions as feeders to the crypto world.

bugs_'s picture

BITCOIN cannot be naked shorted.

 

everything else that you own is.

Urban Roman's picture

The bad news -- I think the Winklevosses are working on an ETF or something. And you can short that ... whether you can redeem it for actual BTC, I have no idea.

wee-weed up's picture

 

 

"the Winklevosses"


FaceFuck wannabees.

vega113's picture

It doesn't matter, as real Bitcoins are traded on exchanges by real regular people. The trick with gold ETFs works only because it is impossible to trade real physical gold for everybody.

Oldwood's picture

We either believe in central control or we don't. If we accept that all markets are manipulated and that our financial transactions and assets are largely transparent to the controllers, why would we believe that a crypto currency, something residing within the realm of their gross control, would be allowed to compete with state currencies? If their powers are as great as many of us suspect, it is only reasonable to believe that their is no real "safe space" for asset protection, and like banks, bitcoin is but another channel of herding, one that will likely proves to be exceptionally easy to manipulate and POSSESS.
I do not believe there is absolute safety, but I will stick with physical money (paper and metals) within my grasp for the moment.

cherry picker's picture

How does one attach a value to crypto currency?  It is currently valued in fiat, isn't it?  X qty of Bitcoin is worrth y USD.

In this facebook/google/microsoft world where we are led to believe crypto currencies are safe and secure, it is something of a contradiction isn't it?

 

PhoQ's picture

Bitcoin is its own measure. If you want to value it in dollars, go ahead. If you want to value it in Euros, have at it. If you want to value it in chickens, it's your book keeping.

Prisoners_dilemna's picture

Their power is not what you wrongly suspect. You know what you sound like, the guy in the crowd point at the emporer saying "wow his clothes are simply radiant". Nope that his skin dummy. It's radiant because you cant see hes stealing from you or his clothes.

Get some Bitcoins. Try using a search engine to ya know... learn something. You ask it questions and it gives you answer to sort through. Use it.

Read losthorizons.com. Or don't. It will set you free.

and quite whining like a snowflake. That's what you sound like. Stay in YOUR safe space.

Stick with your shackles and the plantation. Snowflake.

 

Oldwood's picture

Buy away then. No need to convince me. Everyone knows the internet is as pure as snow, no disinformation,no capture or control, and by all means not fraud or manipulation.

You are the one seeing robes where none exist. I'm simply pointing out that all of the sellers of safety are naked, bit coins and all. What is it that I need study that has not existed since the beginning of time....something for nothing and a safe haven? If bitcoin truly was a harbor from currency manipulation, does ANYONE believe the world's governments would allow it to stand? This is simply another wealth trap where enough people will buy into it at $200 or $1200 or $12000 and gov will come in and claim it all as fraud, evidence of crime or tax evasion and it will be...gone! If it ain't in your hands it ain't yours.

There seems to be a belief that the internet is the foundation of truth transparency and accountability yet as the technology advances we seem to be finding ourselves increasingly fucked. The internet is the easiest fastest means of spreading lies and manipulations in history and somehow we still think we can "research" on the net and come away better informed without any risk of being further indoctrinated. 

History shows us our path while the internet finds it greatest role in rewriting history in coherent and believable tomes that are easily digestible and fit nicely with our preconceived notions. Our challenge is to question EVERYTHING.

TeaClipper's picture

Nice, you win fight club today

Golden Phoenix's picture

Yeah, he won. He got nothing while those who have held bitcoin this year have a triple bagger.

Golden Phoenix's picture

You mean like when the US government outlawed private holdings of gold? Or when there's been a run on a bank and depositors have received pennies on the dollar? Or when the government has devalued the dollar by 95% in a century?  The problems you mention happen to fiat by design. It loses purchasing power every day by design.

 

Fact of the matter is nothing is safe from them. But the more they devalue the dollar the more bitcoin goes up. The Chinese have realized the same is true of the yuan and they are buying bitcoin hand over fist. Simple put the one guarantee in life is getting screwed by the government and they are putting that to work for them.

Prisoners_dilemna's picture

Very well said Sir and I apologize for rudely calling you a dummy.

What can I say to excuse myself??

I get excited over presenting what I think are truths that are not only within an Americans reach, but also easily grasped if only they would substitute some time for learning and sacrifice some football time.

Please let me rescind the comment above except the very first line. I do believe that is true; their power in waning.

THey are losing power. I believe Bitcoin is beyond their reach. And I believe losthorizons.com will also liberate anyone willing to put in the time to learn.

Thank you for the level headed response!

vega113's picture

You can believe whatever you like, the difference with Bitcoin - you can try to read and understand it. 

AUD's picture

Government credit has proliferated at a dizzying pace too.

GRDguy's picture

Good ol' "madoff economics."

geekz_rule's picture

the whole cryptocurrency world has spawned some hard core scammers! I was recently apprached by a friend to look at onecoin. lmao. minor research proved that one specifically is raw scam. built and managed by hard core scammers. at least with bit coin, you can keep your "coins" off the grid in your own wallet, off line. with this onecoin bs, all the "coins" are stored centrally by opaque and fuzzy scammers. beware!

guitarzaan's picture

When the power goes out and the network is down, then what?  All "0's" and no "1's"  Good luck with that.   Nothing is as sound as physical gold and silver.  For over 5000 years gold and silver have always been used to exchange and purchase goods and services.  I'm certain I can buy bread with gold and silver and I'm also certain that the baker will not accept an IOU for bitcoin until power/network is restored.    

adr's picture

Am I supposed to be impressed by 250k transactions per day?

 

Bitcoin is supposedly soaring in value because of Chinese demand, yet the transactions for the entire globe is less than 250k?

 

Just like I have always believed, Bitcoin goes up in value when a handful of insiders tries to spark upward momentum and cause spikes for them to sell at a higher price. Bitcoin is really no different than a penny stock exchange. You know there are penny stocks that jump up 3000%? Why don't we report on every one of those.

 

Scams take many forms. Cryptocurrencies are just one of the latest. When billions upon billions of transactions take place daily, something pushing a few humdred thousand isn't even worth mentioning.

 

For some reason Zerohedge loves to pimp Bitcoin. Every blog has something. Autoblog pimps Tesla and Elon Musk 15 timed a day. I asked every factory owner I met in China about Bitcoin. The answer every time was, "What's Bitcoin?" These guys are millionaires who would be prime candidates to move money and they never heard of it. Most likely Bitcoin is only used by organized crime or the Chinese government.

 

I trust a dollar as much as a trial lawyer, and I trust Bitcoin just as much.

Brekyrself's picture

Crypto currency aka block chain technology is not a scam.  Bitcoin is just the first use case of this distributed database.  Just like VHS tapes, Bitcoin will most likely be replaced with an updated solution without all the downsides.  You are correct however that many of these "projects" are a bunch of bs and it has become difficult to sift through what is legit and what is not.

We have not yet seen any real world use cases to really push this technology mainstream.  Some other projects are working towards this with distributed asset exchanges with items such as BitUSD, BitEuro, BitGold in which are pegged to their real world counterparts.  Interesting times ahead!

vega113's picture

This is bunch of nonsense. bitcoin cap is 9 billion with daily volume on exchanges about 50 millions $ per day - not really penny stock. billions more were invested in bitcoin/blockchain startups. this is not a scam.  just read the white paper on Bitcoin by Satoshi Nakamoto - you will learn that this is real innovation. and finally - bitcoin is used every day by real people for real stuff. and more uses are coming online.  for example - check the bazaar - Bitcoin allows to disrupt companies like ebay - with peer to peer online market places. the techmology is real and disruptive.

guitarzaan's picture

Your 1's and 0's are worthless when it comes to farming, hunting, and building.  I need my brain, my hands, and my guns to protect these and physical gold and silver as the means of exchange between my neighbors and myself.

So, go ahead and convert more of your fiat to bitcoin.  I'll keep converting my fiat to precious metals, guns, ammo, hand tools, seeds, and books -- the physical, paper ones.

 

Good luck.

guitarzaan's picture

23 weeks 1 day, frankie; monty; et alia

Umh's picture

I cannot think of anyone that knows more about cyrptography than the NSA. Just a small observation.

PhoQ's picture

Try your local high school.

Ham Sandwich's picture

I never get a staight answer to this question? suppose bitcoin really is legitimate but .gov restricts banks from interacting with bitcoin exchanges. How am I able to convert a sizable position in bitcoin into fiat when I need it most?

Brekyrself's picture

The most obvious answer is that if bitcoin or any other block chain technology goes mainstream, why would you need to conver this to fiat?  For example, why are we still writing checks that takes days to mail and process.  This could be replaced with a distributed ledger in which you are 100% in control of your funds.

Ham Sandwich's picture

That type of mainstream adoption would be in direct conflict with .gov's issuance of fiat currency. You're supposing that they would take this development lying down. Once again, I still couldn't get a straight answer to my original question. Guess I'll be waiting for awhile...

Brekyrself's picture

No one can answer that until it happens.  Blockchain technology is a global project and we do not know what direction it will take.  There are currently crypto debit cards where you can load crypto funds onto and use anywhere in the world.  If a local gov restricts usage directly, you could send your crypto somewhere in the world where its legal and have them load the value onto a debit card...  There are interesting ways around any and all restrictions.  VPN's blah blah blah.

Ham Sandwich's picture

I'm not buying it- and not because I'm a cryptosceptic. I truly want a viable alternative to .gov fiat. Like you said yourself, we are in the early stages and no one knows which way this will go. I do know this- if it gets popular enough .gov will stick their nose in it just like they do everything else and it will affect crypto's viability.

 

Crypto believers are in love with BTC because it doesn't have a counterparty but remember that .gov is always lurking in the background.

 

If SHTF I personally would love to be able to convert my entire bank account into BTC, take it along with me in a physical wallet across the world and redepoist it in a new bank account (or even just redeposit in my current bank account) to be used as needed. I'm just sceptical that this will be easy to do if we get to the point where this type of action truly becomes necessary.

Brekyrself's picture

Spot on.  On the flip side we also have the problem of trying to travel internationally with phyiscal metals or any sizeable amount of physical fiat.  Problem is we are only allowed to use such fiat under their terms and conditions, we do not actually own it.  Crypto tries to change this thus why it will be very interesting the next year or two.

Look beyond BTC, there are some viable projects with more real world use case scenarios.

Oldwood's picture

As though if times were a screwed as we imagine they will be, that we would be able to travel and that there would be anywhere worth traveling to that would also be willing or equipped to accept crypto currency. Small economies need relatively common currencies and it is hard to imagine that somewhere we might consider a safe haven would also be active in crypto exchanges. Ultimately to actually buy or trade you have to have traders willing to accept your currency. I'm sure bitcoin will be viable for some period of time but no investment is universal in its market acceptance...even gold, so ultimately it always comes down to timing. We see unending efforts by governments to overty and covertly lay claim to the internet. If my wealth depends on they being the gatekeeper middlemen in any bitcoin transaction, I will remain dubious. In the meantime I'm sure there's lots of profits to be made. After all, the dominant profit theme in the world today is not work, but speculation....or as I call it, gambling.

beemasters's picture

And that's a big IF. The problem is it will never go mainstream like paper fiats in any foreseeable future for the simple reason that it is electronic-dependent.