In part 1 of this series we discussed how digital currencies and exchanges work. Part 2 explored blockchains, and differentiated between coins and tokens. In this part we’ll seek to understand some common but potentially confusing terms. We’ll also look at some of the most important factors which influence the prices of digital coins.
Most cryptocurrencies are designed to be freely floating. Their prices are unregulated, and controlled only by market forces. By contrast a stablecoin is a digital currency which is pegged to one or more fiat currencies. It may instead be pegged to a commodity such as gold or oil, or to another digital currency. The price of a pegged stablecoin fluctuates with the value of the asset to which it is pegged. In this way stablecoins are able to escape the volatility of the crypto markets, and are said to be relatively ‘stable’. Pegging a digital currency comes with both merits and demerits.
Bitcoin was the first and the most successful digital currency. Eventually others wanted to emulate its success by launching new digital coins. An altcoin is any cryptocurrency which is not Bitcoin. Simply put, it is an alternative investment to bitcoin. The term itself signifies the overwhelming importance of bitcoin in the crypto marketspace. It is as if all the others are aspiring to compete with the leader. There are a large variety of altcoins out there. Most are based on the bitcoin model (if not the same code) with similar mining protocols. Yet, most altcoins claim to be better than bitcoin in some way or another. With the constant development of new technologies the term altcoin is still evolving.
New bitcoins are created in a process called mining which involves solving complex mathematical equations. Essentially it takes a certain amount of computing effort (and time) before a new block of bitcoins can be mined. When bitcoin was first created in 2008 its inventor put a very interesting feature in its code. After a fixed number of bitcoin blocks are mined (210,000 to be exact) the reward for mining new blocks is halved. After each halving miners can only generate half the previous number of bitcoins per unit effort. Halving will eventually reduce the supply of new bitcoins down to zero. This is expected to occur sometime in 2040.
From an economic point of view each halving reduces the global supply of bitcoins. As with any resource a finite supply and rising demand pushes the price up. There have been three halving events so far. These occurred in November 2012, July 2016, and May 2020. The first two events were followed by dramatic rises in bitcoin’s price. The price rise after the third halving was more predictable. The next halving is estimated to occur in May 2024. Further halving events will take place roughly every four years.
The economist’s view
An investment in cryptocurrencies may protect against uncertainty. In May 2020 many leading US news sites reported that the US Federal Reserve was creating $3.5 trillion in new currency to respond to the COVID-19 financial emergency. Thanks to the Fed the US economy seems to have a limitless supply of dollars. With infinite production the value of a currency depreciates. Over time people need more money to buy the same things. The cost of living rises. This is called inflation.
Many economists proclaim that owning digital assets like bitcoin protects against inflation. Like the price of gold, the price of bitcoin can only rise. The exception of course is that crypto prices are also influenced by market forces such as speculatory bubbles. Even so, because of a finite supply the intrinsic base value of bitcoin is never expected to reduce. This is in stark contrast to owning fiat currencies, which are often deliberately devalued by the governments which control them. Bitcoin and similar digital currencies are not controlled by any government. For these reasons they are often considered safe-haven investments. The debate on the validity of this claim is ongoing.
Bitcoin and ransomware
A ransomware attack is a type of hack intended to extort money. The hacker locks important files and data on the victims’ computers and demands payment for unlocking them. Unavailability of vital data cripples corporations. For the lack of a better/faster resolution the victims often pay-up. A key feature of ransomware attacks is that the ransom is usually demanded in Bitcoin. Cryptocurrencies are not the most anonymous mode of payment in the world. There are some ways to trace crypto transaction. However, they are often the fastest and most reliable way to send money online.
Digital currencies are powered by online peer-to-peer systems. They involve the least number of third parties and middlemen. The bitcoin blockchain is public. This enables the hacker to verify the payment in real time. A poor understanding of ransomware attacks brings undue negative publicity to the use of digital currencies. In reality however, ransomware attacks are really a testament to the efficiency and reliability of cryptocurrencies.
In the next part of this series we’ll look at how digital currencies are set to become the world’s favorite way to transact and invest.
About the author:
Hemant G is a contributing writer at Sparkwebs LLC, a Digital and Content Marketing Agency. When he’s not writing, he loves to travel, scuba dive, and watch documentaries.