March 29, 2022

Cryptocurrency – Explained for Beginners

Rahul Bhurat

Chartered Accountant | Certified Financial Planner | Blockchain Enthusiast

The concept of money has changed significantly from ancient times to the modern era. Humans evolved, so has their money: from goods used in barter, to precious metals such as gold and silver, to modern-day paper and electronic money. There is now a more recent entrant into the league of money – cryptocurrency.

What is cryptocurrency? Why was it introduced?

The modern-day paper and electronic currencies are issued and controlled by central banks. While this system has been in place since the 1700s, the global financial crisis of 2007-08 brought to the fore some of the problems plaguing this system i.e., the deregulated financial industry, unlimited money printing, and inefficient use of monetary policies. the cryptocurrency was introduced to fix these problems by limiting the money supply, removal of intermediaries in the transfer of value from one to another, and reduction in the time and cost of such transfers.

In a traditional banking environment, the banks and the clearing houses are tasked with the responsibility of completing the transfers by verifying the authenticity of the payer and payee, ensuring that the payer has sufficient funds, and updating the banking ledgers to avoid any duplicate transactions. Cryptocurrency aims to solve these problems in its own way using the techniques of cryptography and distributed ledger on the blockchain. In order to verify authenticity, cryptography uses advanced codes in order to transmit data securely to ensure that only those for whom the transaction is intended can receive, read, and process the data. This also ensures that the same balance of the currency is not spent more than once (typically called a “double spending problem”).

How distributed ledger helps?

A distributed ledger in simple words literally means that the ledgers recording the transactions are decentralized and distributed among a wide variety of people across the globe and are not controlled by a central authority. Hence, it helps eliminate intermediaries by recording the transaction across different locations thereby making it extremely difficult to hack or manipulate the records. The reduction of various intermediaries results in another benefit – being fast and cheap.

In most developed countries traditional methods such as card payments and cheques are still the dominant form of payment. Once the transaction is initiated, the money usually takes one to three business days to arrive. Further, the costs of using card payments are high i.e., 2%-4% of the transaction value. Cryptocurrency aims to solve this problem by reducing the transfer time to a few minutes and the cost to negligible irrespective of the size of a transaction.

Why Bitcoin is popular?

Bitcoin today is one of the most popular cryptocurrencies accounting for more than 42% of the market capitalization of the entire cryptocurrency market. The supply of bitcoin through complex program coding is capped at 21 million coins i.e., there can never be more than 21 million bitcoins in circulation, whereas the central-bank-controlled currencies can be printed freely. We have seen this in 2021, when the Federal Reserve in the US printed trillions of dollars out of thin air, thereby causing the existing cash-in-hand to significantly lose value. Scarcity is one of the key benefits of bitcoin.

In our day-to-day life, we have seen that when something becomes popular and is adopted by a lot of people, more and more people start adopting that same thing making it even more popular. This is called as the “network effect”. The best examples are – Whatsapp or Facebook (Meta). Bitcoin is currently going through the same network effect – more people want to own bitcoin because bitcoin is owned by many people. Bitcoin is not the only cryptocurrency, however, due to its popularity, “cryptocurrency” and “bitcoin” will be used interchangeably in the remainder of the article.

What is the legal position across the globe?

Cryptocurrency is still in a nascent stage and the majority of the lawmakers across the globe haven’t clearly defined the legal position with respect to the use of cryptocurrency for day-to-day use or for investment as an asset. According to pro-cryptocurrency voices, banning cryptocurrency denies the people to invest in an alternative to capital markets, real estate, and gold in order to keep up with the increasing inflation and changing economic cycles. Ban also creates an underground secondary market that cannot be controlled easily and also keeps a large population away from the benefits that can accrue from using blockchain technologies for financial transactions.

The anti-cryptocurrency group argues that the values of these tokens are very volatile and cause investors to lose money. Since the Government cannot track the flow of money, it can be easily used for illicit activities. Making cryptocurrency a legal tender on par with respective local currencies encroaches on the central bank’s authority of monopoly over money which is not likely to be given up.

As it currently stands, the United Kingdom, Denmark, France, Germany, Iceland, Japan, Mexico, Spain, India, etc., are some of the countries where there is some form of positive regulations thereby making trading and investment in cryptocurrency legal. Other countries such as the USA are in the process of developing legislation to do the same. Countries such as Algeria, Bangladesh, China, Egypt, Iraq, Morocco, Nepal, Qatar, and Tunisia have absolute bans on cryptocurrency.

With more and more countries realizing that it is impossible to have an absolute ban, the trend is towards regularizing it as an asset class with sufficient safeguards. While El Salvador has made Bitcoin a legal tender in its country, other countries are far from taking this drastic step and losing their sovereignty over “money”.

Who else owns cryptocurrency?

Famous business personalities such as Elon Musk – CEO of Tesla and SpaceX, Jack Dorsey – CEO of Twitter, Tim Cook – CEO of Apple, Mark Cuban – American Billionaire and owner of NBA’s Dallas Mavericks, Michael Saylor founder of MicroStrategy, to name a few, own various cryptocurrency and have been strong proponents of this technology.

The article will be published in two parts. The following topics will be covered in the next edition.

• Is Bitcoin a currency or a store of value? The argument of bitcoin vs gold?
• Should I invest in cryptocurrencies and can I invest by myself?

Disclaimer: The writer has investments in cryptocurrencies and also manages a portfolio of cryptocurrencies on behalf of his clients. Please do your own research before investing in cryptocurrencies. The writer is a Chartered Accountant, Certified Financial Planner, and also holds a certificate in the application of blockchain technology from MIT.