The past two weeks have seen a flurry of talk and head-scratching over what’s next for cryptocurrencies.
The Bank of International Settlements — known as “the central bank for central banks” — has told central banks they’ll have to reckon with cryptocurrencies, and perhaps issue their own; Goldman Sachs is reportedly looking at a new trading operation for cryptocurrencies; and a startup headed by former Google and Facebook employees is launching a cryptocurrency index fund.
If you know how all this will work, you’re in the minority.
While most people have heard of Bitcoin, there’s less in-depth understanding of cryptocurrencies in general, or of blockchain, the technology that underpins cryptocurrencies.
“I think it’s because it’s so early and it’s still fairly unnerving to trade in [cryptocurrency] — it takes some technical confidence to trade in it at this point,” said Vance Brown, interim CEO at the National Cybersecurity Center. “A lot of people are like, ‘Where do I go? Do I call my investment person?’ I believe cryptocurrency is the future, but it’s still very early.
“Investing in crypto is something I think is very wise to do; at the same time it’s very volatile. It’s going to go way up and way down and way up — it’s a rollercoaster ride.”
Cryptocurrencies themselves, Brown calls “a byproduct of a more important thing called blockchain, which is a way more secure environment for data and data flow.
“Cryptocurrencies are just applications built on the blockchain,” he said.
So how does blockchain work, and how does it make cryptocurrencies work?
According to Harvard Business Review, blockchain is “a vast, global distributed ledger or database running on millions of devices and open to anyone, where not just information but anything of value … can be moved and stored securely and privately. On the blockchain, trust is established, not by powerful intermediaries like banks, governments and technology companies, but through mass collaboration and clever code.”
In a blog post, Deloitte Switzerland Operations Director Richard Bradley took the challenge of explaining the original intent of blockchain in less than 100 words:
“You (a ‘node’) have a file of transactions on your computer (a ‘ledger’). Two accountants (let’s call them ‘miners’) have the same file on theirs (so it’s ‘distributed’). As you make a transaction, your computer sends an email to each accountant to inform them. Each accountant rushes to be the first to check whether you can afford it (and be paid their salary ‘Bitcoins’). The first to check and validate hits ‘Reply All,’ attaching their logic for verifying the transaction (‘Proof of Work’). If the other accountant agrees, everyone updates their file… This concept is enabled by blockchain technology.”
Christopher Gorog, lead faculty in cybersecurity at Colorado Technical University, said blockchain makes it possible to “track, very rapidly, all the transactions back through history, transparently, through technology, so we don’t need a bank to verify that somebody has the funds.
“We track back and see when they got them, who they got them from, how long they’ve had them, and all the things we need to know, without a bank involved. It eliminates the need for the trusted third party — the idea being that you trust the network and you trust the code.”
Bitcoin was released in January 2009. At the time, Satoshi Nakamoto (the pseudonym used by the unknown person or people who designed Bitcoin) described it as “a new electronic cash system that uses a peer-to-peer network to prevent double-spending. It’s completely decentralized with no server or central authority.”
Bitcoin was the first mainstream example of a cryptocurrency, and remains the world’s largest blockchain network. Today, it shares the internet with more than 900 cryptocurrencies, including Ethereum, Bitcoin Cash, Ripple, Peercoin, Dash, Dogecoin and Litecoin.
Brown said our current understanding of blockchain is “like the late ’80s early ’90s of internet — the difference is it’ll go exponentially faster because of information, so I think it’s important people know about it … because we believe blockchain is the future security platform.
“Right now it’s a lot more expensive to defend against cyberattacks than it is to attack, but I believe blockchain changes everything,” Brown explained. “It’ll become more expensive to attack than it will be to defend. It comes down to the economics of the whole war.”
A large part of cryptocurrency’s appeal, Brown said, is that blockchain protects personal information and identity better than banks.
“Historically [for] all file server and client server databases in the United States, the way the system works today, there are a lot of places where there’s [a] single point of failure — so if you can attack that, you can take it out,” he said.
“Whereas with blockchain, it’s distributed; there’s no one place to take it out. … The fact it’s decentralized is what makes it secure.”
A widespread grasp on the workings of blockchain and cryptocurrency is some way off, Brown said.
“It’s too much to take in all at once — people go blurry-eyed pretty quickly,” he said.
“As far as [blockchain], it’s: ‘We don’t know what it is, but we know it matters.’ Like when people first saw the Sputnik in the sky, way back, they didn’t really know exactly how it worked or what it was, but everybody knew it mattered,” he said. “Or the internet — we didn’t know ultimately how it would impact our world. I believe this is going to be a similar kind of impact to our world: cryptocurrencies, and more so blockchain.”
The BIS signaled the same in its latest quarterly report, saying central banks worldwide must consider whether to issue their own cryptocurrencies.
“Central banks will have to consider not only consumer preferences for privacy and possible efficiency gains — in terms of payments, clearing and settlements — but also the risks it may entail for the financial system and the wider economy, as well as any implications for monetary policy,” it said.
Sweden’s central bank is considering issuing its own cryptocurrency — the ekrona — within the next two years, partly in response to a dramatic drop in the use of cash among Swedes.
People’s Bank of China is testing its prototype cryptocurrency, while De Nederlandsche Bank, the Dutch central bank, has tested its own cryptocurrency in internal circulation.
The 2017 Global Blockchain Benchmarking Study, released last month, showed 20 percent of central banks plan to deploy blockchain within two years, and almost 40 percent aim to be using the technology within a decade. Eighty percent say they’re researching blockchain with a view to issuing their own cryptocurrencies.
Editor’s note: Next week, the challenges, risks and impact of central bank-backed cryptocurrencies