The following is Part 2 of a collaboration with GINcoin. To read Part I, click here.

Introduction

When you hear the word Bitcoin, chances are you have one of two thoughts: “it’s a bubble” or “when moon?”. There is no doubt that Bitcoin and the broader cryptocurrency market has seen both sides play out. There are many that have become millionaires and even billionaires from investing early, and there are those that won’t touch it, even with someone else’s money!

In Part 1 of “What is Bitcoin” we examined what money is, where it came from, and how we ended up at Bitcoin. Now it’s time to play Devil’s Advocate and look at the current challenges facing a blockchain-based currency.

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Price Volatility

Everyone knows Bitcoin is volatile, and if you don’t, you’ve never heard of Bitcoin. But why is it so volatile? The answer to that depends on your perspective.

The Bubble is Bursting

Most traditional investment guys will first and foremost label crypto (especially Bitcoin) as a bubble. Whether or not this is true depends on the author’s definition or intent of that label. The word “bubble” typically gets associated with Tulip Mania or the Dot Com era where prices rose to astronomical heights, then came crashing down. If you look at the Bitcoin chart for the past year, it indeed looks like the standard “bubble” chart.

Before you assume the critics are right, scale out a bit beyond the one year chart and you’ll notice that the HUGE bubble of 2013-2014 is barely noticeable compared to the run-up of the past year. This is noteworthy because volatility is relative. If you’re investing in a speculative and premature market, it’s important to balance your expectations. Short term investment in almost ANYTHING is going to be volatile.

Fundamentals

A common argument is that Bitcoin and any other cryptocurrency doesn’t have a fundamental basis for its price – it’s pure speculation. This isn’t totally wrong, and much of the market is uneducated retail investors hoping their cash advance is going to moon overnight. However, let’s not forget that the hashrate/hashpower of the Bitcoin blockchain has increased exponentially, even in this current bear market. What does this mean? More people are using their processing power to mine Bitcoin. Real work is being done on the blockchain, and when more work is being done, the perceived value of that blockchain increases. Unlike fiat currency, the creation of Bitcoin requires thousands of dollars of real work (processing power). While it’s not totally inaccurate to say that cryptocurrencies are based on speculation, it is only a half-truth.

Manipulation

Next on our list is market manipulation. Yes, there is market manipulation! ANY market can be manipulated. You may have heard the term “whale” before in various Telegram channels or Reddit threads. These market movers are present in both traditional and crypto-based markets. Simply put, those with more money and market knowledge can fool those in a low volume environment using a relatively large buy order to suggest there is more demand than there is. These spikes are often referred to as “pump & dumps”. One would be wise to think twice before investing hard earned money into a low volume token simply based on hope that it will spike.

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Institutional Investment

In the past 9 or so years that the cryptocurrency market has existed, one investor type has been missing: the institutional investor. For those unfamiliar with the term, an institutional investor is “someone” with very deep pockets. Investment banks like Goldman Sachs would be an example of an institutional investor. A common characteristic of institutional investment is a long term hold. In contrast, the retail investor (you and I) is typically a short-term investor. We want to jump in and out, time the market, etc. These are habits the institutional investor doesn’t have. They are willing to hold for YEARS. Why? Because they’re smart! They know that it is very difficult to time the market and the key to growing your investment is patience.

Many institutional investors are sitting on the sidelines until further regulation is put into place. You may have noticed more and more exchanges are asking for AML/KYC information (Anti Money Laundering/Know Your Customer). These are the stepping stones that will forge a trusted path for a much larger pool of investors. While many early adopters of crypto are cringing at the thought of further regulation, this is a necessary step if Bitcoin and other blockchain-based services are to flourish.

Store of Value

We learned in Part 1 that money should be a storage of value. If we were to own $1 today, we would expect it to have the same purchasing power in 10 years. Bitcoin is often called Gold 2.0, as many believe that Bitcoin will be a store of value much like gold is today. Unfortunately Bitcoin in its present state is very volatile and doesn’t exactly fit the definition of a store of value when the price can fluctuate 10% in a single day.

However, if you’re living in Venezuela where inflation has climbed over 40,000% this year you may be okay with the 10% daily price fluctuation of Bitcoin. On a much more conservative note, the U.S. Dollar has lost much of its buying power in the past 100 years. For example, $1 in 1918 has the same buying power as $16.66 today – while it’s not 40,000%, it’s an issue that is growing by the day.


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Inability to Lend

As the market matures, we are seeing more familiar services typically associated with traditional monies. One such service is lending – the ability to get a loan from a bank and then pay it back with interest in a predefined period of time.

Although these services do exist using the blockchain, they require AML/KYC information. What is still lacking is the ability to enforce the terms of a loan using a service that is anonymous, as many early adopters would like to remain private. At the moment it is very difficult to create a lending platform where the user can remain anonymous while also complying with the lender’s requirements. How comfortable would you feel lending money to someone you have never met, and you have no way of identifying them?

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Hard Caps Make Inflation Impossible

One of the most intriguing features of cryptocurrencies is the hard cap on total supply. This is a totally new concept when we think of money. Most of us are used to things like inflation, interest rates, and printing more money. But what happens when these elements are replaced by a limited supply?

First, let’s make sure we understand the importance of inflation in our current modern marketplace. Simply put, inflation is the rising cost of goods and services. An apple may cost $1 today, but in a few years, it will probably cost $1.50. This increase in cost is seen as good as long as it doesn’t happen too quickly because it incentivizes spending. If we know that these items are going to become more expensive, we will want to purchase them sooner than later – otherwise, we would wait around for a better price. If we wait around for a better price, demand for goods and services will drop. And if demand for goods and services drop, companies lose revenue, employees lose jobs, etc.

So is cryptocurrency a bad thing since it has a hard cap (fixed supply)? If we look at that question from the surface it certainly seems to be the case. But let’s jump into the Magic School Bus and travel to a place where global and national economies are architected around the use of cryptocurrencies.

Enter James Zdralek – part psychologist, part accountant, part industrial designer, and part innovator at SAP.

James imagines a scenario where central banks use a cryptocurrency that is actually tied to the output of a nation. A scenario where a currency could increase in value over time. But how would this actually work? Much like how the US Dollar used to be tied to gold, this system would rely on assets on the blockchain. There are three asset types that would need to be embedded into smart contracts:

Ownership of the factory
Inventory of a company
Prepaid Forward Contract

The Prepaid Forward Contract is the defining element of this setup because it acts as a mutual fund, aggregating all other futures-backed cryptocurrencies. In Jame’s words, “instead of value being degraded by an inflation rate imposed by the central bank, citizens who hold the currency might actually receive a return on its value – or at least would not lose it.”

Many central banks are beginning to look at cryptocurrencies as a way to combat fraud and the cost associated with minting a fiat currency. Venezuela has already created their own cryptocurrency called the “Petro” to combat corruption and have pegged it to the forward value of their oil reserves. Critics, including Washington D.C., claim the cryptocurrency will be worthless once President Maduro steps down from office. Additionally, many in the global community view this new cryptocurrency as a way to avoid sanctions imposed by the U.S.

Time will tell if James’ vision becomes more than a utopian dream, but in the meantime
scaffolding is being put in place, one country at a time.

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Not Truly Decentralised

The promise of Bitcoin and other cryptocurrencies is that they enable a trustless network because of the blockchain. But what happens when one person or small group has most of the nodes? This is a problem that has not been solved, and is currently under-the-microscope with the launch of EOS.

Each cryptocurrency is experimenting with their own protocol, and eventually one of them will find the best solution. It is still very early in the development of blockchain protocols and governance frameworks. Projects like EOS may very well find their footing and update their protocol to resolve what appears to be a very centralized community. In the meantime, do your own research and take caution when investing in an untested solution.

Not Truly Trust-less

You’ve heard it before, the future of the internet is going to be decentralized and trustless – no more middlemen to trust with our precious information. The only problem with this assertion is that we are actually switching from trusting a middleman to trusting a developer or team of developers. How trustless is the network if the entire protocol is written by a couple people?

Unless you are an expert programmer and have the ability to inspect the code for yourself, you’re trusting that someone else has done that for you, or that the creator(s) of the protocol are good people. The reality here is that this current challenge is like the others we’ve discussed. Over time these new unknowns will be battle-tested and not given a second thought.

Not Foolproof

You’re about to send your favorite cryptocurrency to someone else to complete a transaction, they have sent you their address, you have pasted it into the address field, and now you’re ready to send. *Click* You’re all set, right? Technically yes, you have sent the funds to that address but now you’re having second thoughts. You didn’t double check the address and that wasn’t a small sum of money.

Sound familiar? Anyone that has sent funds to someone else knows this feeling. But why so nervous? Because crypto isn’t highly regulated and matured, safety nets like insured funds (FDIC), chargebacks, etc aren’t possible. Once you send that transaction, the recipient has to create a new transaction to send back funds and no one can force them to do so. This immutability is what makes the blockchain so secure, but naturally there are these drawbacks to consider.

Wallet Fragility

From time to time you have to update your wallet or maybe download the wallet to a new computer. You go to import the saved .dat file and you get an error message. Instantly you start panicking. You have never Googled for help so fast in your life! This is a common occurrence for many projects and usually it gets resolved by restarting the wallet, or re-importing the .dat file. But what if that doesn’t work?

There are many folks out there that have lost a ton of money from a bug in a wallet’s code or they misplaced their private key altogether. Crypto is such a new and exciting space that we forget we’re very much in control of our funds. Every heard the phrase “measure twice, cut once”? Nowhere else does this save your sanity than in crypto. Sometimes the situation is totally out of your control! The project was maybe a bit sketchy, the developers not as responsible as they should be and now you have a corrupted wallet and you’ve suddenly lost $5k. Not a good day.

Conclusion

The release of Satoshi’s white paper has changed many lives over the past nine years. From early adopters getting rich, to unfortunate exchange hacks resulting in the loss of retirement savings, the cryptocurrency space has seen it all. While we have seen much development progress through it all, there is no doubt that we will see more pitfalls in the future. We are all here for various reasons but we are all responsible for our own investments. In a land of decentralization and a trustless society, doing your own research is paramount. As we close out this very long document, I’ll leave you with a quote.

As crypto Jay-Z would say, “I got 99 problems, but a glitch ain’t one!”


BC

Editor-in-Chief of CryptoFizz, graphic/web designer, blockchain enthusiast, and semi-pro chef.

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