The profound evolution of cryptocurrencies

On a quiet evening in October of 2008, members of an obscure cryptography mailing list received an email from one Satoshi Nakamoto. It read, “I’ve been working on a new electronic cash system that’s fully peer-to-peer, with no trusted third party.” Little did they know, the brief message would later shake the financial world to its core and spark a decentralization movement worldwide.

​From an idea discussed among esoteric cypherpunks, to being an asset class worth over $1.7 trillion dollars, cryptocurrencies have become a polarizing subject over the years. Recently, however, it seems like there has been more and more indication that this new digital asset will become the currency of the future. El Salvador became the first country to adopt bitcoin as legal tender in 2021. And in the current bull market, it seems like everyone and their grandmother is talking about bitcoin.

​However, the journey to becoming one of the most ventured investments in modern history has not come without a fair share of turbulence. Paul Krugman, the Nobel-prize winning economist, called bitcoin a Ponzi scheme, while Warren Buffett, one of the wealthiest men in the world, referred to it as a fool’s gold.

Despite the harsh criticism from prominent financial figures, and the constant barrage of attacks by the mainstream media, cryptocurrencies have soldiered on and showed that they are not going away any time soon. Thirteen years since Satoshi Nakamoto released his bitcoin whitepaper, the digital currency looks to be stronger than ever, reaching an all-time high of $1.1 trillion in market capitalization just a few months ago. Over 100 million people are now using cryptocurrencies.

Each bitcoin today is worth about $40,000. Currently, there are 18.7 million coins in circulation. A new block is minted roughly every 10 minutes, until there are only 21 million bitcoins, upon which, the currency will become deflationary -which means the price of goods and services, relative to bitcoin,will go down. These are the fundamental principles behind the network, which allows it to be maintained without a central authority, and be easily adopted by many.

The process of minting a new coin is called “mining”, and in the earlier years, you can do this with just an average laptop. Satoshi Nakamoto himself mined about 1 million bitcoins before handing over the reins to Gavin Andresen, an American software developer, before disappearing forever.

Today, however, mining requires top-grade computer equipment and high electricity consumption, which isprohibitive for many. This technical fault shows that bitcoin is not yet perfect, as a network maintained by only a certain group of people means more centralization – something bitcoin was trying to avoid in its conception.

​Just as a powerless infant evolves into a strong, full-grown adult over time, so too will technology evolve from being aprototype to a world-class product. Seeing the imperfections of bitcoin, computer and financial wizards worldwide have developed other cryptocurrencies, with additional features and sometimes radically different concepts to continue the missionof having a “new electronic cash system that’s fully peer-to-peer, with no trusted third party.” These alternate coins are colloquially known as altcoins.

​The first ever altcoin was Namecoin. It was released a little over two years after its predecessor. Namecoin’s primary use is to resist domain name censorship from any governing body.Unlike bitcoin, however, it received little traction and has since fallen to obscurity. Apparently, most people don’t care enough to switch to an autonomous domain. As a result, the price of Namecoin plateaued for most of its life.

Bitcoin and Namecoin price performance.

Source: coinlib.io

The failure of Namecoin shows that major cryptocurrencies are not a fluke. There are many factors that go into the success of bitcoin and other digital assets. Among them: the quality of the network or product, the strength of the project team, the ability to form strategic partnerships and raise funding, a robust coin allocation and token economics, and sometimes, the support or hype from an individual or group with star power. If cryptocurrencies don’t have any of these success factors, they may end up like Namecoin.

Six months after Namecoin was released, another altcoin made its appearance – Litecoin. Where Bitcoin takes 10 minutes to process a block, Litecoin does it in 2.5 minutes, making it a faster network under the same conditions. This altcoin fared better than Namecoin, as it is able to stay among the top 15 coins based on market capitalization.

​However, the largest altcoin to-date is Ethereum. Its dominance is thanks to the smart contract feature, which allows applications to automatically execute when the terms of an agreement are fulfilled. Since then, there has been a plethora of decentralized applications, or DApps, that run on the Ethereum network.

​The fastest growing sector among these applications is decentralized finance, or DeFi. It refers to any smart contracts, protocols, or DApps related to finance. One example isdecentralized exchanges, which allow users to exchange currencies directly with one another without trusting an intermediary. Another example is lending platforms. They use smart contracts to replace banks that manage the lending in the middle.

​These smart contracts hold Ether and other Ethereum-based tokens until the predefined terms of agreement are fulfilled. The value of all these tokens are called “Total Value Locked” or TVL. The chart below shows a parabolic rise in TVL in the past 12 months, reaching an all-time high of over $80 billion in May 2021. If this trend continues, there will be a significant shift in the financial sector, where incumbent institutions such as large banks will lose a huge chunk of their market share. They will have to adapt to the changing technological landscape in order to survive.

Source: defipulse.com

​Today, there are over 10,000 different cryptocurrencies and over 300 crypto-exchanges. Besides El Salvador, other Latin American countries such as Argentina, Brazil, Mexico, Nicaragua, Panama and Paraguay have also started to look into adopting bitcoin as legal tender, shattering into pieces Paul Krugman’s argument against bitcoin. Warren Buffett’s company, Berkshire Hathaway, has invested $500 million in a pro-bitcoin digital bank. So, he seems to be backtracking from his “fool’s gold” comment. MicroStrategy, a software company listed on NASDAQ, is on a bitcoin shopping spree, investing billions of dollars to hoard the digital asset. Hedge funds are now eyeing to add bitcoin to their portfolio, adding up to an estimated $300 billion dollars flowing into the market in the next five years.

​However bullish this news may be, there are stillfundamental problems with cryptocurrencies that need to be solved before they can reach mass adoption. By design, cryptocurrencies’ ledgers are distributed among many computersto verify its authenticity. In theory, the more computers the ledgers are distributed to, the more decentralized and secure the network is. However, this comes at the cost of an increased environmental impact, and an incredibly slow network.

​There is an immense research and development going on to solve these issues. Ethereum core developers are looking to release a groundbreaking update called ETH 2.0 which could do just that. This update is broken down into three phases, the first one of which, called the Beacon Chain, is already live since December 2020. The second and third phase is estimated to be rolled out in within the next two years.

​The importance of fixing these environmental and scalability issues cannot be stressed enough, as the idea of a stagnant, underused, and overhyped asset could only mean one thing – a bubble. And when a bubble pops, a lot of people, especially unexperienced retail investors, are going to get hurt.An excitement to see a life-changing technology develop in front of our eyes must be accompanied by a healthy sense of realism. So, do not invest more than you can afford to lose.

From developing technical solutions, devising robust monetary policies and supporting cryptocurrency growth, we carry a great responsibility to nurture this young industry.Satoshi Nakamoto’s bitcoin paper sparked a worldwide revolution for decentralization, and it is up to us to see whether that spark turns into a flame, or goes out silently.