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How and Why Cryptocurrencies Are Revolutionizing Money

The trouble is, cryptos are an immature technology at present and that fact may doom many of the current ones

At Expensivity, Bernard Fickser, who has explained how to sell non-fungible tokens (NFTs) now offers “The Truth About Cryptocurrencies: A Clearheaded Guide to the Crypto World.” (January 15, 2022) For your convenience, we are serializing his work, which can be read in whole here. Here’s Part 4:

4 Crypto’s Revolution in Money and Finance

Cryptocurrencies seem different from mass delusions of the past. They do novel things in the world of finance that many people want, such as allow for anonymous exchanges of digital currency that feel a lot like exchanges of ordinary cash. They promise to bypass intrusive government control. And they’ve attracted a lot of very smart talent that is deploying some very cool mathematics and computer science.

At the same time, cryptocurrencies raise a lot of concerns, some of which I touched on in section 1.2 (“Dangers, Pitfalls, and Snares”), but others that seem more fundamental and may upend cryptocurrencies in the long run (see the later sections of this article).

The biggest concern for me personally with blockchain-based cryptocurrencies as they exist now is that they may in fact represent an immature technology, and thus in the end may give way to a better form of cryptocurrency. Just as the automobile did away with the horse and buggy, such a superior cryptocurrency of the future could do away with cryptocurrencies of the present by greatly devaluing them or even sending them to zero.

Even so, I want therefore in this section to consider some of the features of existing cryptocurrencies that commend them and that even in their present form are making them a revolution in money and finance. At the same time, I want to point out some of the fault lines that may make this revolution less than totally successful.

4.1 Used Like Money

Cryptocurrencies provide a way of securely moving digital items across digital space, These digital items look like currency and that in some places are actually used as currency. In Venezuela, for example, Bitcoin circumvents the country’s discredited central bank and the hyperinflation it has caused. More strikingly, in early June of 2021, the El Salvador government approved Bitcoin as legal tender.

Since then, Bitcoin has become ever more entrenched in the El Salvadoran economy. In October 2021, Bloomberg reported:

Adoption of the cryptocurrency is a way for Salvadorans to access more payment methods in a nation where more than three-quarters of citizens are unbanked, [according to central bank President Douglas Rodriguez}. He called it a means of inclusion for those whom the financial industry deems too low-income or high-risk. 

Salvadorans began using the government’s Chivo wallet last month, which came preloaded with $30 in Bitcoin, to buy dips and sell rallies with fractional amounts of the cryptocurrency [thereby allowing Salvadorans even to speculate, on a small scale, with Bitcoin]. 

Businesses in the capital of San Salvador, from Starbucks and McDonald’s to local electronics stores, have begun to accept it in exchange for goods. Rodriguez reiterated that use of the cryptocurrency was optional and expected it to be used alongside the U.S. dollar. 

The next step for the government is providing Salvadorans living in the U.S. with identification numbers, a requisite for opening a Chivo account, he said. Doing so could offer a cheaper way for those living abroad to send money back to El Salvador, Rodriguez added. 

The central bank expects remittances to rise to a record $6.3 billion this year, 31% more than in 2020…

Meanwhile, in August 2021, the city of Miami began experimenting with its new MiamiCoin token, based on the CityCoins mining process built on the Stacks protocol. According to the Washington Post, reporting at the end of September 2021, “Since CityCoins unveiled ‘MiamiCoin’ in August, the protocol has sent about $7.1 million to Miami.” That’s over $7 million in crypto-taxes in less than two months. And in December 2021, Jackson, Tennessee became the first US city to make Bitcoin a payroll option for employees.

The volatility of Bitcoin and other cryptocurrencies means that, at least for now, they are less than ideal as a long-term store of value capable of reflecting consistent stable prices (i.e., prices that don’t swing wildly). But for instant payments where prices can be adjusted on the fly, cryptocurrencies can work like money. Even with their price volatility, cryptocurrencies offer protection against hyperinflation.

Moreover, if the example of Miami in using crypto to pay for city expenses (and thus essentially to act like a tax) is any indicator of things to come, crypto’s volatility may be on its way to settling down, After all, tax levels are usually set a year in advance, stabilizing expectations about tax payments and city expenditures, and thus acting as a curb on volatility. But are we talking crypto in general or Bitcoin in particular? Bitcoin seems to be the go-to crypto for companies and governments that want to use crypto for payments. It will be interesting to see if other cryptos start competing for such payments with Bitcoin.

There’s the old joke that when something looks like a duck, walks like a duck, and quacks like a duck, then it’s a duck. The philosopher Leibniz restated this joke, without the humor, in his principle of the identity of indiscernibles. This principle states that if things resemble each other exactly, then they’re identical. Accordingly, it would seem that cryptocurrency isn’t merely like money — it is money. Whether it can be a sound, universal form of money is the deeper question, and one we’ll touch on.

4.2 The Remittances Market

Remittances are international money transfers. In the previous subsection, Bitcoin wallets were described as making remittances easy for El Salvadorans by offering “a cheaper way for those living abroad to send money back to El Salvador. Remittances have a significant place in the global economy. The global remittances market is above $700 billion currently and is expected to top $900 billion by 2026.

Cryptocurrencies are ideally poised to handle remittances. That’s because anybody can download a wallet for any cryptocurrency, and then begin exchanging that cryptocurrency without restriction or borders. Any two people with wallets handling the same cryptocurrency can then send each other cryptocurrency from one wallet to the other. Geography is no obstacle here. All you need is an internet connection. People in different countries can quickly and easily send each other cryptocurrency. In fact, it’s no more difficult to send cryptocurrency to someone across the globe as to send it to someone in the same room with you.

This immediacy of cryptocurrency transfers represents a vast improvement over sending funds overseas. Suppose I want to send U.S. dollars from my bank account in the U.S. to a bank account in Germany to pay for some art object, say. I’ll need a SWIFT code for the German bank as well as the account number of my German seller. I’ll need to authorize my U.S. bank to debit my account and send the funds. Those funds may also need to go through an intermediate or corresponding bank here in the U.S. before they are sent overseas.

Once the funds are in Germany, more than one bank may be involved there to ensure that the funds are exchanged into euros and properly transferred, with at least one of those German banks also holding dollars to guarantee the exchange. What exactly gets sent in dollars and what exactly ends up deposited in euros will depend on the exchange rate at the time, which changes in real time. It’s complicated, and all that complication disappears by dispensing with conventional banking and going with crypto.[7]

4.3 DeFi

DeFi, which stands for “decentralized finance,” has become the catch-all term to describe all the expanded benefits and possibilities that cryptocurrencies are supposed to bring to the world of finance.[8] Because cryptocurrencies bypass banks and borders, DeFi becomes an apt description of crypto transactions even with only a rudimentary blockchain-based cryptocurrency such as Bitcoin. But where DeFi gets its power is from smart contracts. Smart contracts are the central concept of DeFi. Even non-fungible tokens (NFTs), which have recently become big in DeFi, can be viewed as a form of smart contract.

What smart contracts do is add a layer of programmability and automation to a blockchain-based cryptocurrency, making it much more convenient and powerful in financial transactions. Smart contracts are computer programs that ride on top of a cryptocurrency, and that automatically engage in certain cryptocurrency transactions depending on the fulfillment of certain conditions. The release of escrow funds, for instance, can be programmed into a smart contract, e.g., “release this amount of crypto on such-and-such a date.”

Without smart contracts, the exchange of crypto happens only by one wallet owner explicitly transferring funds to another wallet owner. The parallel with conventional money is individuals exchanging money directly with explicit authorizations for each transfer of funds and for each exchange of goods. But we all have experience where such exchanges can, at least to some degree, be automated. For instance, a vending machine removes the immediate oversight of the seller. A subscription that delivers the same good or service monthly likewise represents a “smart contract.”

Smart contracts in crypto allow a full universal Turing machine (i.e., a full-fledged computer) to run on a cryptocurrency blockchain, and thus allow unlimited programmability of smart contracts. Essentially, smart contract capability turns a cryptocurrency blockchain that’s only good at transferring funds into a fully computerized blockchain that happens also to incorporate a cryptocurrency. This capability is best built into the cryptocurrency from the start. Ethereum blazed this trail and it remains to this day the go-to crypto for smart contracts (though Solana shows some signs of becoming a serious contender in this space).

The unlimited programmability of Ethereum and other subsequent cryptocurrency blockchains opens up immense possibilities for smart contracts and DeFi, but it also poses serious dangers. The problem is that for anything except very simple programs, bugs and unanticipated consequences can occur.

In ordinary human contracts, this is less of a problem because people will realize when something totally unexpected happened and then will try to resolve what happened with the benefit of hindsight. But with a smart contract, there is no recourse, once it is activated, to right the ship short of the peer-to-peer network that runs the underlying crypto blockchain to institute a “reset” contrary to existing protocols.

Such a reset, taking the form of a hard fork, happened on the Ethereum blockchain. In spring of 2016 Ethereum initiated an elaborate smart contract called the DAO (Decentralized Autonomous Organization). In its heady early days, the DAO was even referred to as an “employeeless company,” as though all activity being run by computers without real-time human intervention were a virtue.

Because of vulnerabilities in the DAO, a hacker was able to siphon off 3.6 million ether (worth $50 million at the time, and currently around $15 billion) to an address/wallet under his control. This led to key players on the Ethereum peer-to-peer network, notably Ethereum founder Vatalik Buterin himself, to institute the reset, reassigning the 3.6 million ether that had been siphoned off.

All’s well that ends well? Some of the players/nodes on the Ethereum peer-to-peer network regarded this deus ex machina intervention by Buterin and his followers as medicine worse than the original problem. In response, they forked Ethereum into Ethereum Classic, and you can find both to this day listed as on the crypto exchanges. The original problem was that a hacker was able to make off with 3.6 million ether, but had operated completely within the bounds of Ethereum’s protocols. Buterin decided to make an exception. The purists, who went with Ethereum Classic, saw this as a slippery slope that could ultimately undo Ethereum’s integrity as a cryptocurrency.

DeFi faces many open problems. Perhaps the most interesting one is how to institute what are known as “oracles,” which attempt to draw in information from the outside world. Blockchains, even with smart contract capabilities, are self-contained. For many financial transactions, it would help to fold in outside information, such as how the housing market in a certain location is doing and whether to implement a certain crypto transaction once the housing market reaches a certain level.

Oracles would provide such outside information into a cryptocurrency blockchain. But guaranteeing the reliability of such information and programming a smart contract on how to act on it remains an open question. In fact, it may be an insurmountable problem because outside information is inherently open to manipulation by bad actors. Blockchains, as immutable ledgers, can preserve their internal consistency and integrity. But they cannot control the outside world.

One of the big themes in DeFi is crypto’s promise to minimize “friction” in financial transactions. Friction here refers to the intermediation fees and bottlenecks that are said to infect conventional finance (such as sending money from one country to another, requiring an exchange from one currency into another). In principle, given the ease with which crypto can be transferred from wallet to wallet, friction, such as transaction costs, should be low and stay low. That said, it’s not clear what will happen as we get dependent on crypto transactions.

Existing blockchain-based cryptocurrencies depend on a peer-to-peer network, which consist of nodes that need to be in place and operating for crypto transactions happen. But how do we know that no inflation of transaction costs awaits us with crypto? What would happen, for instance, should Bitcoin miners think that the amount of newly created bitcoins that they might win during any block validation is no longer giving them enough profit? The only other place of profit for them on the Bitcoin blockchain will then be through transaction fees.

I’m not saying that a significant inflation is about to hit cryptocurrency transaction fees. But raising this doubt doesn’t seem too far-fetched. It’s not like any cryptocurrency has a constitution that fixes certain protocols forever and can forever guarantee low transaction costs. The majority of nodes can always decide otherwise. Peer to peer is a democracy, and democracies can change anything with enough votes. Even the US Constitution allows it to be amended with a suitable majority of votes.

One encouraging sign that cryptocurrencies may indeed be able to minimize friction and thus keep intermediation fees low is that transactional scalability now finally seems in reach. Until recently, the transactional speed of cryptocurrencies was so slow that it couldn’t keep pace with world commerce, and thus it threatened to undercut DeFi. Transactional speed of cryptocurrencies is measured in TPS (transactions per second). The scalability problem — scaling up the speed of transactions — has been a serious concern weighing on cryptocurrencies.

Bitcoin maxes out at the pokey pace of around 5 TPS (you can actually see all Bitcoin transactions in real time, along with their blocks going right back to Bitcoin’s inception, at Blockchain.com Explore BTC). Ethereum does better with a TPS of 25. Ripple hoped to be a game changer by upping the TPS of its XRP to 1,500. But for world commerce, you really need a still higher order of magnitude TPS. Solana has finally achieved that with TPS in excess of 50,000. For comparison, Visa handles about 2,000 TPS, so Solana looks poised to be a global transactional cryptocurrency. Not to be outdone, Ethereum is planning a multi-phase upgrade to Ethereum 2.0 that is supposed to increase its TBS to 100,000. 😉

Nonetheless, even with a blockchain technology that allows for super-fast transactions and keeps friction low, it’s still unclear whether the peer-to-peer community running such a blockchain will in fact keep transactional costs low. Again, it’s up to the community. A recent article in Business Insider is titled “Ethereum Transaction Fees Are Running Sky High.” I personally have been debited what I regard as unreasonable transaction fees both for Bitcoin and for Ethereum transactions, so I’m skeptical that transaction/intermediation will be kept in check.

DeFi is a big and fast moving field, and I’ve barely touched on it in this section. What DeFi does for cryptocurrencies feels very much like what derivatives (such as futures and options) have done to traditional equities (such as stocks and bonds). In the same way, DeFi enhances, embellishes, and expands crypto.

But derivatives, as we learned in the financial crisis of 2007-08, can hide many perils. DeFi, to the degree that it is wedded to smart contracts, may face similar perils. Unanticipated consequences of automation, whose behavior and correctness cannot be guaranteed in advance (as is typical with all but the simplest computations, the halting problem setting a particularly formidable obstacle: basically the halting problem says that for most programs you can’t tell what they’re going to do until you run them), may come to infect DeFi. The concern here is about the limits of artificial intelligence, and it is not an idle concern.

The failure of automated driving to reach level 5 (i.e., full automation with no need of human intervention) serves as a cautionary tale for DeFi. A few years ago (around 2017), Big Tech promised us that level 5 driving was right around the corner. Now, that promise is hardly mentioned. Erik Larson, a contributor to Expensivity, draws out the lesson in his Harvard University Press book The Myth of Artificial Intelligence: “Self-driving cars are an obvious case in point [the point being, as Larson stated earlier, that these “systems are idiots”]. It’s all well and good to talk up advances in visual object recognition until, somewhere out on the long tail of unanticipated consequences and therefore not included in the training data, your vehicle happily rams a passenger bus as it takes care to miss a pylon. (This happened.)”

We may already be seeing rumblings that DeFi may be imperiled and that it has no easy exit from its perils. Earlier we reviewed the 2016 debacle of Ethereum’s DAO. In 2017, there was still high optimism for DAO’s in general, and the parallel with self-driving cars was explicitly made:

Imagine this: a driverless car cruises around in a ridesharing role, essentially an autonomous Uber. Due to its initial programming, the car knows exactly what to do, given the variables it needs to deal with. It finds passengers, transports them, and accepts payments for its transportation services.

After dropping someone off, the car uses its profits for a trip to an electric charging station, using ether – Ethereum’s native token used for paying to use decentralized apps – to pay for the electricity.

This car is just one in a fleet of vehicles owned by a DAO. As the cars earn ether, the money goes back to the shareholders that have invested in the entity.

That’s one “thought experiment” brought to you by former bitcoin contributor Mike Hearn in which he describes how cryptocurrency and blockchains could help power leaderless organizations in the future. What Hearn described is one fanciful use case for a DAO, an idea that began to get traction in the crypto community not long after bitcoin was released in 2009.

“What is a DAO?” by Alyssa Hertig, CoinDesk, March 2017

But level 5 automation for driving is dead, and short of some revolution in artificial intelligence, not likely to be coming back, except as hype, but not as reality. DAOs as such (rather than “the DAO” that petered out in 2016) continue what at best could be described as an anemic existence. For all the talk about leaderless, decentralized, non-hierarchical, transparent organizations, traditional organizations run by a few smart people who call the shots and provide the vision still seem to be the way to go.

In practice, a much bigger problem for crypto than decentralized autonomous organizations is the prospect of any cryptocurrency facing a hard fork and the uncertainty that can bring. Ethereum, for instance, has experienced a number of hard forks since the 2016. Bitcoin has a history of hard forks as well. Even Solana, despite all its technological horsepower, experienced a hard fork when its network failed in response to overdemand. That shouldn’t have happened: Solana is the new kid on the block. It was released in April 2019, so it had a decade of cryptocurrency research from which to draw to avoid the mistakes of the past. The fact that it didn’t hardly inspires confidence.

Just to be clear: hard forks are a real unresolved problem for all peer-to-peer run blockchains. A hard fork represents a failure of consensus and thus a rift in the community that runs a blockchain. Such a community ultimately determines the fate of any cryptocurrency running on the blockchain. So, in investing in a cryptocurrency, you really need to ask yourself if you want to entrust your wealth, even a part of it, to such a community. To say that such a community is decentralized or minimizes the need for trust may assuage worries, but resolves none of the underlying problems.

The whole series in order:

Part 1: Some brute facts about Bitcoin and other cryptos Crypto is transforming money and finance. Like the computer, you don’t need to use one but you’re wise to know the basics. Start here. Crypto functions much like cash, avoiding or minimizing the increasing ability of government or other big institutions to snoop on who you give money to.

Part 2: If you want to stick a toe in Bitcoin’s world … read this first. This short guide offers a quick introduction to the two biggies, Bitcoin and Ethereum. Whether you are investing or just using the system, you need to be very cautious with passwords. It’s not your street corner bank.

Part 3: As money slowly transitions from matter to information… Let’s look at a brief history of cryptocurrencies — which is not quite what we might think. The mysterious Satoshi Nakamoto, founder of Bitcoin, did not invent new concepts in computer science or cryptography; he put them together in a way that worked.

Part 4: How and Why Cryptocurrencies are Revolutionizing Money The trouble is, cryptos are an immature technology at present and that fact may doom many of the current ones. Bernard Fickser looks at the “hard forks” where things went badly wrong. There are problems that decentralization and minimizing the need for trust can’t solve.

Part 5: Is cryptocurrency selling out to centralization? Crypto wealth is radically centralized in the hands of a few, compared to more conventional forms of money. A bit like the politician who goes to Washington to change things and leaves it unchanged — but has become a millionaire in the meantime…


Part 6: Why cryptocurrencies like Bitcoin are not ready for prime time Bernard Fickser at Expensivity — friendly to cryptos in principle — offers an unsparing look at the current problems. Unsolved problems include insane energy consumption, dead coins, and the potential of government subversion, if not suppression.

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How and Why Cryptocurrencies Are Revolutionizing Money