It seems like over the last few months, more and more time is being spent on financial media – television, the web, and so on – talking about Bitcoin. Is it the wave of the future, a new form of currency that will revolutionize global commerce? It could be – it has spawned an entirely new kind of asset class known as cryptocurrency, with other types of digital currencies, like Ethereum, ZCash, and others jumping into the fray. Since being invented in 2008 by a mysterious character (person? group of people operating under a single name? nobody knows) named Satoshi Nakamoto, cryptocurrencies haven’t just gained notoriety, but also adoption across the world.
Over a period of a little over four years, from 2013 to to 2017, the total number of worldwide users of cryptocurrencies was estimated to have increased from as little as about 300,000 to almost 6 million. It is also gaining more and more acceptance among merchants; in 2015 it was estimated that approximately 100,000 merchants across the world accepted bitcoin as a form of payment. One of the attractions is that payment processing for bitcoin involves much lower fees – instead of the normal 2-3% charged by credit card processing services, bitcoin processing fees are usually below 2%, and in some cases as low as 0%.
If bitcoin, and cryptocurrencies in general, are seeing so much growth as a legitimate form of currency exchange and commerce, why am I telling you to forget it? It’s pretty simple – bitcoin may have been around for about a decade, but to most people it’s still a brand new thing, and while it is getting more and more attention all of the time, the fact is that it isn’t easily understood. It has existed as a largely unregulated form of commerce since its inception, but as it gains more and more attention, the decentralized, and distributed nature of the technology beneath bitcoin makes it hard for regulators to pin down exactly how to treat, or tax bitcoin transactions. That adds to the uncertainty, not only about the present viability of the asset, but also about its direction and usefulness for the future.
Uncertainty in any financial market breeds volatility, and bitcoin’s recent history is a perfect example. At the beginning of 2017, a single bitcoin was valued at about US$913. Five months later, in the first week of June, it had more than tripled in value, finishing above US$3,000. Only a week later, it dropped by more than $400, a loss of more than 14%; by the first week of July, that loss had accelerated to almost 36%, with the currency dropping below US$2,000. By the first week of December, it had picked up a new, HUGE gain of more than 500%, topping out at nearly US$20,000. During this time, more and more people had started to use bitcoin for trading, using the massive swings from high to low to speculate. From that top, however, the currency has come under major pressure, dropping more than 50% as of this writing to justa little over US$9,000. The extreme levels of volatility in bitcoin, not just from week to week or month to month, but even from day to day have led some experts to speculate the days of easy money in bitcoin are over, and other notables, including Alan Greenspan to go as far as calling bitcoin the next “bubble”.
Bitcoin isn’t going anywhere; it has become too widely used and popular as an online payment method to call it just another fad. For a conservative investor that wants to focus on finding value-baed opportunity, however, its extreme volatility, and generally expensive cost really make it impractical as a legitimate investment candidate, on even a long-term basis. That doesn’t mean there isn’t opportunity to be had; only that, as my headline for this article suggests, I think the best way to take advantage of the “bitcoin boom” right now, and in the long-term, actually lies in the foundational technology, blockchain, that bitcoin is built on.
What is Blockchain?
Blockchain is a pretty strange-sounding term, but if you’ve worked with a spreadsheet, the initial concept is pretty simple. It’s really just a transactional ledger, which by itself doesn’t sound all that revolutionary. The innovation comes in the way that ledger is stored, distributed, and updated. If you’ve worked with just about any kind of collaborative application, like Google Docs, you have a pretty good, but basic frame of reference for how the blockchain works.
Imagine creating a spreadsheet (or, in other terms, a database) that then gets duplicated thousands of times across a network of computers. That’s the beginning of a blockchain. Every time the blockchain updates itself with a new group of transactions, the group is called a block, and each new block includes cryptographic data that links it to the block prior to it. The addition of more and more subsequent blocks to the database is what creates the blockchain. The blockchain is designed to update its transactional data in ten-minute intervals.
One of the reasons blockchain is useful is that since a blockchain exists as a shared, and continuously updated and reconciled database, all of its records are public and easy to verify. However, for a new block to be added to the chain, it must include what is called “proof-of-work,” which can only be generated by the completion of a series of increasingly complex mathematical problems. Once a block has passed the proof-of-work test, it is added to the existing blockchain.
The computing power required to generate an acceptable block (a process that is called mining) is immense and time-consuming, but the difficulty involved also improves the security of the blockchain. Each new block that is added makes it harder to modify a previous block, since hacking a single block would require modifying every block that follows it. The distributed, decentralized nature of the database means that it cannot be controlled by a single entity, so there is no single point of failure; combined with the complexity of the block generation, the blockchain provides a very high level of data security that hasn’t experienced a significant disruption since its inception in 2008.
Blockchain, of course, was originally devised for digital currency, namely bitcoin; but the decentralized nature of the network that maintains the blockchain, and the highly secure characteristics of the blockchain itself can actually be applied in virtually any kind of transaction imaginable. That makes blockchain a technology that can be used to help secure information in virtually any kind of setting.
Applications of Blockchain beyond Bitcoin
As the security, reliability and scalability of blockchain has proven itself, it’s attracting the attention of business and governmental organizations, many of whom have started allocating their own research and developmental resources to finding ways to adopt the technology to their operational models. Here are just a handful of the types of transactions that are either already starting to incorporate blockchain or are likely to be completely revolutionized by it.
Considering that blockchain’s original design was to facilitate bitcoin transactions, this is the most natural and obvious area for its adoption. The decentralized and distributed nature of blockchain essentially creates a two-way, peer-to-peer network between each side of a transaction. That eliminates the need for a central authority, which can and should help to simplify all kinds of other financial transactions. Investment banker Goldman Sachs could help to optimize clearing and settlements, in part by eliminating the need for intermediaries and middlemen to facilitate the process. In theory at least, the same principle can be applied to everything from international remittances to stock market trades. That speeds up financial settlement issues and lowers costs, for businesses as well as their customers. Imagine buying shares of your favorite stock, and instead of waiting three business days for the trade to clear as things currently stand, your shares become available almost immediately to be used as you wish.
Banking, stock trading, mortgage lending and credit markets are all places that could reasonably use blockchain to implement streamlined and optimized changes to the way financial transactions are processed and managed.
Data and Identity Management
One of the biggest risks to e-commerce is the ongoing threat of identity theft. As I wrote about earlier this month, the simple fact is that the need for cybersecurity isn’t going to go away. If anything, it is understood that it is an always-changing, always-moving target. We aren’t going to stop conducing commerce using the Internet, and that means the ability to verify and protect your identity and your personal data will always be the lynchpin of any kind of useful transaction, no matter whether you’re buying an article of clothing, a book, or placing a stock trade.
This is an area that bleeds into virtually every part of digital life. Banks and other financial institutions all over the world have been required for decades to perform costly, labor-intensive and multi-step process to verify new customers and to evaluate their financial needs. Social media sites like Facebook, Twitter and Instagram, for example, essentially exchange your personal data for free access to their platform. The security of that data is of paramount importance to the ongoing viability and usefulness of those platforms. Blockchain offers the potential to simplify many of those verification processes and to improve the security of the data you make available on social media.
From its beginning, the Internet has been built primarily on a centralized, client-server relationship. In general, any given web site can be tracked to a specific, centralized server (or server farm). The Web’s ever-increasing content creation and delivery puts an enormous amount of stress on the centralized server model, which is always struggling to keep up with the demand. Blockchain offers a decentralized, distributed mode of operation that is completely different to the existing framework of the Web, which not only decreases the storage demand on any one server, but would logically also speed up everything from file transfer times to streaming data speeds. It also significantly decreases the chances of files from getting hacked or lost due to server failure, malfunction, or administrator error.
Among other things, smart contracts provide a way for people on opposite sides of a transaction to set the transaction’s conditions and results, and then automatically have the contract enforced. The cryptographic security of blockchain, and the fact that it cannot be modified, only added to makes it a perfect place to store the contract’s information.
Smart contracts right now generally involve digital currency exchange, most commonly using Ethereum, but it has a lot of potential to applied in a variety of settings. In the financial market world, for example, a natural fit could include the tracking and fulfillment of equity options contracts. These aren’t new transactions, but as they currently exist, they do require the involvement of brokers and market makers, each of which charge their respective fees and commissions. The possibility of creating the same transaction as a Smart Contract reduces the number of people involved to just the buyer and seller, with the blockchain providing the means of securing the contract and its terms and conditions and then automatically tracking the result all the way through the contract’s end. It would theoretically lower costs for both the buyer and seller, and could even decrease the spread between an option’s Bid and Ask prices, making trade on any option contract far more efficient.
Another useful application of smart contracts comes in the protection of intellectual property. The ability to reproduce, copy and freely distribute copyrighted information currently acts as a significant drag on the effective sale of all kinds of creative work. Smart contracts can eliminate the risk of file copying and redistribution, protecting copyrights and ensuring creators are compensated fairly for their work.
It’s true that the increasing popularity and acceptance of bitcoin means that e-commerce, and the way we interact with money, will continue to evolve and change. From an investment standpoint, however, the highest probability of significant growth in the coming years aren’t going to come from cryptocurrencies themselves, but rather from the blockchain technology they are all based on.