IV. Why are Cryptocurrencies Developed?
In the general sense, cryptocurrencies can act just like currency that is in your wallet (or, maybe, more like your checking account). Cryptocurrencies are relatively new and innovative forms of currency that, although similar, are very different from historic forms of currency used in the past. Whereas ancient forms of currency, including shells, animals, paper currencies, and precious metals, required a person to have ownership of a physical object, cryptocurrencies require digital ownership, which is theoretically traceable from its origin. For those of you who ever wrote (or saw) a name or address physically written on the back of a dollar bill, cryptocurrency, through use of a blockchain, creates a digital “address” for each transaction.
While credit cards also allow people to make transactions instantaneously, they do not provide the anonymity, freedom from third-party intermediaries, ability to enter into “smart contracts,” or the investability that are fundamental components of cryptocurrencies. However, like older forms of currency, cryptocurrencies still depend on a party’s faith of the “currency” in order to assign an intrinsic value, which can fluctuate in price- much like the dollar, gold and other forms of currency. Many governments, however, have raised some concern due to the fact that (most) cryptocurrencies are not backed by the full faith and credit of a government, which may have complex fiscal policies and a centralized bank to manage the output of currency, control inflation, and stimulate economies.
Bitcoin is the most well-known cryptocurrency, and was created in 2009 by a mysterious person or group of people who went by the name Satoshi Nakamoto. It was created after one of the worst financial crises in American history when faith in the traditional banking sector and government was at a record low. Many believe that the initial intent was to create a digital currency with the capacity to circumvent third-party intermediaries (banks), government oversight and the inherently-public nature of using traditional forms of money. This new form of currency could also be borderless – transactions could take place between people from any place in the world using the same currency. In that respect it is meant to represent a universal currency, much like the U.S. dollar, British Pound, and more recently the Euro have been treated over the past several decades.
The flexibility and privacy of Bitcoin was bolstered by the fact that it was not subject to government fiscal and monetary policies. There is no “Bitcoin Reserve” that can print more Bitcoins whenever it wants in the way that the “Federal” Reserve can. Bitcoin is “free to float” in price so that its price is determined by the market as opposed to policy considerations and “expert” opinions.
As a result, whereas some countries may seek to artificially manipulate their currencies through a policy of depreciation in order to increase the amount of goods they sell to foreign countries, no individual country can enact such policies with regard to many cryptocurrencies. Likewise, having a fixed number of coins (often also referred to as “tokens”) helps to reduce the chances that a cryptocurrency experiences inflation. Bitcoin and many other cryptocurrencies that have followed it, are capped to a certain number of “coins” to be issued in order to prevent inflation of the currency due to overprinting by central banks. However, because some of these cryptocurrencies (including Bitcoin) are infinitely divisible, inflation can actually occur despite the fact that the number of Bitcoins will never surpass 21 million and the number of Litecoins will never surpass 84 million (for example). One could argue that inflation may be controlled naturally as people lose their cryptocurrencies over time and the supply decreases. Therefore, while cryptocurrencies are not actually immune to inflation, they are less likely than paper currency to fall victim to so called disastrous policy decisions that end up in catastrophic devaluation of currency.
Other cryptocurrencies were developed for many of the same purposes but incorporated other features such as the ability to enter into smart contracts, faster transactions, automatic mining, and in the case of the Venezuelan government’s cryptocurrency, to switch from a failing bolivar to a (hopefully) more stable and trusted currency.