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The Triumphs, Trials and Tribulations of Cryptocurrencies

Cryptocurrencies have transitioned from a fringe black market currency to an asset class that is traded by mainstream brokerage houses. Their proponents claim that cryptocurrencies will bring a new level of efficiency to the financial sector by facilitating decentralization.
3-5 Crypto
Jaydeep from Pixabay

The thinking is that this will be good for society and the economy as a whole because it is dangerous to leave interest and inflation rates in the hands of a committee of central bankers that decide these things on a whim. If the transition toward decentralization via cryptocurrency is inevitable in the long run, should we all be holding cryptocurrencies as sound investments?

The difficulties of decentralization

The big idea behind all cryptocurrencies (i.e. bitcoin, Ethereum, Dogecoin and others) is that financial transactions can be stored in an encrypted electronic ledger that can never be altered. When encrypted, the content of the electronic ledger can be broken up into segments of code. When the encrypted segments become decrypted by third-party machines, and it can be verified that this was done correctly, they are issued a certificate showing proof of work for what they have decoded. The proof-of-work certificates are then traded as currency, and referred to as coins.

The advantage of this, according to some, is that there is no government or central bank that decides how many coins will be in circulation. The amount of coins that are issued depends on how many computers there are decrypting or “mining” for the coins. Because this is market driven, and no single player could ever be powerful enough to mine so many coins so as to dictate the market, so we now have a currency whose creation is market driven. This would mean that the days of inflationary spikes and rapid interest rate changes would be a thing of the past, because there would be no single entity (i.e. the Federal Reserve, European Central Bank, Bank of England) that would have the ability to flood markets with their country’s currency and hence dictate interest rates or inflation levels.

The cons of crypto

This argument does not mention that each cryptocurrency (i.e. Ethereum, Bitcoin, Dogecoin and others) has their own distinct cryptographic hash times. A cryptographic hash time refers to the amount of code that must be decrypted to receive a coin. All of this means that we could end up in a scenario where the cryptocurrency that wins the day is one where cryptographic hash times can be altered as segments of newly encrypted code become available. The longer the cryptographic hash, the fewer the number of coins will be issued. The effect of this on the money supply would be long lasting because the financial return on mining will have gone down (i.e. more computing power will be needed to capture the same amount of coin). This sounds a lot like the federal reserve policies of the 1980s, where the creation of money was greatly curtailed following the inflationary spells of the previous decade. Whether they do this using greenbacks or cryptographic hash times, what is the difference?

What should you do?

If you want crypto currency to be a part of your portfolio, talk to an advisor and make an informed decision. As with all investments, crypto or not, there is a good reason for the saying, “don’t put all your eggs in one basket.”

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