InDepth Night!

Welcome to my InDepth learning center!

Over the process of my InDepth journey, I covered a variety of topics with my mentor, from market analysis, to customer segmentation, to researching individual companies and deciding what stocks to invest in. But the topic I found most interesting by far was cryptocurrency. For my learning center, I will be presenting a relatively info-heavy lesson on how crypto works, why it works, and some strengths as well as weaknesses that come with the crypto-currency mechanism. 

Feel free to either check out my voice-over Prezi presentation, or read the following post if the video does not work.

https://prezi.com/v/vm1foo5iligj/

Crypto! Will it be the new cash or will it be gone in a flash?

Over the process of my InDepth journey, I covered a variety of topics with my mentor, from market analysis, to customer segmentation, to researching individual companies and deciding what stocks to invest in. But the topic I found most interesting by far was cryptocurrency. For my learning center, I will be presenting a relatively info-heavy lesson on how crypto works, why it works, and some strengths as well as weaknesses that come with the crypto-currency mechanism. 

How crypto works

In short, crypto is essentially digital gold. Not in the valuable sense, but in the literal sense, as in it isn’t tied to any particular government, it has no inherent value, and it can’t be spent on anything. However, just like gold, people believe that it has value, so now it does.

Similar to gold, through a complicated mathematical algorithm known as SHA 256. The system essentially generates a new random number every several hours, and people can test their luck by trying to guess the number. Every certain period of time a new piece of digital gold will be mined from the system, just as real gold is mined from the earth, and whoever guesses the lucky number to mine the gold gets to keep that piece of crypto. However, every 4 years the amount of time it takes to mine a piece of crypto doubles, until eventually, the supply runs dry, meaning the total amount of bitcoins that will ever be in this world has a hard limit. 

So, to summarize this big blob of text, cryptocurrency is essentially a new super-rare precious metal that can only be digitally handled. How it works is that I value it, so I buy it, someone else values it, so I sell it to them, and as enough people value it starts to become its own currency. Similar to other metals, the supply for this currency is very limited and only one piece is found every several hours, but a difference is that everyone can mine for it and you can do it from any device, making it much more inclusive and accessible. 

If you are interested in learning more, please visit my 4th blog post.

Now that you know how bitcoin works, it’s time for the next question, why does bitcoin work. What makes it any better than another random cryptocurrency functioning off of the same mechanism? What makes it better than the US dollar? What makes it more valuable than another random rare mineral? 

Well, to understand this, you have to understand two economical concepts. The value of money, and the supply and demand curve. Starting with the value of money, fundamentally speaking, money is worthless. Currencies as a whole can generate value, but each individual currency by itself is worthless. A currency only becomes valuable, when it is valued. For example, a Euro in America is less valuable than the equivalent amount of US Dollars, as fewer people accept it as a form of payment, while it is more valuable than an equivalent amount of US dollars in… say, France, as more people will accept the Euro than the USD. The same applies to all currencies, and as it gains acceptance, it gains legitimacy. For example, if you’re the only person who uses a type of currency, no matter how good the currency is, it’s useless, as it can’t be traded for anything and isn’t worth any more than its raw materials. Now when your friend also uses the currency, it becomes a bit more valuable, as you can at least refer to it when talking to someone, and when the entire country or world uses it becomes very reliable and precious, as you know even if someone doesn’t accept the currency, most will, and as long as you have some amount of this currency, you can get something in return for it. Bitcoin works the same way. Currently, it’s valuable because people recognize it, and although a bitcoin itself doesn’t have any value, I know I can trade it for hundreds of thousands of dollars, which I can in turn use to purchase products in real life, so this gives bitcoin value. This answers some of the previously posted questions, as bitcoin is valuable because it is widely recognized, which can’t be said for random minerals or some random other cryptos, making it more valuable as a currency than those items.

The second concept is supply and demand. Look at this graph for a second. 

The concept is rather straightforward. The value of an item is determined by how scarce it is, and how desired it is. The more scarce or desired, the more valuable, while more common or less desired items are less valuable. For instance, antiques are very scarce, while many collectors want to bid for them, driving their price up. Dirt, on the other hand, is very common, and not many people really want that much of it. Even when someone does want to buy dirt, many people are willing to sell it, making it less valuable. As previously mentioned, bitcoin has a very limited supply, while many people want to possess it, so it has a high value.

Of course, these aren’t the only reasons for bitcoin’s value, but these are two fundamental concepts that you have to understand to understand the actual reasons. Some of these reasons include:

Technological advancement – people think it’ll be the next big thing so jumped on as soon as possible, which feeds into the cycle, as higher demand means higher prices, making the currency look like it actually is the next big thing.

Speculation – And, above all, the main driving force of bitcoin was certainly speculation.

When someone sees something grow and other people earn money, they may feel afraid to miss out, and jump on board, driving up demand. When demand grows, so do prices, and even more people get FOMO, which is a cycle that repeatedly feeds into itself, constantly driving growth.

Inflation – To stimulate economical growth, governments aim for a 2% inflation rate each year, meaning cash becomes more and more valueless. Bitcoin doesn’t suffer from the same problem, in fact it grows each year, making it appealing to people who just want to save their money and invest it somewhere.

Decentralized currency – This financial terminology may be a bit complex, but the core idea is simple. People don’t like being bossed around, especially not by governments. A modern government controls its populace through monetary policies, so whether it’s out of distrust of the government or censorship avoidance, many people are opting for bitcoin for its nature of not being tied to any particular government. This can be argued as a good thing as well as a bad one, but it’s certainly one of the attractions for this currency.

Now, although crypto has all these strengths, it also has many weaknesses, namely lack of governmental support and small-scale adoption.

Starting with lack of governmental support, previously we said that a strength of crypto is it doesn’t have inflation, but similarly, it also doesn’t have regulation. This means that whatever happens, no one will be able to save the currency, and it’s not in any major corporation’s interest to protect the currency the way it is in the government’s interest to protect its national currency.

Next, onto small-scale adoption, and that’s exactly what it sounds like. Previously we mentioned that bitcoin is widely adopted, being one of its strengths, but that’s only compared to other cryptocurrencies or newly discovered minerals. Compared to gold, silver, or many established national currencies, it’s only accepted by a very small population, making it less valuable than it can otherwise be.

So, what happened? Recently crypto as a whole and bitcoin suffered two huge crashes, with bitcoin losing nearly 50% of its value from 78k to 41k, but what caused the crashes? Well, the first crash was caused by Tesla. First, the company branded bitcoin as the cash of the future, going as far as to accept payment in bitcoin, but then suddenly severed ties with bitcoin, moving onto other cryptocurrencies. When Tesla encouraged people to use bitcoin, many consumers did, leading to a huge spike in price to the 78k previously mentioned, but when Tesla pulled out the price dropped significantly, leading to many people selling in panic and causing a market crash.

Just when bitcoin somewhat recovered, another disaster struck, in the form of China banning bitcoin. This forced a significant portion of bitcoin’s customers to sell their crypto, and the market crash again triggered panic reactions from many holding onto the crypto, leading to a second crash, ending at the trough of 41k, nearly 50% from what it was at its peak.

Thank you for your time, and feel free to check out my other blog posts if you are interested in this topic.