Cryptocurrency. We’ve probably all heard about it by now. Bitcoin….and bitcoin…and yeah…That’s all I really know (knew) about it. That was before I got a WONDERFUL- emphasize wonderful- opportunity to take some time off and actually learn something about it. And really, it wasn’t that bad. So let me enlighten you a little about cryptocurrency, how it really works, and how it relates to Central Bank Digital Currencies. (CBDC).
So let’s start with the basics. What exactly is cryptocurrency? Well, for starters, cryptocurrency is “a digital payment system that doesn’t rely on banks”, or a third-party, “to verify transactions.” In short, it’s a digital currency that is an alternative form of payment by using encryption algorithms. (We’ll get into more of that later.)
Compared to a typical database, a blockchain structures its data into blocks which are strung together, rather than into tables. This structure makes an irreversible timeline of data when implemented in a decentralized nature. As a block is filled it finalizes and becomes part of this timeline.
So why would cryptocurrency be made? What was the main purpose? Anything made is often to make something easier. We always innovate something new to make what we’re already working with easier, faster, and simpler.
Well, for starters it was to engage in financial transactions without exclusively relying on banks or governments. When we usually partake in transactions, a third-party, such as a bank, is used to do so.
Whenever we perform transactions, our money doesn’t immediately get transferred to the other person. For transactions from different banks, it can take one to five days. Why does this happen? Well, it’s excessive to continuously pay a transaction to another bank in small amounts. If I make a transaction of $10 dollars to another person, someone else could be making a transaction of $50 to another. Instead of continuously processing transactions in amounts like this, something called the Delta of Transactions takes place. This process happens over a periodic basis.
So let’s say I make a transaction of $30 to someone at another bank, and someone at that bank needs to pay a transaction of $10 to someone at mine. Instead of updating a don performing every transaction, the banks will wait until the end of the day, and transfer the net amount to each other. In this case, since the other bank will ‘gain’ $30 and ‘lose’ $10, my bank will transfer $20 to the other bank. That is the net amount.
What cryptocurrency does is take out this step. Because we rely on the bank or a third-party to deliver the transaction, this Delta of Transactions process takes place, and our payment gets transferred after a while. But with cryptocurrency, it happens immediately. The thing with cryptocurrency is that your money stays with you. Compared to all your money being with the bank, you have your money. So whenever you want to process a transaction, it happens immediately because you’re doing it yourself. The only problem is that, if your money is with you, you could lose all of it. Cryptocurrency needs a cryptocurrency wallet. It’s something that stores the public and/or private keys for cryptocurrency transactions. Basically like a vault or a bank account. It holds the keys and allows you to access your coins. Because it’s with you, if you lose that ‘wallet” you end up losing all your money. If you have money stored in the bank, if you lose your wallet, you would still have money, and not have lost all of it.
However, there are certain situations where cryptocurrency is actually beneficial. Let’s take the Bahamas for example. The Bahamas consists of 70 scattered islands, and it can take over half a day to simply reach the bank. As a result, the Bahamas established a style of cryptocurrency called Sand Dollar to make money easily accessible.
So I mentioned CBDC at the very beginning. CBDC (Central Bank Digital Currency) is digital currency issued by a central bank, rather than a commercial bank. While CBDCs are controlled by a central bank, cryptocurrencies are almost always decentralized, meaning they cannot be regulated by a single authority.
CBDCs are pegged to the value of a country’s fiat currency. This fiat currency is issued and regulated by a nation’s monetary authority or central bank. ( Such as the US Treasury) In the US along with many other countries, many people do not have access to financial services. The main goal of CBDC is to “provide businesses and consumers with privacy transferability, convenience, accessibility, and financial security.” It would also reduce the risks of using digital currencies in their current form. Cryptocurrencies are highly volatile and have a constantly fluctuating value. This can cause severe financial stress in many households and affect the overall stability of an economy. Bitcoin was made anonymously. Despite being believed to be made by a pseudonym group, nobody knows who created it. That being said, they can do whatever they want with Bitcoin. Who knows if they choose to make Bitcoin valued at a high price or suddenly drop it really low. To prevent this but still provide digital currency, governments are starting to create CBDCs.