Complex Made Simple

Some of the Crucial Pieces of the Blockchain Puzzle and How They Fit Together

In a few short years, the words crypto and blockchain have managed to enter the public vocabulary in a big way. Nevertheless, many people still find them confusing. So, what do they refer to and how do they relate to each other?

Decentralized record-keeping cannot be altered without all parties agreeing that a change has taken place Cryptocurrencies are capable of rapidly sending sums of money anywhere in the world for almost free Cryptographic security and verifiability of blockchain are important in the creation of new digital identity systems

by Giles Coghlan, Chief Currency Analyst at HYCM

The word crypto is now used to refer to a new type of cryptographically secured, digital asset. If you hold the private key to units of cryptocurrency, no one without that private key can have access to them. Cryptocurrencies are also decentralised, meaning that there is no central authority in charge that can prevent you from accessing your holdings. 

Blockchain is the technology behind these cryptocurrencies. Blockchain combines cryptography, decentralised ledgers (public records that no one party is in control of) and a system of incentives that allows value to be safely transferred from one party to another without the need for central authorities.

Bitcoin was the first cryptocurrency and in many ways is still the most influential. However, it’s important to understand that digital money is just one of many possible applications that blockchain technology can support. Since cryptocurrency is the first application, the following paragraphs will look at four intriguing pieces of the blockchain puzzle that you should definitely be aware of. 

Immutable Records

Digital money was an ideal proof-of-concept for this new technology. Firstly, because everyone is interested in money, but also because a unit of currency is supposed to be scarce and unchangeable, otherwise it can’t function as money. In the digital realm, a unit of currency is essentially an entry in a ledger. A transfer from one party to another is merely a record that the transfer took place. Blockchain creates the possibility for other kinds of decentralised record-keeping that cannot be altered without all interested parties agreeing that a change has taken place. 

Now, forgetting money for a second, imagine the many instances of record-keeping we currently rely on that could benefit from being made transparent and frictionless in the manner outlined above. 

Food supply chains using blockchain could allow you to determine with certainty where your food originated from and when. Smart energy grids could enable you to monetise the power your home produces in a much more efficient way. Blockchain digital rights systems could allow you to prove, cryptographically, that a photograph, video, piece of music or another piece of content belongs to you. Blockchain property rights systems can extend that reach into the physical world, allowing you to prove that you own a real-world asset (house, car, work of art, etc.) as well as empowering you to monetise that asset by securely renting it out, or using it as collateral in a new digital economy.

Micropayments

The idea of micropayments is the next piece of the puzzle. Remittances were one of the initial use cases touted in bitcoin’s earliest days. Cryptocurrencies quickly proved themselves capable of rapidly sending sums of money (from pennies to millions) anywhere in the world for almost free. In these domains, they managed to outperform centralised services like money transmitters or banks, which either charge hefty fees or take days to complete transfers. The fact that cryptocurrencies do not require central authorities and can be sent anywhere almost instantly has greatly lowered the cost of transferring value. Of course, fees have gone up in recent years as some of the higher-profile public blockchains like Bitcoin and Ethereum have become more congested, but the technology behind them has proved itself and has opened up many avenues of innovation.

Blockchain provides the ability to transfer tiny bits of value in a cheap and secure manner, allowing for many new possibilities. Content creators could be paid per view, per listen or per read. Smart grids can incentivise energy efficiency and increase local energy production by individuals. 

Before the invention of blockchain, the problem with micropayments was that the smaller the amount you were attempting to transfer, the greater the percentage of the overall transaction would be taken by fees. It wouldn’t make any sense in a world before blockchain to pay an artist a fraction of a cent for every second their music had been streamed. This is because you wouldn’t be able to:

1. Confirm the precise amount of time streamed in a manner in which all parties could verify and trust, or

2. Justify the cost of transferring miniscule amounts of money when the fees would be multiples of the amount you wished to transfer. 

Digital Identity

Everything we’ve discussed so far rests on digital identity. Our existing internet was built at a time when none of the above was even possible, let alone concerning. As such, it doesn’t do a very good job of providing users with secure and trusted digital identities that can be used across the Web. 

The type of future that we’ve envisioned above requires much more robust identity systems than we are currently using. Remember that not only will your name and image be associated with these digital identities like today, but your assets (digital and physical), your content and other data will also be connected to them. This is why the cryptographic security and verifiability of blockchain is important in the creation of these new digital identity systems. 

Everyone from tech giants like Microsoft to banks like Barclays and national governments like Estonia are currently experimenting with their own digital identity systems that will allow for a new kind digital citizenship and fluid online commerce. As with so much else in tech, their success relies on developing a standard that can be used across the board, rather than proprietary systems that aren’t interoperable.

Stablecoins

Although stablecoins are technically a type of money that could fit into the cryptocurrency category discussed at the beginning of this article, they happen to be a bit more complicated than that. Stablecoins are a type of digital derivative that tracks the value of fiat currencies. The same marriage of cryptography and distributed ledgers makes this possible, but rather than having a free-floating value of their own like bitcoin or Ethereum, stablecoins are designed to be pegged to real-world currencies like the US dollar or the Euro.

Why would you need such a thing? Because it’s much quicker to move digital dollars around than their physical counterparts. More importantly, you can’t run an economy using a currency that’s as volatile as bitcoin is. Economic actors rely on knowing that their spending power will be the same tomorrow as it is today.

Stablecoins allow for the creation of a digital economy by creating units of value that have all the benefits of crypto (security, verifiability, instantly transferable) while maintaining the kind of stable value that conventional economies rely on. The huge publicity and controversy surrounding Facebook’s proposed Libra stablecoin last year was all about this race to develop a stablecoin that will be used across the Web. It’s the same issue that has had central banks researching the viability of their own digital currencies, or CBDCs (central bank digital currencies). 

This is definitely a space to watch as there are so many competing interests. Everyone, from governments and central banks to regulators and tech companies are vying to have a say in how money on the internet will work in the future.

It’s Bigger Than Just Crypto

Blockchain’s explosion onto the tech scene in the past decade or so has touched many industries and its influence is only growing; there are now multiple ways to play the blockchain boom. There are the public blockchains like Bitcoin, Ethereum, Zcash, Neo and many others that allow you to gain exposure, but there are also a host of established players each working on their own private blockchain solutions to leverage the technology for their own businesses. This is also an option for investors who are not comfortable with the volatility of traditional cryptocurrencies.

Google, Microsoft, Facebook, JP Morgan, Samsung, and many others are all working towards bringing their own blockchain solutions to market. There is no indication at present as to whether the future will see public or private blockchains winning out, or if there’s even room for both to coexist. This means that for those who get their research right, there’s a great deal of opportunity in both crypto and equity markets to gain exposure to the future of this exciting technology.

At HYCM we offer access to a large variety of markets, from the biggest tech companies in the world to the most innovative crypto disruptors. No-matter your investment style or level of personal risk-tolerance, you will find the right asset for you.

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