A recent story of triumph followed by failure told of a man who was arrested after he made over $1 million selling Chuck E. Cheese tokens that he passed off as Bitcoins. The story went viral, although it turned out to be satire. It’s easy to laugh at the idea of gullible people buying cheap metal tokens thinking they are worth thousands of dollars, but the fact is that most people are still confused about what Bitcoin is and whether it has any value in the real world.
Bitcoin is a cryptocurrency, which means it is an asset that exists only in the digital world. It functions much like any other type of currency but is secured through cryptography rather than a safe or a bank account. Bitcoin was created through open-source software, which contains a ledger showing all Bitcoin transactions. The software uses a strong encryption algorithm called a blockchain that ensures that no one can change the ledger—Bitcoins cannot be copied, stolen, or lost (although some people have accidentally thrown away or forgotten the passwords to their Bitcoin accounts worth millions of dollars.) The blockchain is decentralized, meaning there is no bank or government in charge of the system. Anyone who uses it can see all Bitcoin transactions, which are conducted through anonymous identifiers.
Bitcoin is the most well-known cryptocurrency, but there are over 1,000 cryptocurrencies available, and more are being created each week. (By comparison, there are 180 world currencies recognized by the United Nations.) So far, none of cryptocurrencies have caught on as a mainstream medium of exchange, although a few retailers and other businesses accept them as payment. One of the most valuable uses of cryptocurrency is the ability to instantaneously transfer large sums of money between countries, with typically very low transaction fees. In contrast, the traditional process of transferring money is often slow and is subject to large fees. However, Bitcoin’s transaction fees have been increasing due to its increasing popularity, and these increasing fees may undermine its usefulness as a medium for transferring money across borders. It should also be noted that cryptocurrency is an attractive option for illicit transactions because of its anonymous nature.
Another use of cryptocurrency is purchasing CryptoKitties, the first cryptocollectibles. These collectible, one-of-a-kind digital cats—several of which have sold for over $100,000—were introduced in November 2017. They are based on the same blockchain technology that forms the backbone of most cryptocurrencies and can only be bought using a cryptocurrency called Ethereum. In its first month, the total volume of CryptoKitty trade was worth the Ethereum equivalent of $20 million.
Unlike stocks and other traditional investment products, there is no objective way to measure the value of Bitcoin or to predict how much it will be worth in the future. Some people think that Bitcoins are worth nothing, whereas others think they are worth millions. At this point, buying cryptocurrency is essentially a gamble—people who purchase it are betting that other people will come along and purchase it at a higher price. This doesn’t mean you can’t make a lot of money buying and selling cryptocurrency; it just means that cryptocurrency is a risky, volatile market to get into. (A market that lacks the governmental protections and regulations that come with traditional investment products.) You might have a Facebook friend who constantly posts about the latest cryptocurrency fads, but keep in mind that cryptocurrency is closer to gambling than investing. I have a Facebook friend who won $1 million in a poker tournament last year but that doesn’t mean I’m ready to cash out my retirement account and hit the poker tables.
Cryptocurrencies may be showing consumers new financial possibilities and may be showing more traditional financial institutions what they will need to do to keep up. For example, one thing that cryptocurrencies get right is that transactions are nearly instantaneous. In this digital age, consumers have a hard time accepting that banking transactions can still take two to three full business days to process. With cryptocurrencies presenting a speedier alternative for transferring funds, banks may need to increase their efforts by catering to their consumers’ new digital habits and lifestyles. Integrated, functional, secure, and usable, online banking tools will be a requirement for institutions that want to provide a positive customer experience while maintaining the long-standing trust and security that consumers associate with their financial institutions.