In essence, crypto-currency is a virtual asset that can be exchanged for products and services online
For decades, e-commerce transactions have used a trust-based system that involves financial institutions to process payments. These organisations have almost exclusively served as trusted third parties that verify information on behalf of the transacting buyers and sellers. In 2008, a paper titled, Bitcoin: A Peer-to-Peer Electronic Cash System, proposed to alter the way the world made payments over the internet.
This paper was emailed to a crypto-currency mailing list by Satoshi Nakamoto, whose identity remains a mystery. Since then, crypto-currencies have become a global phenomenon. However, few people fully understand the way they work and their implications.
In essence, crypto-currency is a virtual asset that can be exchanged for products and services online. Unlike most investments, however, it is based on block-chain technology that ensures transactional data integrity. Block-chain technology was first described in the early 1990s by a group of researchers intending to prevent the tampering of online documents. This technology remained largely unused until 2008, when Nakamoto described a system that would allow online payments without the need for a financial institution.
As the name suggests, block-chain technology consists of blocks of information that form a continuous chain. Each block – except the first one— contains information in the form of codes about its preceding and the following block. If the details of a block are altered, its code is recalculated. Consequently, it becomes profusely challenging to add or edit information without tampering with the entire chain. However, given the computational capabilities of modern computers, there is a possibility that the information of a block can be altered, and codes of all following blocks can be recalculated to make the block-chain valid again. The block-chain utilises a mechanism called proof-of-work, which slows down the creation of new blocks to prevent the recalculation of codes. Hence, if the information on a single block is changed, proof-of-work of each following block will need to be calculated.
Instead of a central entity managing the chain, the technology uses a distributed peer-to-peer network that anyone can join. Whenever someone successfully joins the network, they receive a complete copy of the block-chain. Information is sent to each chain member, who independently verifies it for tampering and adds it to their block-chain after confirmation — effectively adding a new block to the chain. This system ensures a consensus among all members. Each member verifying this information is referred to as a “miner” and is typically rewarded with crypto-currency. The distribution of the block-chain network makes the technology extremely secure.
In the case of crypto-currency, these blocks contain information about transactions between different parties. The distributed nature of the technology allows it to operate outside the control of financial institutions and governments. Through its decentralised processing system, crypto-currency essentially stops central banks from manipulating the money supply.
These features have allowed users of crypto-currency more autonomy over their money. As there is no need for a third-party institution, banking fees have been eliminated and the overall transaction costs are meager. The online system enables populations to transact anywhere internet access is available. Due to these advantages, crypto-currencies have exploded in value over the past few years. Individuals have scrambled to invest in crypto-currencies with the expectation that their value will increase further as the technology gets refined.
Crypto-currency ensures that governmental manipulation does not occur. There is also no central authority to provide corrective action if something goes wrong. The nature of the system makes it susceptible to illegal activities such as money laundering and tax evasion. In the past, essential stakeholders such as the government and banks have been slow to adopt sweeping changes like crypto-currency. The primary reason for this reluctance is the heavily regulated nature of the financial industry. Given the lack of a central controlling agency, governments are averse to adopting crypto-currency. Another reason for their reluctance is that most governments worldwide do not entirely understand the implications of the new technology. Despite this resistance, crypto-currencies and block-chain technology can disrupt many industries all over the world.
The writer is a LUMS graduate. He can be reached at [email protected]