Following the path of digitalization in Slovenia and Europe: What is cryptocurrency?

Cryptocurrencies have flooded the world in the last ten years. Not long ago, most people would disregard them whenever the word was mentioned. After a while, the prevailing opinion was that this was just a “fad” and would be over soon. However, it is now clear that cryptocurrencies are slowly but surely emerging into essential places in our society.

Cryptocurrencies have emerged relatively recently, and many people feel that they have overtaken them. Programmers and computer scientists who understood the new technology found their way to cryptocurrencies very quickly, some of them making good money. If nothing else, they all probably enjoy cryptocurrencies.

But – what exactly are cryptocurrencies? Why do they represent something special? How do they work, and in what dimension do they exist if we cannot touch them in any case?

The most common explanation, of course, is that cryptocurrencies are digital or virtual money. But that definition does not make anything more apparent since many people also mark the euros deposited in their bank account as virtual currency. While it is true that we bring cash to the bank and deposit it in our account, however, if we then send that money to a friend in France, the cash will not go on to their bank account. The only thing that will increase in a few days is our friend’s (digital) balance in their bank account.

Cryptocurrencies only exist in the virtual world, so we cannot hold them in our hands, and they are protected by cryptography, hence their name. However, they are protected in a way that they cannot be falsified or duplicated.

What does mining have to do with cryptocurrencies?

Have you heard the saying, “we are all equal before the law?” Well, with cryptocurrencies, we are also all equal. No bank or other intermediaries are required to hold, trade, send or receive cryptocurrencies. Cryptocurrencies are therefore decentralised. All that is needed for the system’s successful operation are miners, which is just a unified term for the operators who use their computers to confirm crypto transactions and thus run the system.

However, no banking license is required for this; miners can theoretically be anyone with powerful enough computer equipment. In addition, due to cryptography, they do not have insight into transactions. Therefore, recipients and senders of cryptocurrencies are anonymous, which cannot be said for banking transactions.

Most cryptocurrencies are powered by blockchain technology. This may sound like something complicated, but this technology is simple at its core. Blockchains are like a kind of book or database of all transactions that occur under a specific cryptocurrency. It is a digital database that is simultaneously copied and synchronised across multiple computers worldwide, and many people can access it.

SIt can be accessed by practically everyone currently mining cryptocurrency, and all transactions are entered into this database upon confirmation. All this leads us to a critical feature of cryptocurrencies: their operation cannot be influenced by any individual, institution, or government.

What can we do with cryptocurrencies?

Today, cryptocurrencies are primarily used for capital storage and speculation. This means that most people buy a specific cryptocurrency to sell it at a higher value in the near or distant future, thus making a profit.

Proponents of cryptocurrencies are working on their use in other areas as well. The word “currency” does not stand in the name for no reason, as cryptocurrencies can be used the same way as all other “traditional” currencies.

We can receive a salary in cryptocurrencies and buy bread from a bakery. We can shop online or pay for a drink at a bar with them. All this, of course, is only on the condition that the recipient and the sender of the money agree to this, as the employer or the store owner must enable the receipt or sending of cryptocurrencies.

In the Central American country of El Salvador, the cryptocurrency Bitcoin has been granted status as a legal tender. What does that mean? Since September 2021, sellers of products and services must accept both Bitcoin and the US dollar whenever possible; the dollar has been legal tender since 2001.

However, cryptocurrencies fluctuate enormously in their values, so vendors are not too happy to use cryptocurrencies as a means of payment. A vendor would have to change a product’s price in cryptocurrencies every day, if not every hour.

On the other hand, Crypto debit cards allow individuals to make purchases in a store or online and withdraw cash at an ATM, even if these locations do not accept cryptocurrencies. They work just like the debit card hiding in your wallet now, with the difference that this debit card has no euros but is loaded up with Bitcoin instead.

You are at the store; you take a juice that costs 1 euro and proceed to the checkout. Once you use your Crypto debit card, the system will convert the cryptocurrency into euros at the time of purchase. The trader gets euros on his account, and your balance in cryptocurrencies decreases.

Instead of exchanging cryptocurrency for “traditional” currency because you have to buy something, you leave it as is and use your debit card. When you find yourself at the cash register or in front of an ATM and use the card, the system automatically converts the required amount of cryptocurrency into euros and completes the transaction.

Advantages of cryptocurrencies

Cryptocurrencies represent a new, decentralised form of money. In this system, intermediaries such as banks and financial institutions are not required to review transactions between two parties. Thus, the cryptocurrency system eliminates the risk posed by a centralised financial system. There is no danger that specific critical points would break, such as a bank or some other institution, which would trigger the domino effect of crises worldwide, as was caused in 2008 by the collapse of major US financial institutions.

Therefore, because cryptocurrencies do not use external intermediaries, transfers of cryptocurrencies between two users are faster when compared to standard money transfers. In addition, crypto transfers are not restricted by a country’s border unless the country, or state, decides to regulate or ban cryptocurrencies.

Weaknesses of cryptocurrencies

Crypto transactions are anonymous, but they still leave a digital footprint that can be deciphered by governments or other agencies. This poses a risk of controlling and monitoring the financial transactions of ordinary citizens.

Cryptocurrencies have also become a popular tool for illegal activities like money laundering and buying illicit items. Cryptocurrencies are already almost a standardised payment method on the so-called Dark Web, where many such activities are carried out. Hackers also use cryptocurrencies in extortion and abuse activities.

In theory, assets in cryptocurrencies are supposed to be divided among the many operators involved in the blockchain. In reality, however, ownership is very concentrated. For example, an MIT study MIT (Blockchain Analysis of the Bitcoin Market) found that only 11,000 investors own just under half of all Bitcoins globally.

Speaking about crypto mining, we like to emphasise that anyone can do this, which is true in principle. However, profitable and long-term cryptocurrency mining requires extremely powerful computer equipment and vast amounts of energy. Thus, mining has also moved under the roofs of larger institutions that can afford it. According to a survey by the National Bureau of Economic Research, 10 per cent of miners account for 90 per cent of all mining activities.

At this point, it is difficult to determine where the development of the crypto world will lead. But one thing is for sure – regardless of new technologies, it is still about the people facing these technologies. Just as we humans are responsible for all the advantages and disadvantages of “traditional” currencies, we humans are also responsible for all the advantages and disadvantages of cryptocurrencies.

Author: Marko Želko

Keywords: cryptocurrencies, blockchain, mining, advantages, weaknesses

Disclaimer

This article is part of joint project of the Wilfried Martens Centre for European Studies and the Anton Korošec Institute (INAK) Following the path of digitalization in Slovenia and Europe. This project receives funding from the European Parliament. 

The information and views set out in this article are those of the author and do not necessarily reflect the official opinion of the European Union institutions/Wilfried Martens Centre for European Studies/ Anton Korošec Institute. Organizations mentioned above assume no responsibility for facts or opinions expressed in this article or any subsequent use of the information contained therein.