Demystifying Cryptocurrencies & the 'Coinbase Effect'
Unless you’ve been living under a cave, you’ve probably heard of Cryptocurrencies. The original idea behind it, was to be a digital form of money which was not controlled by any central authority.
But, something entirely different transpired. People started ‘investing’ in Cryptocurrencies like Bitcoin, Ethereum & most recently Dogecoin - with the sole purpose of getting rich quick.
In this episode, we spoke about the reasons for the meteoric rise of Cryptocurrencies, about some key terminologies & the recent Coinbase IPO and how it has the potential to widen the reach of Cryptos.
The Rise of Cryptocurrencies
I am a traditional investor, I have grown up reading books like ‘Intelligent Investor’ - and the importance of fundamentals while investing. However, in the past two years - I have witnessed a ‘currency’ going up by more than 6000%, and I wasn’t able to wrap my head around it.
Take Bitcoin. It doesn’t pay you any interest or dividends. It doesn’t make profits. It’s a currency [for god’s sake] & the entire purpose of a currency is to be stable in value.
So, why have these shot up so spectacularly?
There are a few factors responsible for pushing Cryptocurrencies into the stratosphere:
Increased acceptance of Cryptos [you can buy a Tesla with a Bitcoin now!]
Rebellion against Centralized authorities
FOMO [Fear of Missing Out]
Can cryptocurrencies like Bitcoin, Dogecoin & Ethereum keep rising in value? I wish I knew the answer.
In this episode, we also demystified certain jargons used in the Crypto world - and if you’re looking to make an entry into this space, it is essential you understand these technical terms.
#Jargon No.1 - Blockchain
In simple words, it is a database. It’s a ledger, which records all the transactions that happen in cryptocurrencies. Each cryptocurrency has its own blockchain, on which transactions in that particular crypto are recorded.
For eg. Let’s say you buy a Tesla for 20 Bitcoins. When you pay Tesla, this transaction - is recorded on the blockchain. And, here’s the thing - a transaction once recorded on a blockchain - cannot be deleted.
And, what makes this technology really interesting - is the verification process.
Normally, when you transact in money - it is verified by the bank & that’s it. Once the bank verifies your transaction - it is executed.
In the case of Cryptocurrencies, the transaction needs to be verified by multiple people (known as miners) and unless >50% of them approve the transaction, it is not executed. [However, different blockchains have different verification rules]
And, there are 3 different verification mechanisms on the Blockchain:
Proof of Work
Proof of Stake
Proof of Authority
#Jargon No. 2 - Proof of Work [PoW]
Proof of Work, is the most widely used verification process. Because, Bitcoin uses PoW.
How does it work?
When a transaction happens, it is sent to multiple miners for verification. To complete the transaction, these miners have to solve a complex puzzle - which requires a lot of computing power. For solving the puzzle & verifying the transaction, the miners get a reward [in the form of cryptocurrency].
The reason why PoW is not sustainable - is because it forces miners to compete for computing power & use vast amounts of energy. As transactions increase, more energy will be required & it might be a serious threat to the environment going forward.
Which brings us to our next verification mechanism….
#Jargon No. 3 - Proof of Stake [PoS]
Proof of Stake, is slightly different than PoW - because in a PoS, the miners are selected based on the ‘stake’ they have in a Cryptocurrency.
The miner with a higher stake, has a higher probability of being selected to validate the transaction [and earn more rewards in the process]
So, it doesn’t matter if a miner has a 100 Supercomputers - if they don’t have a ‘stake’ in the system - they will not get selected.
Ethereum, is one of the Cryptocurrencies using the PoS to verify transactions on it’s Blockchain.
#Jargon No. 4 - Proof of Authority [PoA]
Proof of Authority, doesn’t require computational power or a stake in the system. In PoA, miners are selected arbitrarily as trustworthy entities. And, only those trusted miners can verify and validate transactions on a Blockchain.
The purpose of PoA, is to streamline & reduce the transaction time. [Why? Because a transaction made in Bitcoin takes 10 minutes!]
#Jargon No. 5 - Decentralized
This is a word which is tossed around a lot.
‘Cryptocurrencies & Blockchains are decentralized in nature…’ - but what do you mean by that?
It means, that there is no single [central] authority - which approves transactions. Every transaction has to be approved by multiple miners & only when the miners reach a common consensus - the transaction is added to the Blockchain.
The entire purpose of Cryptocurrencies & the Blockchain technology - is to disrupt centralized control. To distribute the concentration of power. And, this is one of the reasons which makes it such an exciting technology.
We also talk about the…
‘The Coinbase Effect’
The IPO had a stellar listing and at some point the company was worth more than $100B in Market Cap. The listing also jacked up the prices of majority of Cryptocurrencies.
The reason why it is such a big deal is because Coinbase’s IPO, is expected to boost the credibility of crypto trading & widen the reach of Cryptocurrencies. A lot of people [including me] thought that this was a fad, and eventually people would forget about Cryptos. But with this IPO, the game has only begun.
The potential for Coinbase, as a business model looks really solid as well - as more people adopt transacting in Cryptos.
Coinbase had a Q1 ‘net income’ of $800 million which was more than the combined net income of the previous FY, which is quite impressive to say the least.
No wonder that investors like Cathie Wood - have been consistently increasing their stake in Coinbase - irrespective of how steep the valuations look like!
Let us know your feedback/questions - in the comments section.