A simple way to understand crypto values and risks


Let us create a new crypto -”IdeaCoin” and put it on a blockchain. What is a blockchain? Blockchain is a distributed database of records of transactions. Let us create a transaction where we transfer 1 IdeaCoin from an address X owned by a person A to an address Y owned by a person B. Now, persons A, B and miners have IdeaCoins. Do these IdeaCoins have values? No. At this stage IdeaCoins have no values, because they have no practical utilities. They just abstract numbers/information recorded in the distributed database -blockchain.

Suppose that all parties AGREED to exchange IdeaCoins for bananas with the exchange rate equal to 1 banana per 1 IdeaCoin. Now, for the reason that we can exchange abstract IdeaCoins with real bananas IdeaCoins have values. The value is called -derived value, because it is derived from the underlying asset (banana) via the exchange mechanism. Where is a risk in this system? The risk is that a party with bananas will not exchange our IdeaCoins for bananas at some point in time. This risk is called a counter party risk.

Is IdeaCoin a currency/money? No. The underlying asset in this case (banana) has no properties of money/currency. For IdeacCoin to be a currency we need to connect it to some asset, which has properties of a currency.

Suppose that all parties AGREED to exchange IdeaCoins for dollars with the rate of 1 IdeaCoin to 1 dollar. Now, IdeaCoins have derived properties of the currency/money and can be used as such.

A blockchain also has it own properties (transparency, speed, etc.), which combined with the derived properties of the underlying asset (in our case dollar) creates a new value (improvements), which is called a synergistic value (from the effect of synergy between the components of this system.)

As we can see from examples above, cryptos have no intrinsic positive values, but they have derived and synergistic values.

Short term risks (failures, hacks, frauds, scams, etc.) are well known, therefore we will not consider these risks here. Instead, let us concentrate our attention on the most important long term risks, because long term risks are not widely known even among crypto experts. The counter party risk is the first important long term risk in cryptos.

The second important long term risk is political risk. Governments have monopolies on money, therefore they will eliminate any competitor which will pose any threat to these monopolies. When CBDCs will be implemented by governments all cryptos, competing with CBDCs, will be eliminated.

The third important long term risk is technological risk. Modern quantum computers could brake cryptographic algorithms on which cryptos are based very soon (see [1] ). According to the U.S. Department of Homeland Security a fault-tolerant quantum computer could be capable of breaking current encryption used for Public Key Cryptography as soon as 2030 ( see [2]).

 

Conclusions:

1. Cryptos have no intrinsic positive values, but they have derived and synergistic values.

2. The most important long term risks in cryptos are: counter party, political, and technological.

 

References:

[1] https://www.dynpass.online/pqc.html

[2] https://www.weforum.org/agenda/2023/01/the-world-quantum-divide-why-it-matters-davos2023/

 

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I_g_o_r
I_g_o_r

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