This article cannot be an exhaustive discussion, but we felt this highly technical subject needs to be addressed in toddler language for citizens over 60, who are still largely using traditional brick and mortar investing.
Toddlers love to play with ABC blocks, so visualize that you have a dozen sets of such blocks with a large (but not endless) closet supply of more sets any time you need them. Now suppose whenever your toddler comes up with a word combination of 5 blocks, you add $1 to his allowance. We could call this transaction one blockchain. But it isn’t quite that simple, because it is necessary to uniquely mark that set of blocks and to connect the set to the next set of blocks that occurred in time sequence after it. In other words, we are not dealing with only one toddler, we have a whole preschool and they are making words, selling them with each other, and cashing out to go home at various times of the day. Without transactional time linkage, it would be impossible to keep the finances straight. In blockchain purchases, computers do the transactions automatically and uniquely. The system is created in such a way that each time a new blockchain is created, there are fewer blockchains (fewer blocks to work with), which implies higher demand. Higher demand pushes the price of making a chain of blocks higher — Johnny then gets $5 for each word he makes!
Is this a pyramid scheme? Not at all. It is traditional capitalism. It is more akin to a high-risk investment portfolio. Anything bought or sold is a risk of some sort. If you spend $10 for 10 lbs of potatoes, you have a risk that some of the potatoes are not good, and perhaps you could have done better buying a different product. The risk is low, but it is there. Now you may find there is a shortage of potatoes, and thus suddenly that same bag of potatoes is $20. If you see the store shelves are empty, you might be able to re-sell your bag of potatoes for $30 to a customer who really wants potatoes. This is basic supply and demand economics. The greater the supply, the lower the price. The greater the demand, the more people will pay for the product. It is nothing different in cryptocurrency — as demand for a currency (think of it as something that can be bought and sold for profits, like potatoes or scalped football game tickets) — as demand rises, so does the potential profit from sale of the item.
Like any product, hype or marketing can make cryptocurrency increase value temporarily, but once the value has settled, it usually decreases only when people decide they want to get rid of the investment they have made. You spent $10 on potatoes – great, you have 10 lbs of potatoes and assuming they don’t all instantly rot, you’ll have $10 value tomorrow. However, if a booming potato crop that year hits the market, chances are you are not going to be able to sell your bag of potatoes to get your $10 back. BUT, you still have 10 lbs of potatoes. Did you lose anything? Not really. The financial world calls this unrealized gain or loss. It appears potatoes are worth less (not worthless, less worth) but you still have 10 pounds, so how is it worth less? It only has less worth if you attempt to sell. Free market economics changes the value of your “potatoes”.
The newness of cryptocurrencies makes them relatively high risk. At one point in United States history, the American dollar was high risk. Some might argue it is high risk today. Again, everything comes with risk. For some, the potential price increases in putting money into a new cryptocurrency is well worth the risk they face, for they guess, the currency will likely increase rather than decrease in value over time, much like land and other traditional investments do. The key reason for this phenomena is the fact that given any apple pie, one can cut it into 8 slices, and sell each slice for $1, but at some point, that 9th person wants a slice and then the value of a slice doubles to $2, and if a 10th person wants it too, now you can ask for $4 for that last slice, and so on: supply and demand economics. Blockchains are intangible assets that are wholly controlled by electronic programs which record each transaction, keep ledgers automatically, and limit the size of the pie so the value of the block never disappears completely. The worst thing that could happen, is that millions of people suddenly decide to sell their cryptocurrency at the market prices. With each sell, the price will drop slightly until the very last person who sells may get back less than originally invested and pay transaction fees. They will think they have been shorted, but have they? They bought $10 worth of potatoes, kept them for a year (supposing potatoes never rot), and then they went back to the store a year later and sold them for whatever price someone would give them. They neither won nor lost anything. Only, because of inflation, they find when they want 10 lb of potatoes they now have to spend $12 to buy them!
The main consideration that makes cryptocurrency different from a bag of potatoes (or stock, or land purchase) is the fact that cryptocurrency is entirely digital in nature. Even if the lights go off I can feel the potatoes and count them, but if the world’s computers were suddenly destroyed, cryptocurrency would essentially cease to exist — at least until electricity was restored — for all the records would be merely in electronic format and no one could know who owned what until the computers came back online. Would the records disappear? No, very unlikely, because the whole idea behind blockchain is duplication of records across hundreds of different networks so that not one, not two, and not even a multi-failure of networks brings the whole system down. It might work more slowly for awhile, but it will still continue with the same records. It would take a TOTAL failure of every connected network around the world for it to be catastrophic enough to make the currency inaccessible, and thus without value.
Caution should not be thrown to the wind with regard to purchase of cryptocurrency. While cryptocurrency investment can be a very legitimate form of investment, as with any investment, it carries substantial risk. Risk also means potential for increase on the positive side, or potential for loss on the negative side. The rate at which a particular cryptocurrency is fluctuating must be carefully considered. Unlike stocks, which can be traced back to physical assets and corporate production of products or services, cryptocurrency has no backing other than the transactional record of deposit itself. Thus a run on the cryptocurrency system — everyone trying to cash out at once — will definitely affect the price of the Nth person who cashes out. The last person out will be sorely disappointed, while the first person out will likely take a windfall profit. It is anyone’s take, however: As long as your cell phone works or you can get to a public computer, everyone has essentially equal access to cash-out at any random moment.
B.A. Computer Services is not a broker or investment advisor. Nothing herein constitutes investment advise or recommendations. We merely provide our best effort to break down technology lingo for the “average Jo[e]”.