Markets have a way of correcting themselves, and this time we may have found the limit. It is easy to imagine a future where everyone uses a single currency, like the Euro. But what if that currency loses value? What if it is no longer accepted by anyone except criminals? What if the central bank of the country that issues it decides to deflate its value by printing money and then stop issuing it?
The most susceptible currency to a virtual currency crash would be one which is open-source software, like Bitcoin and Ethereum. These currencies are also the most likely to become more valuable.
Bitcoin is digital gold; the first cryptocurrency, created in 2009. Ethereum is a more recent cryptocurrency that uses blockchain technology to create what are basically smart contracts.
These are applications that will run on top of the Bitcoin network. They allow us to have contracts that automatically execute when certain conditions are met. Bitcoin is not just money; it’s also a store of value and a method of payment. And Ethereum has the potential to do even more, like creating new types of decentralized applications (dApps) that can be run on Bitcoin’s virtual currency layer.
Both Bitcoin and Ethereum are susceptible to a virtual currency crash. But the difference is that with Bitcoin, you only lose money if you hold it for too long, and with Ethereum, you may lose money even if you don’t hold it at all.
Ethereum’s smart contracts function like computer programs. If a contract fails, the funds are returned back to the people who originally deposited them. But this does not work if people keep buying and selling without waiting for the contract to fail.
Virtual currency is a speculative bet. It is not backed by any physical asset. It is not used to make transactions across the world. And it faces a number of risks, some of them familiar: How will the rate of money creation be regulated? Who will regulate it?
But there is another risk that has been identified only recently: The computer science makes it possible for entire countries to get together to attack the global financial system. If a sophisticated enough virtual currency can be hacked, then an entire country could crash the system.
Bitcoin and Ethereum are most susceptible to this risk. They are both blockchain-based systems, meaning they use cryptography to facilitate secure transactions. The problem is that both systems run on open source software, which means anyone can look at the code and learn how it works. In some sense that makes Bitcoin and Ethereum vulnerable to attack from outside the system: If someone in Russia were able to hack their way into the Bitcoin network, or could convince a majority of miners in China or Iceland to go along with it, then Bitcoin would no longer be decentralized.
Two of the main reasons why Bitcoin looks as if it will hold its value are that it has a fixed supply, and there’s no legal way to create more of it. Both these things make it attractive to investors. But Bitcoin is not the only digital currency, and it’s not the most important one.
The most important one is Ethereum. It has a fixed supply of coins (there will be about 18 million of them) and no legal way to create more. So its price may fall if there is a crash, because some people will sell their Bitcoins in exchange for Ethereum.**
If, in the future, you want to use all the features of a bitcoin but don’t want to use bitcoins themselves, you can use ethereum or other virtual currencies instead.
Bitcoin was the first virtual currency, but it has become less useful and less popular because there are now many other virtual currencies that are easier to use. The most likely candidate for a new third-generation digital currency is ethereum.
The value of the currencies is highly speculative and vulnerable to extreme volatility. This has been demonstrated by Bitcoin, which has suffered regular crashes since its inception in 2009. Many people have lost money investing in Bitcoin, and there is no guarantee that it will continue to hold its value in the future.
The instability of the price of Bitcoin is not due to any flaw in the underlying technology but rather a reflection of how little confidence people have in the currency.
The main question I’ve been asked recently is: what are the biggest risks to Bitcoin’s success?
The answer is: lots of things. Most of them are only dimly foreseen and unlikely. Bitcoin itself is not immune, however: it has its own weaknesses, including a potential for a “single point of failure”.