Blockchain 101: The Root Value of Cryptocurrency

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Lately, many of the people who ask me about cryptocurrencies are fascinated by the hype around the technology. They don’t want to jump into investing because they don’t understand why there is value in the ecosystem. For people thoroughly exposed to the space, it is really easy to get caught up in the blockchain hype that we all are exposed to and forget the value proposition of cryptocurrency.

Often, explaining what makes this technology so valuable comes in a convoluted way. All that you really have to remember one thing – Blockchain technology represents a potential 3%-10% cost savings on every good/service that uses it as a medium of exchange. This is due to the reduction of transaction costs (this will be addressed in an article to itself later in this series). We have never seen a single technology that directly lowers the cost of transaction such as this. Think of the great technological advances, the wheel, the automobile, Microsoft Excel. None of these technologies can tangibly be pointed to as saving this much money on each transaction everywhere. With the adoption of blockchain technology (or perhaps other distributed ledger technologies), we will see these types of savings.

The reason that blockchain offers this increase in global wealth is that it cuts out middle men throughout the financial system and elsewhere. Through some savvy cryptography, and a public, distributed ledger, people can trust who they are transacting with without the need for Visa or the numerous other middle men that are in place to provide trust.

You may be thinking: Where does cryptocurrency fit into this whole equation? Cryptocurrency has two major functions. First, it acts as the economic incentive system for those building and operating the infrastructure of the given blockchain. There will be huge demand for efficient operational blockchains as we progress. This gives a sort of baseline value to the cryptocurrency. The second way in which cryptocurrency derives value is trust and use. Trust and use are the main factors that give value to any currency/means of exchange. The more that a currency is adopted, the higher value it will retain. On top of that, when adoption is increased, relative trust in value is strengthened.

This natural spiraling effect of adoption of currency has already been seen in Bitcoin. The volatility of Bitcoin since its inception has slowly fallen off. As you can see in the graph below the average volatility per day oscillates a lot with different market pressures, however we have seen an overall downward trend as adoption has increased over the past seven years. If price action continues in similar patterns, we should see prices stabilize with time.