Economic analysis of “cryptocurrencies”

There has been a lot of talk floating around the Bitcoin community and media about a phenomena labeled “cryptocurrencies”. Not much explanation can be found for whether this term is supposed to refer to the p2p networks (usually running a copied and slightly modified Bitcoin protocol) or the tokens whose ownership these networks record. People holding cash balances in Bitcoin are often presented with an argument that Bitcoin is not the only currency based on public key cryptography and a blockchain architecture, and the competitors can replace Bitcoin as the main currency of this type at any time in the future. Since Bitcoin can be replaced, a prudent strategy of diversification dictates that people hold cash balances in other tokens too – and what they do hold in Bitcoin should only be a minuscule amount which they can “afford to lose”.

How Bitcoin works – episode 1: the Bitcoin island

As mentioned in the introduction, Bitcoin belongs to the category of abstract token money. In its essence it is a system that records ownership of tokens called “bitcoins”. The banking system operates in a very similar way, but in most people’s minds it still records ownership of a physical token – banknotes. A 100 US dollar balance of a bank account equals ownership of a 100 US dollar bank note, the numbers represent something tangible in the real world.

How Bitcoin works – intro

Understanding how Bitcoin works on the technical level can be a little tricky. For most people it usually takes a lot of time and studying as Bitcoin combines a lot of innovative approaches to solve the problems of a free market monetary system. These approaches often don’t have any parallels in technologies we are already familiar with so we have to challenge ourselves with understanding completely new concepts.