Introduction to Digitial Currencies

Lesson 4 – Blockchain 2.0 and the Future of Digital Currencies

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Welcome back to Introduction to Digital Currencies, an original Coin Academy course. There are four lessons in this course. And we’re on the final lesson, Lesson 4, where we take a look at Blockchain 2.0 and the future of digital currencies.

Let’s get started with the question we hear most often. That is, what’s the future of Bitcoin? Well, we’ll start off by saying that Bitcoin is a good store value, but it’s not so good as a medium of exchange. There are two reasons for this. First, the long transaction confirmation times: it takes at least ten minutes for a Bicoin transaction to be confirmed. Second, an issue that a lot of people don’t see, the peak transaction volume for the Blockchain is actually quite low. It’s only seven transactions per second. This is actually a significant cap on growth and compares very poorly to PayPal and the MasterCard and Visa. For Bitcoin to scale up, something in the Blockchain is going to have to change or the process is going to have to change.

Now, there had been forks of Bitcoin that had been specifically designed to improve on the transaction utility of Bitcoin. Litecoin is one clear example of this, they do offer improved transaction speeds, and it has seen good adoption as a result of this. But Bitcoin may become used as the basis for other currencies that are more nimble and are better suited to transactions. For example, Sidechains hold promise. What’s a sidechain? Well, a sidechain is a parallel currency. It is another currency based on Bitcoin that is processed independently at Bitcoin. It can be processed much more quickly, and then, those transactions are actually backed up by processing secondary transactions against the Bitcoin Blockchain.

There are other issues. First, Volatility. Volatility is a significant problem and has kept a number of traders on the sidelines. An issue that’s related to that is Bitcoin’s China problem. What do we mean by this? Well, currently, about 60 percent of the global Bitcoin volume actually occurs inside of China. China, however, has refused to give its blessing to Bitcoin, and when they did actually say Bitcoin is not approved, there was a big dip in the volume and the value of Bitcoin in the market. Should China ever make a concerted effort to stamp out Bitcoin, it would have a significant negative effect on the trading market. Additionally, whenever the institutional traders finally reach the point where they decide Bitcoin is a good bet and they come in off to side lines, it’s going to be a whole new game with transaction volumes and valuations going through the ceiling.

Another topic that needs to be touched on is the fact that Bitcoin will be regulated. There is consensus in the market that this is coming. How? We don’t know. When? We don’t know. By whom? We don’t know. This is an area of a great deal of uncertainty, but certainly one that bears watching. The bottom line, with widespread adoption by both consumers and merchants and a market capitalization that’s many times the size of the nearest competitor. Bitcoin’s here to stay though we think its role is likely to evolve over time.

Let’s look at another coin, which is causing changes in the marketplace. What is Blockchain 2.0? The real innovation in Bitcoin is the Blockchain, that is a peer-to-peer transaction recording and verification system. That system can carry much more information than simply numbers. As a result, Blockchain 2.0 looks to use this Blockchain technology to do a number of things including registering contracts and assets and making them available for digital transactions. There’s an entire new wave of start-ups that are looking to tap into the potential of the Blockchain. And we expect to see a number of innovations come out of this second wave of innovation. Another area where we’re expecting to see big changes is in the world of financial transactions, and here, we jump back and look again at Ripple, which we looked at in the previous lesson.

The Ripple protocol is designed to revolutionize financial transactions. There is also a currency associated with Ripple. It’s called the XRP. But the XRP is primarily a bridge currency allowing people to easily move between fiat currencies, digital currencies, and commodities inside of the Ripple network using the Ripple protocol. In other words, the XRP is the enabler whereas, the protocol is really the heart of the system and really the innovation here. It has nearly immediate clearing, two to five seconds, so it does improve significantly on the transaction speeds of Bitcoin. The fees for doing a transaction inside of the Ripple network, they’re nominal, and it’s already been adopted by several banks. There are also gateways currently opening up around the world. There’s quite a bit of growth in this area though it is the early days.

So let’s look at this in a little more detail. How does it work? Well, if you’re inside the Ripple network, you can transact in a number of ways. First, you can transact with any balance you have in your wallet. Now, that balance can be a fiat currency, it can be digital currencies, XRP, Bitcoin, Litecoin, or it could even be commodities. It’s really up to what arrangements the gateway has made. You can also transact using the XRP digital currency. You can also act as a market maker. That is someone who facilitates transactions, either by providing swaps in the different currencies or providing a way for people to get their money out of the system. And you can earn money on those swaps and those services if you are a market maker. Let’s look at this in a chart. It helps explain it a little bit.

Now, in this exhibit on the right-hand side, the big circle in the middle, it says XRP. That’s the Ripple network. The XRP lives inside the Ripple network. The people who are part of that network can use it or not use it, it’s entirely up to them. Now, in this network, we show four market participants. We have two individuals, Pat and Bob. Pat likes to transact an Indonesian Rupiah. Bob likes to transact in US dollars. We also have two institutions, a bank which transacts in Euros and a bakery which transacts in US dollars. These people may also have other currencies in their wallet. They may have XRP. They may not have XRP. It doesn’t matter, they’re in the system. They can use whatever currency or commodity they prefer.

Now, let’s say that Bob works at the bakery and the bakery wants to pay Bob his salary. Well, since both bakery and Bob function in USD, all bakery has to do is transfer part of their USD balance straight to Bob. Again, the transaction takes two to five seconds, the fees are nominal. It’s very similar to the way a current bank would work where if the employee account was at the bank; they could transfer the salary directly inside of the system. But it is cheaper and faster. Now, let’s take a different example. Let’s say that Pat needs to get money into the bank and Pat transacts in Indonesian Rupiah. The bank transacts in Euros. But let’s say that both of them are willing to accept XRP. So what can happen here? Very simple. Pat converts Indonesian Rupiah into XRP, gives XRP to the bank. And the bank can then do what they want with the XRP, transfer it back in Euro or hold it in an XRP balance in their wallet.

Now, let’s take another example. Let’s say that Pat wants to make a payment to the bakery. Pat transacts in Indonesian Rupiah, the bakery transacts in US dollars, and the bakery doesn’t accept XRP. Well, in this situation, Bob can become a market maker. So basically, Pat transfers part of her IDR balance to Bob. Bob then transfers USD directly to the bakery and along the way, makes a percentage on the transaction. This is the beauty of the Ripple network is the flexibility that it gives in conducting these transactions and the ability it gives market participants to actually participate and extend the network and add additional functionality. It’s quite interesting. The adoption by banks at this point in time is very reassuring. They are seeing it as a competitor for SWIFT and as a cheap fast alternative to SWIFT. Since it is a protocol it also means that it could be widely adopted, forked and used in other situations. We will see what is happening here, but it’s an area that definitely bears watching.

Let’s move on now. Let’s look at the future of contracts and insurance, and here we’re going to talk about something called Codius, which ironically is from the same people that brought us Ripple. Codius is a Blockchain 2.0 type initiative. It allows the creation of what are called smart contracts. That is, contracts that incorporate automatic payment once conditions are met. Then, they use the Blockchain to verify that the conditions have been met and release the payments. Simple example here would be a time-based contract where payments to be made every quarter. Instead of relying upon somebody to actually go off and do this, if you used the smart contract, the contract would actually release the payments automatically itself. Now, it is open source. That is, it’s meant to be forked and they’re actually encouraging other people to fork this. They are really pushing hard for widespread adoption of the smart contracts protocol. It does have potential to decrease conflict and litigation, and it does have the potential to allow for greater certainty in contract, and particularly, we’re talking about time-based performance payments.

Blockchain technology can serve essentially as a digital escrow agent. And it removes the need for a physical intermediary, and that’s largely what Codius and smart contracts set out to do. Again, another area that’s in very early days that bears watching. What’s the future of private currencies? If you remember a couple of lessons ago, we looked at private currencies and said some of them are still in circulation in various cities. Brixton, Ithaca, Toronto, and Vancouver were some of the examples. Well, is the future of private currencies digital currencies? Very possibly. Are they going to replace things like Air Miles and loyalty cards? Very possible. We are seeing some interest from corporations to set up their digital currencies oftentimes using things like BitSharesX or NXT to help facilitate these moves. We think there will be an increase in this usage.

One example that’s already in place is called Hub Culture. Hub Culture is an invitation-only social network. It has about 20,000 people in it, a relatively small community, but it actually has its own currency, the VEN. The VEN is pegged against the basket of currencies, and then, it can be used for purchase and exchange between members of the Hub Culture. But increasingly, it’s crossing into the physical world and being used to purchase services. There is even a fund that deals with VEN. VEN has managed to become fairly well-established despite having a very small user base. Part of the reason is it’s digital, it’s simple, the fees are low, the utility value is very high. And it’s widely adopted within that social network. It gives us some idea of how a private currency using the digital system could evolve.

Finally, let’s look in an area that doesn’t get a whole lot of conversation that bears looking at. That is virtual communities and MMO currencies. First off, definition, MMO, Massive Multiplayer Online as in the MMO gaming industry. As virtual communities grow, so do the virtual economies. And some of these communities have become very large. In fact, they’re so large that some of the sites now employ economists to manage their virtual communities and manage their virtual currencies. There are even exchanges that handle nothing but MMO currencies. And this really sort of runs totally under the radar largely because most of these are purely private, they’re used purely within their communities, but that’s changing. Some of the names that you should know here: World of Warcraft, Second Life, Eve Online, Diablo, Final Fantasy, many others as well, but these five are five of the largest in terms of the value and activity with their MMO currencies.

Probably, the best known is Second Life’s currency, the Linden dollar. The Linden dollar’s actually been around since 2003. There are currently a million users who use Linden dollars, and the turnover is running about $75 million a year. Importantly, the Linden dollar does have some crossover and it can be used to purchase items offline and you can purchase Linden dollars with fiat currency. This is fairly unique in the world of MMO currencies. Most of them don’t allow you to transact offline. In fact, what they do, they erect barriers to that. That said, there are ways around it. There is a substantial grey market, and people would do things like trade items in one game, $4 in another game. Or some games have game cards that allow you to buy playing time, where you can purchase those with the dollars, and then inside the game, you can exchange those for the MMO currencies. So there are intermediaries that allow this to bridge into the real world.

Are there implications here for the future in terms of money to be made, markets to be watched, arbitrage to be had? It’s hard to say. But one thing is certain; this is a rapidly growing area and certainly, even from just purely a novelty point of view, it bears watching.

That’s all we have for you in this course. We hope that you’ve enjoyed it and we hope you’ve learned a few things and please join us again for the next Coin Academy course. Thank you.