In 2009, Bitcoin became the first cryptocurrency in existence. Today, just over ten years later, the currency has a market capitalization of over $700 billion, and thousands of other cryptocurrencies, collectively known as altcoins, have been developed. Nevertheless, the focus has been on investing in cryptocurrencies rather than actually using them—the vast majority of people are still conducting their day-to-day lives with dollars and other traditional currencies. All of this makes us wonder: What are cryptocurrencies hoping to accomplish? If cryptocurrencies were to become mainstream, which ones would we be using? And what would their relationship be with traditional currencies and governments?
Cryptocurrencies were created to provide people with an efficient currency system that places more control in the hands of users. This is done primarily by bypassing the “middlemen”—centralized institutions like governments, banks, and credit card companies—and instead keeping track of transactions on a decentralized system, allowing transactions to be faster and cheaper. This system, called the blockchain, is accessible by everyone, with each individual’s information kept secure through cryptography. But with so much more attention directed toward making money off of cryptocurrencies rather than using them for everyday transactions, it’s important to consider what kind of a future people are actually investing in.
The answer may not be entirely clear yet. Money has many uses, and different applications call for different features, which different cryptocurrencies may provide. Professor Marco Di Maggio1 of the Harvard Business School says “we’re in an infancy stage with several niches developing in parallel, so it’s hard to see who the winner will be.” For example, he notes that Bitcoin’s scarcity makes it in principle suitable as a store of value and a hedge against inflation (like gold), while stablecoins like USD Coin are a good option as a medium of exchange (like dollars).
Bitcoin has the advantage of being the first and most widely used cryptocurrency. “Its network has proven to be secure, and it’s an effective barometer of the strength of the cryptocurrency market,” Di Maggio says. Still, its features don’t cover every need out there, so many alternative cryptocurrencies have been created to address those needs.
One issue is that Bitcoin operates on a blockchain whose blocks are limited to one megabyte in size, each of which takes about ten minutes to confirm and add to the blockchain. That results in a scalability problem—if too many people transacted with Bitcoin, there would be a backlog of transactions waiting to be confirmed. Several altcoins have been created in order to address this problem: for example, a Bitcoin variant called Litecoin reduces the block confirmation time, while another variant, Bitcoin Cash, allows larger block sizes.
But these variants don’t solve all of the concerns about Bitcoin. Its environmental impact has faced criticism: the problem is that Bitcoin (as well as Litecoin and Bitcoin Cash) run on a proof-of-work consensus protocol, which requires computers to make a massive number of guesses at difficult mathematical problems in a competition to solve them first and confirm a block—and thus receive a reward. (This is the process referred to as “mining.”) But immense computing power translates to immense energy consumption, with substantial environmental consequences. In response, an alternative protocol called proof of stake has been developed, which selects users to confirm blocks based on the amount of the cryptocurrency they own. That means more computing power doesn’t increase the chances of mining the block, and thus there is no incentive to consume large amounts of energy. Cryptocurrencies like Cardano, the fifth largest by market capitalization, are already using proof of stake, and Ethereum, the second largest, is in the process of switching to it.
Another major concern is that Bitcoin is extremely volatile—its price is prone to changing rapidly. That makes it undesirable as a medium of exchange (although it does make it a good speculative vehicle), because no one wants to exchange their Bitcoin for a good or service when the currency could be worth significantly more the next day. Conversely, many wouldn’t want to accept it as payment either since its value could suddenly drop. As a result, Bitcoin buyers tend to hold on to their Bitcoin rather than use it. In fact, this is an issue that affects many cryptocurrencies, including Ethereum, Cardano, Litecoin, and Bitcoin Cash. A solution is available in the form of stablecoins. These cryptocurrencies, which are pegged to another asset—often a traditional government-issued currency—eliminate this volatility and the desire to hold in hopes of a return on investment. As a result, stablecoins show the most promise for use in everyday transactions. An example is Tether, a stablecoin pegged at approximately a 1:1 ratio with the US dollar, which is currently the third largest cryptocurrency by market capitalization. USD Coin, mentioned earlier, runs on a similar idea. They offer the efficiency of cryptocurrency transactions without the worry of volatility.
However, without greater government oversight, it’s difficult to verify that stablecoins are fully backed by another asset. That’s why the Federal Reserve is looking to increase regulations on stablecoins—and even perhaps issue a digital currency of its own. This is called a central bank digital currency (CBDC); in fact, China has already begun experimenting with a digital yuan. Although not a cryptocurrency (since it wouldn’t be decentralized), a CBDC would be stable, government-backed, and more easily regulated, and its operation would be fully digital. To some, the idea of a government-issued digital currency misses the point—after all, cryptocurrencies were made in order to conduct transactions without the involvement of centralized institutions. But CBDCs do offer efficiency advantages over traditional currencies, as well as stability advantages over cryptocurrencies like Bitcoin.
What’s the end result of all this? As Professor Di Maggio points out, it’s really too early to tell. But he does believe that many different cryptocurrencies will continue to attract users and settle into their own applications. It’s easy to exchange one cryptocurrency for another—easier than it is to exchange dollars for euros, since there are no intermediaries to go through—and there is work on creating systems that will allow separate blockchains to talk to each other. In other words, even though it seems likely that no one cryptocurrency will emerge as an all-encompassing currency, we can be assured that having several in use at once won’t bog down the system. People will turn to different cryptocurrencies for different needs, and though Bitcoin dominates the public consciousness, we should be aware that it probably won’t be the one people will use every day if cryptocurrencies become mainstream. In reality, it’s more likely to be useful as a safe place to keep your money when you’re concerned about inflation, much like buying gold in today’s world. Other cryptocurrencies will handle everyday transactions: stablecoins could be used in place of the dollar. And Ethereum is notable because it isn’t just a cryptocurrency—it’s a platform that supports decentralized finance, which aims to be a substitute for the entire traditional financial system, as well as other decentralized applications; for example, yield farming is a way of depositing cryptocurrencies in return for interest. In short, we’re looking at a wide range of options for a wide range of uses, each one with its own features and flaws. With time, and with the inevitable development of newer technologies, we’ll see which currencies will fill which roles.
1 Marco Di Maggio is the Ogunlesi Family Associate Professor of Business Administration in the Finance Unit at Harvard Business School and a faculty research fellow at the National Bureau of Economic Research.