Technology is dynamic and drives innovation. It has advanced exponentially from traditional radios and televisions to computers, smartphones, the cloud, and digital assets. And today, we’ll be telling you all about this new up-and-coming technology – The Blockchain.
Blockchain has transformed every arena – from healthcare and manufacturing, to real estate and the government sector. The most notable contributions of blockchain have been in the financial sector, leading to the emergence of digital asset types like cryptocurrency and non-fungible tokens.
In this blog, we’ll introduce you to the basics of blockchain and provide a glimpse of cryptocurrency and non-fungible tokens to help you get familiarized with this new technology that is revolutionizing the world today.
To put it simply: blockchain is a technology that focuses on making transactions secure and transparent. It is a public distributed ledger wherein all the transactions distributed across the network of computers are stored and maintained. Let’s explain with an example.
Let’s say there are a hundred computers in a network connected by blockchain. These computers are referred to as nodes. Suppose node A sends money to node B, then each transaction, as in, the money sent by A and that received by B are recorded in a ledger. Moreover, all of the computers in this network can view and verify this.
Next, B sends money to D, and E receives money from A, etc.;- all of these transactions will be stored in the blockchain. Each transaction will be created as a ‘block’ and appended to the previous transactions in a chronological sequence, forming a chain. Thus ‘blockchain.’
These blockchains are highly secure and tamper-proof. None of the nodes in the network can modify the transactions in this public ledger. If any cybercriminal tries to make changes to the data, they would have to modify all the preceding blocks in the chain. Additionally, a copy of the current state of the transactions is maintained at all of the nodes.
So, for the scammer to make foolproof changes, they would have to tamper with each node of the blockchain network, which is nearly impossible—the more extensive the network, the lower the odds of being attacked.
Blockchain technology paved the way for many digital asset types. Their ability to ensure security, immutability, and transparency of transactions has made them significant in the realm of finance. Immutable, in this case, means the transaction cannot be changed once verified.
One of the remarkable applications of blockchain technology in finance is cryptocurrency. Cryptos are digital currencies powered by blockchain technology that offers the benefit of decentralization. Unlike fiat money like US Dollar or Euro, which are regulated by a centralized authority, cryptocurrency does not need any regulatory mechanism as it is decentralized.
Cryptocurrency combines the features of cryptography and blockchain. These digital currencies use various consensus mechanisms for the participating nodes to reach an agreement on the existing state of a transaction. Each cryptocurrency on a blockchain network uses its native crypto token; for example, Bitcoin uses its token BTC, and Ethereum uses ETH.
Bitcoin, the pioneer in the realm of cryptocurrency, completely revolutionized the world of finance. The first cryptocurrency emerged in 2009 and was founded by someone, or several someones using the name Satoshi Nakamoto. The whitepaper of this group resulted in the launch of Bitcoin. Later, several other cryptocurrency coins evolved – Ethereum, Polkadot, Terra, Avalanche, Stellar, Dogecoin, Shiba Inu, and more. These were known as altcoins, short for alternative cryptocurrencies that are not Bitcoin.
Bitcoin uses a particular form of consensus algorithm known as Proof-of-work. For example, let’s say node A sends money to B, then the other nodes in the network have to verify and confirm the transaction. The nodes are presented with a complex mathematical problem based on cryptography. The computer that first solves the problem correctly gets the chance to validate the transaction or group of transactions known as a block.
The majority of the nodes on the network must confirm the validation by voting, which results in the block getting added to the chain. Thus, node B will receive the amount. Hence, without the need for any bank or central exchange, the Bitcoin blockchain operates decentrally on a peer-to-peer network to make transactions possible. (You might recall the days when you would download MP3s peer-to-peer via Napster or Limewire. Similar concept!) Additionally, the node that validates the transaction first receives a reward in Bitcoins (BTC).
The process of solving complex mathematical problems to earn Bitcoin rewards by the nodes is called mining, and the nodes are called miners. The mining process consumes a considerable amount of energy and resources, which is why specialized computer systems are used to mine Bitcoin. A Bitcoin is produced every 10 minutes, and a maximum of only 21 million bitcoins will ever be made. Currently, approximately 18 million BTC are already in circulation.
Non-fungible tokens or NFTs are digital assets stored on a blockchain that offers uniqueness and digital ownership. As the name suggests, NFTs are non-fungible; they cannot be exchanged for another because they are one-offs. You can exchange 1 BTC for 1 BTC because cryptocurrencies are fungible, which means they can be traded one for another. However, you cannot exchange a Mona Lisa painting for a Van Gogh painting as they are truly unique. The majority of NFTs are supported on the Ethereum blockchain today. You may have heard of the Beeple art that sold for $69.3million! Other examples of NFTs that took the world by storm are CryptoKitties and CryptoPunks collections.
Not everyone can buy a Van Gogh painting; but, you can make a .png or .jpeg image file version of the painting to try and create a unique digital version. By applying a process referred to as minting, you can create an NFT by utilizing specialized software to turn the ordinary file into a non-fungible token and store it on the blockchain platform. That said, NFTs have metadata information where a brief digital description of the digital asset is stored along with specific attributes and other key factors. Think of metadata as your digital fingerprint.
Each NFT has a unique identification code and metadata information that differentiates one NFT from another. In addition, these attached identifiers contain the owner or creator’s information, making them the sole owner of the NFT asset. An NFT can have only one owner at a time.
Non-fungible tokens can extend the existing functionalities of physical items by incorporating digital representations. Modern finance systems use complicated loans and trading processes for various asset types, from lending contracts to artwork to more common assets like real estate. NFTs are redefining how the financial transactions relating to tangible assets operate by adopting the digital counterpart of the asset.
NFTs can democratize investing by fractionalizing physical assets. Let’s stick with the previous Van Gogh painting example. The physical Van Gogh painting might have only one owner in the real world. However, a digital representation could allow multiple owners to own a piece of the Van Gogh painting. These arrangements could potentially increase the value of the physical art collectibles by providing access to other interested parties. This idea of “tokenizing” an asset can be extended from real estate to artwork.
NFTs have carved a niche in the digital asset space spanning art, collectibles, and more. Besides, there are NFT marketplaces where you can buy, sell or trade NFTs for a potential profit or loss. However, a point worth mentioning is that the price of NFT depends on its demand and what people are willing to pay.
The rarer an NFT, the higher its demand will be. Unlike stocks or commodities, where technical indicators or fundamental analyses determine the price, NFTs aren’t driven by these factors. It is possible that you bought an NFT at a very high price, and then having to sell it at a much lower price.
The question now is: should you dive into the world of NFTs? That depends on your risk tolerance and objectives for investing in an NFT. Investing in any digital asset today is highly volatile and involves much uncertainty. Bear in mind that NFTs are highly speculative and significantly riskier than a diversified portfolio of stocks and bonds. Do your research and tread cautiously.
Learning the basics of blockchain technology and cryptocurrencies is essential to being successful with it. Digital assets like NFTs are here to stay. These innovations will soon transform how we live, interact, and work. With the next iteration of the internet, Web 3.0, being inevitable, we will foray into the metaverse era where blockchains and cryptocurrencies will govern everything. People will use their NFTs as profile pictures on social media. A lot is happening even right now as you are reading this blog.
So, stay tuned! There is much more to come!
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Article written by Peter Kim, CFP® on June 18, 2022