In contrast, cryptocurrency introduces digital scarcity - making it dramatically easier to create and transfer anything of value. Just as the internet upended the media world, the cryptocurrency economy will transform the (also highly monopolistic) financial world.
What Is a Cryptocurrency?
A traditional currency is backed by a government. The dollar is worth what it is because the government has built a set of policies and actions to support a particular value. When people lose trust in their government, the value of that currency falls.
Similarly, the value of a cryptocurrency is based on the trust investors have in a computer program running on a network of independent computers. The most famous cryptocurrency is Bitcoin.
In practical terms, bitcoin is a computer program that pays computer owners (called miners) to run copies of itself on their computers. Investors then pay miners protect a highly secure ledger that records which investor owns each bitcoin. Bitcoin is a very clever computer program that incents miners and investors to collaborate in order to profit from each other.
Although there are thousands of cryptocurrencies, 75% of the $2 Trillion cryptocurrency market is split between just two currencies: Bitcoin (valued at $1.1T) and Ethereum (valued at $0.4T). These two cryptocurrencies are very different:
- Bitcoin is a speculative asset like gold, based on a secure ledger.
- Ethereum is similar to Bitcoin but adds a programming language to a secure ledger, making it much more flexible. This flexibility makes Ethereum the choice of developers who are building the next generation of Decentralized Finance (DeFi) applications. These applications will upend the world of finance.
What Is Decentralized Finance (DeFi)?
Any financial application can be broken down into an agreement between two parties to transfer value according to certain rules. A Decentralized Finance application creates agreements – called smart contracts – makes them part of an Ethereum transaction to record an unbreakable agreement between two parties.
Why Is DeFi Better?
The traditional finance world is composed of heavily regulated, monopolistic companies. They face limited competition and even more limited opportunity for innovation.
In contrast, the DeFi world is composed of companies who are “born integrated” with every other value creation and transfer application in the cryptocurrency ecosystem. Entirely new financial solutions are being created on a daily basis that incorporate elements of the financial world that have never been combined before.
For example, it is easy to make an investment and at the same time insure against exchange rate risk and security risk for that investment. The only market disruption that matches the level of innovation and change going on in DeFi is the Internet boom of the early 2000s.