Hype vs Reality: Cryptocurrencies and Blockchain
Updated: Nov 14, 2022
Cryptocurrency and blockchain have been the subjects of countless news articles and feature stories over the last few years. The hype surrounding them has reached a fever pitch. Some see these technologies as the future, while others believe they are just a flash in the pan. Whatever side you are on, it is good to distinguish between hype and reality.
Busting Myths Surrounding Cryptocurrency
#1: Cryptocurrencies are decentralised
Owners make decisions
When Bitcoin emerged in 2009, an unexpected hero named Satoshi Nakamoto came to the forefront. The only catch was that nobody had ever seen him or met him, and to date, his identity remains a mystery. Furthermore, having no “owner” made Bitcoin a fairly decentralised cryptocurrency in spirit because no one made decisions on mining coins, their availability, etc.
However, most cryptocurrencies flooding the industry today are marketed by their owners, who have become celebrities in their own right, with many loyal supporters rallying behind them. Their impact on the community is such that a single statement can change market dynamics greatly. Take controversy-marred Justin Sun’s recent tweet, for example, that read “Big news of #TRX NEXT WEEK!”. His announcement gathered enough momentum to take Tron to a four-month high, despite the cryptocurrency failing to live up to its hype in the past.
Virtually nothing stops founders and co-founders from pushing their agendas and making key decisions that have long-term impacts. If our “blockchain celebrities” have such command over market prices and momentum, doesn’t it contradict the very basis of decentralisation?
Bitcoin cannot escape some centralisation
Although Bitcoin is the proud flag bearer of decentralised technology, several studies and statistics have proved the contrary. For example, a 2008 peer-reviewed study at Cornell University called “Decentralization in Bitcoin and Ethereum Networks” measured the actual practice of decentralisation in these two cryptocurrencies instead of the hype around them. Their research showed that in both Ethereum and Bitcoin, “mining [is] very centralised, with the top four miners in Bitcoin and the top three miners in Ethereum controlling more than 50% of the hash rate.” Indeed, the “entire blockchain for both systems is determined by fewer than 20 mining entities.”
In 2020, Flipside revealed that 2% of the anonymous ownership accounts that can be tracked on Bitcoin’s blockchain control a whopping 95% of the digital asset. Furthermore, it convincingly showed that a few large holders called whales had a significant piece of the pie, thus controlling Bitcoin.
Some services aid centralisation
Many cryptocurrency enthusiasts depend on third-party services or centralised institutions to carry out various processes and transactions. A few of these services, such as myetherwallet.com, draw a considerably large number of users to their platform. If these centralised services are hacked or breached, the stakeholders will face severe consequences. The existence of such tools and the possibility of cyberattacks undermine the decentralised nature of cryptocurrency.
Like our “blockchain celebrities”, we have other influencers who can sway market sentiments at the drop of a hat. In February this year, Tesla said that it had bought $1.5 billion worth of Bitcoin, causing the cryptocurrency’s price to rise by a record 17%. A few days before this news, Tesla’s CEO, Elon Musk, had added #bitcoin to his Twitter profile page, already driving up prices. Now comes the twist.
Fast forward to May, and Elon Musk says that Tesla will no longer accept Bitcoin for vehicle purchases due to climate change concerns. The backtrack resulted in a 10% drop in Bitcoin’s prices, creating panic among investors.
But Elon Musk still has experience in cryptocurrency markets; other celebrities don’t necessarily have it. For example, reality TV star Kim Kardashian posted a story for EthereumMax, a not-so-well-known token, as a part of her advertising commitments. According to a study by Morning Consult, a data intelligence company that surveyed 2,200 U.S. adults in September, 1 in 5 respondents had heard about Kardashian’s ad. And the striking point—19 per cent of respondents who said they heard about the post invested in EthereumMax.
#2: Cryptocurrencies are backed by solid technology
A few years ago, memes took social media by storm. And today, it’s meme coins taking the cryptocurrency markets by storm. Most of you would have heard of Dogecoin, Shiba Inu coins, Game of Thrones coins and very recently, the Squid Games coins. While they all look fancy on the outside, they are all examples of the classic pump and dump scheme.
Meme coins rely heavily on the buzz that owners create on social media and in communities globally. The owners or operators of these coins hold them at low prices, but as retail investors start buying into the hype, the price starts getting artificially pumped. As this pump takes place, owners start selling meme coins to investors purchasing large quantities. With the simple forces of demand and supply coming into place, the price starts dropping, and retail investors are left with a coin that has practically no use and no value. The simple funda is to pump the price when needed and dump the price when done.
Dogecoin, which was admittedly started as a joke, was worth around US$ 0.2 in April 2021. Its value went up three times over the next two weeks and dropped to half the peak level in the following ten days. Essentially, the coin can buy you Starbucks one day, a three-course dinner the next day and just a lollipop on the third day.
If you’re confused about such market behaviour, let me introduce the Greater Fool Theory that will tie it all together. This theory simply says that you can make money from an overvalued asset during a market bubble because another person will always be willing to buy it at an even higher price. In the case of meme coins, it is clear that they have no actual use case, but their exorbitant valuations reflect the presence of “greater fools” in the market. All this despite the fool knowing what happens when the bubble bursts!
#3: The supply of cryptocurrencies is limited
There are very few cryptocurrencies with a limited supply in the true sense. For example, it is possible to mine a maximum of 21 million Bitcoins, after which its supply will be exhausted. However, apart from Bitcoin and a handful of others, most cryptocurrencies can and do have an unlimited supply.
Take Etherium, for example. Overall, there is no limit on the supply except an annual threshold of 18 million ETH. The power to make and change conditions lies with the founders. For instance, Ethermium’s founder, Vitalik Buterin, can decide at any point to double the supply in the market. Although inflationary, there is no absolute limit on how many ETH can be available. This is the case with a majority of cryptocurrencies in the market. It also poses an important question: if the supply is unlimited, what is the currency worth in the long run? Because only something with a finite supply will carry a value.
#4: NFTs make sense
Non-fungible tokens (NFTs) have become the new big thing on the internet today, with a few fetching millions of dollars from buyers. However, one of the most significant downsides of NFTs is that it is a market with artificial scarcity because, in reality, there is no limit to the number of NFTs you can create. Any bit of data can be authenticated and sold.
In all likelihood, there will be a flood of artists selling NFTs and trying to cash in on the craze, given the massive hype. This is because there is virtually no added cost of producing an NFT—anyone can do it any number of times. Again, by virtue of simple economic forces, supply will overwhelm demand leading to an eventual crash in the market.
Another drawback is that nothing stops people from creating NFTs for digital assets that they did not make or own. If the original owner never created an NFT, there is no way of verifying that the asset belongs to them. Imagine a scenario where you made a piece of digital art a few years ago and feel it can fetch a good amount if sold as an NFT. Just as you decide to go ahead with it, you see that someone has already created an NFT for your art. There is practically nothing you can do about it. Regardless of who the original creator is, NFTs of any digital asset can be sold by anyone for any amount of money.
Busting Myths Surrounding Blockchain
#1: Blockchain is the ideal technology
Blockchain enthusiasts believe in the massive potential of this technology, and it is possible, provided that what is on paper is actually practised. We have already seen that cryptocurrencies are centralised in many aspects, and it is valid for blockchain too. This impedes the technology from achieving its true capabilities.
On the blockchain, transactions must be validated through multiple nodes before acceptance. Anyone can add or validate transactions, but the process takes place one at a time. Therefore, it is time-consuming. Users generally have to pay substantial transaction fees to validate their transactions quickly. Those who cannot afford to do so have only two choices—wait longer than others or stop transacting all together. Similarly, mining Bitcoins on the blockchain network is expensive and resource-intensive, which have resulted in the formation of concentrated “mining pools”. These mining pools lead the way and validate a majority of the transactions.
Additionally, any person can suggest updates or changes that need to be made to the blockchain network. In reality, however, they are generally proposed by a select number of developers and commentators, making the process relatively centralised.
#2: Blockchain implies truth
As suggested earlier, the truth or validity of transactions is done through miners working on thousands of mining nodes. However, miners can collude during this process and carry out malicious transactions that others may not pick up. Although the risk is lower in larger networks, collusion is a strong possibility in private blockchains, such as banks.
It is not just the miners that need to be reliable; blockchain cannot judge if the inputs are factually correct either. For example, fake invoices entered in the system would be considered valid if the blockchain’s conditions are met.
#3: Blockchain is tamper-proof
Blockchain is a digital ledger, which means that blocks of information are connected in an unbroken sequence. This sequence is made up of digital signatures that form the blocks, and each block carries the signature of the preceding block. Therefore, changes to one block would require modifications to all blocks in the chain, making the system resilient to tampering.
However, attacks can still occur. For example, if a group of participating individuals control a majority of the network’s hashing power, then tampering might be possible. This can also lead to a double-spending attack in the case of cryptocurrencies, where high-value transactions can be reversed, and amounts can be spent a second time.
#4: Blockchain is efficient
Users have imposed exceptional trust in blockchain technology, but they fail to realise that it is beneficial in some cases, not all. It cannot be blindly implemented across industries. People who make the mistake of using blockchain without a thorough understanding of its consequences might end up with bigger inefficiencies. For example, in private or governmental centralised institutions, a decentralised technology does not fit in. It is the same as a dictator saying that the country is democratic, but only he will vote.
Furthermore, blockchain is expensive to implement and requires computational power, electricity, servers, and related infrastructure. Therefore, blockchain should be evaluated just like any other technology is and see if the benefits are enough to offset the costs.
#5: Smart contracts are useful
Smart contracts are self-executing programs on blockchain that run when a pre-determined set of conditions are met. Recently, a lot of money has been invested in projects, especially those backed by Ethereum. As a result, smart contracts have become the basis of small and large businesses, including those in the insurance and lending industry. In addition, many assets such as ICOs and wallets have also adopted smart contracts. Therefore, due to their massive expansion, smart contracts have started attracting power-hungry cybercriminals who can get huge payouts after a successful attack.
The first loophole that hackers exploit is the code. Contract developers have to be extremely careful while writing the code and ensure that it is free of bugs. Even during rigorous testing, it has been observed that loopholes remain that are used by hackers for financial gains. Sometimes, coders themselves are not well versed in writing a secure smart contract, leading to severe consequences. A 2018 article reported that half a billion dollars were either stolen or lost due to poorly coded smart contracts in the previous. About 50% of those came from Ethereum.
Secondly, smart contracts are often fed data from sources not on the blockchain, known as off-chain resources. To connect them with the blockchain, trusted oracles are used. Unfortunately, like fool-proof coding, accurate oracle systems are also challenging to produce. Their inability to provide correct data or execute functions can fail the entire system in one go, sometimes even exposing sensitive information.
Another characteristic of smart contracts is immutability because once deployed, the code cannot be changed. While this seems advantageous at first, the flipside is that even errors remain locked in and cannot be fixed. There is no authority you can contact to rectify mistakes, and they will continue to execute as long as conditions are met. As a result, it provides an excellent opportunity for cybercriminals to make a move and exploit any existing vulnerabilities. In 2018, researchers found that 34,200 Ethereum-based smart contracts worth $4.4 million ETH had identified flaws. Since then, far more complex technology has taken over. You can stretch your imagination far and wide to find the number for 2021.
Contrary to the general practice, it is unreasonable to make blockchain the basis for all contracts, especially those subject to change or unpredictability. Even if there is a mutual agreement between the parties to amend a clause or part of the contract, there is no immediate solution. And what if the blockchain itself is hacked? Well, you know the drill by now. And might I add, the legality of smart contracts is not even close to being defined, so you genuinely have a lot to lose.
If cryptocurrency and blockchain are flawed, why are they worth trillions of dollars?
Because that is just how all bubbles are formed—inflated valuations without solid groundwork.
The valuation fits well in today’s financial world, where cryptocurrency is being bought as a digital asset without any use case. When prices go up and down depending on tweets, celebrities and media coverage, it will not be long before the system breaks down. If you can justify a meme coin going from zero to a hundred and back to zero in the span of a few days, let go of some of that optimism and prepare yourself for a rough ride. Weak foundations lead to a house of cards, bubbles and eventual crashes.
And just because everyone else is doing it does not mean it is right. Collective human actions and dependence on others doing the right thing have proved fatal many times in the past. Remember the 1999 dot com bubble? Pets.com? The 2008 subprime crisis? The millions of homeowners and astounding delinquency rates? The problem is that our brains are wired to follow the herd. It is too hard to go against the crowd or make decisions not influenced by social activity. When this herd mentality comes into play, trillions of dollars in valuation do not seem significant.
If you look closely at cryptocurrencies, they spread like typical MLM (Multi Level Marketing) schemes. Due to the lack of global precedence, governments have been reluctant to monitor and regulate cryptocurrencies. Large-scale influencer campaigns, persuasive social media messages and full-page advertisements build the same craze that MLM companies traditionally do for their businesses. Unfortunately, it is so easy to fall into their trap because no one cares to check the facts, and no one wants to be the party pooper.
The recipe for the success of MLM-like cryptocurrency schemes is simple. First, you talk about the progressive, life-changing opportunity that it is. Then, you drop the names of the crowd’s favourite celebrities who endorse it. Lastly, you throw in random figures for the market size and growth potential. If this sounded strange, let me tell you this is the same narrative that has been used for centuries, only moulded differently to suit the times. It was in play during the tulip mania of the 17th century, carried on into the 20th century with the dot com bubble and has entered the 21st century with this meme coin led cryptocurrency bubble.
In 2017 it was ICOs, in 2018 it was STOs, in 2019 it was Defi, in 2020 it crypto currency became crypto asset, 2021 is about NFTs, and 2022 onwards will be around Web 3 and Metaverse. Every year or so, a new gimmick is added to the valuation games of these stories, without much achievable real value.
Even if we ignore the lessons from history, it is hard to perceive why FOMO is taking over good sense. Buying into the hype without doing your research is a disaster. Because when the markets come crashing down, and they will, in all certainty, no celebrity will come to warn you. And even if you make a few bucks in this game, remember there are a select few—the whales—holding the strings and making millions more.