Editor’s Note: This is the second in a three part series exploring the world of cryptocurrencies and crypto assets on Tri-Campus. The first part of this series looked at student involvement, and the last part looks at investment recommendations and the university’s connections to space.
Notre Dame finance professors agree that one way to understand the value of a crypto token is to examine the technology behind it — the blockchain.
Blockchain is a shared, immutable ledger for recording transactions. For cryptocurrencies like Bitcoin, the technology tracks and confirms information across a distributed network without a central party.
The purpose of the blockchain is already in the name. The technology records data like bitcoin transactions in a “block”. Once the block is complete, it becomes part of the “chain” with other blocks before and after it that prevent changes to the data or transaction information.
Jason You, a Notre Dame sophomore studying computer science, said the applications of blockchain are more complex than the technology.
“Blockchain is actually a general purpose database, but the benefit of it is that it can secure transactions and prevent untrusted parties from tampering with the data,” she said. “Blockchain is unique because there is no centralized server there, but they can still allow untrusted computers to work together and they can record the same data on all of those computers or most of them.”
A cryptographic process called mining is the key element to achieve consensus within the network.
“You want all computers to store the same data. You want them to agree on the things that they communicate about and that requires some kind of mechanism,” she said.
They compare mining to solving a complicated mathematical puzzle. In reality, this puzzle is a hash function that works like a trapdoor, meaning a computer can efficiently find the door or input, but has trouble finding the output in reverse.
In the cryptocurrency mining process, the first computer to solve the puzzle gets a crypto coin reward. Once a function has been solved, it is virtually impossible to solve it in reverse, creating the security of a blockchain-powered currency.
Still, you said the technology could be improved in terms of security and user interface. He also said that blockchain’s applications are far more valuable than the technology alone.
“Blockchain alone isn’t going to add that much value because it’s just a database technology,” You said. “It can allow multiple untrusted parties to collaborate and store the same data in the database. This is something that has never been achieved before. When [developers] understand that point and then apply it to other technologies or industries, then that can potentially be revolutionary stuff.”
Currently, many companies are applying blockchain technologies to currencies. Whether this is the best use for the technology remains unknown.
Bill McDonald, a Notre Dame finance professor, said the value of cryptocurrency could come from applying the blockchain to monetary transactions.
“If you look at cryptocurrencies, you need to look at the valuation proposal in a similar way. It’s like, ‘Is this a useful medium of exchange?’” McDonald said.
The potential value is enhanced in countries where the national currency is unstable, he said.
After teaching multiple courses on crypto assets and bitcoin, McDonald is unsure about the future of cryptocurrency.
“At the end of the day, I’m not sure if it’s going to take over the world or not, but when I look at the people that work in this space, I’m very impressed,” McDonald said.
He compares the unknowns of cryptocurrency’s potential to the unknowns of the Internet’s potential in its early stages.
“I saw the Internet come online for the first time and I saw how difficult it was to say to someone, ‘Your computer will be able to talk to my computer.’ People used to say, “So what?” They don’t think of Amazon. They don’t think of eBay. You don’t think about what you can do when you open that door,” McDonald said.
The cryptocurrency’s growth narrative could follow that of the internet, or it could be buried in the graveyard of overhyped technologies, perhaps alongside the Blackberry smartphone, Theranos health screening scam, or even the less dramatic dot-com bubble.
“I don’t think most people understand some of the things that can be done in the crypto space‘ McDonald said. “I think it has tremendous potential, but I’m not entirely confident that we’ll ever realize that potential or that our countries will ever get comfortable with growing these currencies within their own borders. There are potential benefits, but as always there are risks.”
Like any new technology, buying cryptocurrency is a risky investment game, but much like playing a poker table in Vegas, a huge risk comes with an opportunity to offset the reward.
Brad Whitton, a Notre Dame senior and future associate at Chicago-based crypto-asset investment firm Walden Bridge Capital, downplayed more dramatic narratives that Bitcoin would replace the US dollar, saying cryptocurrencies have potential value as a hedge against inflation.
“I don’t really see a world where bitcoin will undermine the stability of the dollar. At the end of the day, people have to pay taxes in dollars. All transactions are settled in dollars. I don’t think that’s ever really going to change,” Whitton said. “People talk about bitcoin as an analogue of digital gold. I think that’s a fair view at the moment and I think going forward that’s a good mental frame to think about.
Bitcoins and similar cryptocurrencies have limited availability, creating economic pressures that mirror those of the gold market. Similar to buying gold, some investors are considering buying crypto assets as a way to diversify their portfolio. While cryptocurrency prices are volatile, their prices often move independently of the market, giving them a potential portfolio diversification advantage.
Whitton said cryptocurrencies may even have an advantage over physical gold.
“[Cryptocurrency] has many of the same qualities as gold but is better in the sense that you don’t have to pay to store it and you can transfer it over the internet. It cannot be confiscated,” he said.