Editor’s Note: This is the second of a three-part series exploring the world of cryptocurrencies and crypto assets on the tri-campus. The first part of this series covered student involvement, and the final part will cover investment recommendations and University connections to the space.
Notre Dame finance professors agree one way to understand a crypto token’s value is to examine the technology behind it — blockchain.
Blockchain is a shared, immutable ledger for recording transactions. For cryptocurrencies like Bitcoin, the technology tracks and confirms information through a distributed network without a central party.
The purpose of blockchain is right in the name. The technology records data, such as transactions of Bitcoin, in a “block.” Once the block is complete, it becomes part of the “chain” with other blocks before and after it that prevent any changes to the data or transaction information.
Jason You, a second year Notre Dame doctoral student studying computer science, said the applications of blockchain are more complex than the technology.
“Blockchain is actually a general purpose database, but the advantage of it is that it can secure transactions, preventing untrusted parties from tampering with the data,” You said. “Blockchain is unique because there is no centralized server in there, but they can still allow untrusted computers to work together, and they can record the same data on all of these computers or the majority of them.”
A cryptography process called mining is the central piece for achieving consensus within the network.
“You want all the computers storing the same data. You want them to agree on the things they are communicating on, and that requires some kind of mechanism,” You said.
You compares mining to solving a complicated mathematical puzzle. In reality that puzzle is a hash function that works like a trapdoor, meaning a computer can efficiently find the door, or the input, but struggles to find the output in the reverse direction.
In the cryptocurrency mining process, the first computer to solve the puzzle receives a crypto coin reward. Once a function has been solved, it is virtually impossible to solve it in the reverse direction, thus creating the security of a blockchain-powered currency.
Still, You said the technology has room for improvement when it comes to security and user interface. He also said blockchain’s applications are far more valuable than the technology alone.
“Blockchain by itself won’t create that much value because it’s just a database technology,” You said. “It can allow multiple untrusted parties to work together and store the same data on the database. That’s something that’s never been accomplished before. If [developers] understand this point and then apply it to other technologies or industries, then that can potentially be revolutionary stuff.”
Right now, many firms are applying Blockchain technologies to currencies. Whether or not this is the best use for the technology remains unknown.
Bill McDonald, a Notre Dame finance professor, said cryptocurrency’s value might come from blockchain’s application to monetary transactions.
“When you look at cryptocurrencies you have to look at the valuation proposition in a similar way. It’s a matter of, ‘Is this a useful medium of exchange?’” McDonald said.
The potential value is magnified in countries where the national currency is unstable, he said.
After teaching multiple classes on crypto assets and Bitcoin, McDonald remains unsure about cryptocurrency’s future.
“At the end of the day, I’m not sure whether it will take over the world or not, but when I look at the people working in the 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 beginning stages.
“I lived through the Internet first coming online, and I saw then how hard it was to explain to somebody, ‘Your computer will be able to talk to my computer.’ People used to say, ‘So what?’ They don’t think about Amazon. They don’t think about eBay. They don’t think about the things you can do when you open that door,” McDonald said.
Cryptocurrency’s growth narrative may follow the Internet’s, or it may end up buried in the graveyard of overhyped technologies, perhaps next to 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 crypto space,” McDonald said. “I think it has tremendous potential, but I am not fully confident we’ll ever realize that potential, or our countries will ever become comfortable allowing these currencies to grow within their own boundaries. There are potential benefits, but as always, there’s risk.”
Like any emerging technology, buying cryptocurrency is a risky investment play, but much like a poker table in Vegas, huge risk comes with the possibility of compensating reward.
Brad Whitton, a Notre Dame senior and future employee for Chicago-based crypto asset investment firm Walden Bridge Capital, downplayed more dramatic narratives of Bitcoin replacing the U.S. dollar and said cryptocurrencies have potential value as a hedge against inflation.
“I don’t really see a world where Bitcoin is going to undermine the stability of the dollar. At the end of the day, people have to pay taxes in dollars. All business is done in dollars. I don’t think that is really going to ever change,” Whitton said. “People talk about Bitcoin as being analogous to digital gold. I think that’s a fair way of looking at it right now, and I think going forward, that’s a good mental framework for how to think about it.”
Bitcoins and similar cryptocurrencies exist in limited supply, creating economic pressures that mirror those of the gold market. Much like buying gold, some investors consider purchasing crypto assets as a method of diversifying their portfolio. While cryptocurrency prices are volatile, their prices often move independently of the market, giving them a potential portfolio diversification benefit.
Whitton said cryptocurrencies may even have an advantage over physical gold.
“[Cryptocurrency] has a lot of the same properties 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’s non-confiscatable,” he said.