Seeing several issues with over-centralized and not clearly backed by anything fiat currencies, cryptocurrency was created as a smart and better alternative to the existing financial system. Over-centralization, as a key feature of the existing financial system, ensures that every transaction passes through centralized authorities, including central and commercial banks.
The central bank, on the one hand, dictates countries’ monetary policies, while commercial banks serve as a conduit for every financial transaction. It is safe to say that the current financial system and its inadequacies gave birth to cryptocurrency as a better alternative to the status quo.
From stablecoins to Bitcoin, to altcoins, every cryptocurrency in the book claims to be best equipped to replace fiat in everyday transactions. Practically, however, no cryptocurrency has substantiated its bold assertions of being the perfect replacement for conventional fiat currency.
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What is the Perfect Cryptocurrency, and what are its Most Crucial Features?
It is best, to begin with, a caveat; this piece is intended for educational purposes. You should consult your financial adviser for an expert opinion. Please fasten your seat belt while we explore the major characteristics a fiat replacing cryptocurrency must possess.
1. Must address volatility
Volatility is the big elephant in the crypto room that must be addressed before achieving its fiat-replacing ambition. Volatility refers to the largely unpredictable swing in the price value of a crypto asset over a period of time. Crypto volatility is a double-edged sword. On the one hand, it encourages people to hold a crypto asset in anticipation of a price increase. On the other hand, it discourages people from holding a crypto asset as an asset or using it as their main payment mechanism.
Generally speaking, the volatility rate is so high that a cryptocurrency can lose 25% or more of its value in a short period of time and vice versa. The perfect cryptocurrency must shift past price speculations and achieve predictability using defined indices.
One effective way to address crypto volatility is to develop a mechanism that corresponds to its demand with supply automatically, thus increasing its price stability.
2. Fair, just, and equitable initial coin distribution
The perfect cryptocurrency must be based on a solid foundation of fairness, justice, and equity.
While most worthwhile crypto projects began with an Initial Coin Offering (ICO), the fact remains that these are largely early-investor-centric if they aren’t fraudulent. An ICO refers to selling cryptocurrencies to the public to raise funds. Investors, just like in IPOs, purchase cryptocurrencies in an ICO in anticipation of a price increase. Experience over the years has shown that most ICOs are not desirable because many crypto projects that have conducted ICOs are exposed to regulatory scrutiny and gains are often skewed to the team and initial investors, which is not fair or equitable.
The hypothetical perfect cryptocurrency should avoid an ICO altogether if possible. Alternatively, a fair launch or an airdrop should be considered. Bitcoin for example was a fair launched crypto, which can be done by simply publicly stating that this currency will be launched and everybody can mine it. However, at this point in time, this is tricky as there are many bad actors. Crypto governance proposals could be used in conjunction with a fair launch approach to have more control to ensure fair distribution, but making this a reality is a tricky endeavor.
An airdrop could also be used, often done by projects in e.g. the Cosmos ecosystem. If the cryptocurrency is using a proof-of-stake consensus mechanism, this may be the way to go.
3. Secure consensus mechanism
A consensus mechanism refers to a blockchain’s security maintaining, transaction validating, and authenticating system. The most common consensus mechanisms in the crypto space are proof-of-work (e.g. BTC, LTC, ETC) and proof-of-stake (e.g. ETH 2.0, ADA, XTZ).
The proof-of-stake consensus is more prone to attack and compromise. All participants in a proof-of-stake consensus who have enough capital could acquire above 50% authentication capability in the blockchain and in a worst-case scenario could hold the whole blockchain ecosystem for ransom.
On the other hand, the proof-of-work consensus is environmentally and financially unsustainable due to its high energy requirement and lack of scalability.
The perfect cryptocurrency should develop a comprehensive consensus mechanism that is highly secure, environmentally sustainable, and requires low-end hardware to process. I do not believe this exists yet, but there is a huge opportunity once we crack this.
4. In-depth thought-through tokenomics
This is probably the most complicated aspect. Many believe Bitcoin (BTC) cannot play the role of digital tokens for payments because of its tokenomics. Many see BTC more as “digital gold”, or a store of value in digital format. This is because of basic economics — in general, the demand for BTC increases, but the supply decreases, so the price increases. This dynamic means that people will not want to spend their BTC, as they believe it will be more valuable in the future, which could lead to a deflationary death spiral.
We know that a fixed or inelastic supply, like with Bitcoin, may lead to deflation, and an infinite or elastic supply may lead to inflation, so the potential solution may be an instant, automatic supply adjustment based on demand to try to keep the price constant. Potentially a peg to an asset that everybody recognizes, which is not a fiat currency, could also be considered.
5. Decentralization, scalability, and security
Described as the Blockchain Trilemma by tech entrepreneur and founder of Ethereum, Vitalik Buterin, decentralization, scalability, and security in conjunction is the greatest hurdle the perfect cryptocurrency must overcome. Vitalik argues that a cryptocurrency cannot be secure, decentralized, and scalable simultaneously. He believes that cryptocurrencies can only solve two of these trilemmas. While many cryptocurrencies claim to solve this triple hurdle efficiently, there is no convincing evidence to support these spurious claims. Experts believe that as transaction volumes grow rapidly, centralization will be needed since fewer nodes will be able to store the blockchain’s transaction history.