## What Are Cryptocurrencies?

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### Uses of money
- Money serves as a store of value, a means of exchange for goods and services, and a unit of account that measures value.
- Historical evolution cited:
  - Commodity monies: sea-shells, copper, silver, and gold.
  - Fiat money example: paper money in eighth century China under the Tang dynasty.
- Modern central banks seek to maintain price stability by regulating the supply of money on behalf of governments.
- Historical risk example: "people moving cash around in wheelbarrows in post–World War I Germany."

### Bookkeeping and ledgers
- Complex financial systems required trusted intermediaries and credible accounting systems; double-entry bookkeeping in Renaissance Italy was a major innovation.
- Central banks and computerized bank ledgers play a coordinating role in validating transactions among financial institutions.
- Example transaction flow described:
  - Mehrnaz uses money from her account in bank A to buy goods from Mary, who has an account in bank B.
  - Bank A debits Mehrnaz’s account.
  - The central bank moves money from bank A to bank B and records the transaction in its central ledger.
  - Bank B then adds the money to Mary’s account.
- The system is based on trust in the central bank and its ability to safeguard the integrity of the central ledger and ensure that the same money is not spent twice.

### Distributed ledger technology and cryptocurrency operation
- Many cryptocurrencies eliminate the need for a trusted central agent by relying on distributed ledger technology, such as blockchain.
- Ledger construction and validation:
  - The ledger is maintained across a network; each member verifies and validates transactions using technologies derived from computing and cryptography.
  - Once decentralized consensus is achieved among members of the network, the transaction is added to the ledger, which is validated.
  - The ledger provides a complete history of transactions associated with a particular cryptocurrency that is permanent and cannot be manipulated by a single entity.
- Network participants who verify and validate transactions are usually rewarded with newly minted cryptocurrency.
- Pseudo-anonymity and key pair mechanics:
  - Holders have two keys: a public key (such as an account number) and a private key required to complete a transaction.
  - Example: Mehrnaz is identified by public key ABC and Mary by public key XYZ. Mehrnaz initiates a transaction with her private key; network members verify that ABC has the money by solving a cryptography puzzle. Once the puzzle is solved, the transaction is validated, a new block is added to the blockchain, and the money is transferred from ABC’s wallet to XYZ’s.

### Genesis, prevalence, and limitations
- The first cryptocurrency, Bitcoin, was introduced in 2009 by a programmer (or group of programmers) using the pseudonym Satoshi Nakamoto.
- As of April 2018, there were more than 1,500 cryptocurrencies, according to coinmarketcap.com; along with Bitcoin, Ether and Ripple are the most widely used.
- Current limitations relative to the functions of money:
  - High volatility limits usefulness as a unit of account and store of value.
  - Limited acceptance for payment restricts use as a medium of exchange.
  - High production cost for many cryptocurrencies reflects large energy consumption to power computers that solve cryptographic puzzles.
  - Decentralized issuance means no entity backs the asset; acceptance is based entirely on users’ trust.

### Benefits and risks
- Potential benefits:
  - Distributed ledger technology could reduce the cost of international transfers, including remittances, and foster financial inclusion.
  - Some payment services now make overseas transfers in a matter of hours, not days.
  - The technology can be used beyond finance, for securely storing important records such as medical histories and land deeds.
- Risks and challenges:
  - Pseudo-anonymity makes many cryptocurrencies vulnerable to use in money laundering and terrorism financing if no intermediary checks transaction integrity or identities.
  - Cryptocurrencies could present challenges for central banks if they affect control over the money supply and therefore the conduct of monetary policy.

*Antoine Bouveret and Vikram Haksar, Finance & Development, June 2018.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2018/june/basics.pdf_