Demystifying Cryptocurrencies, Blockchain

Introduction:

Bitcoin, blockchain, ICOs, ether, and exchanges are all terms used to describe cryptocurrencies. Cryptocurrencies (and their language) have generated quite a stir in the media, online forums, and perhaps even in your dinnertime talks, as you've no doubt seen. Despite the excitement, many individuals still don't understand what these terms signify. We could say it as succinctly as Stephen Colbert below, but we'll be a little more specific.

Cryptocurrencies have gone a long way in terms of technological innovation and appeal since their early days as havens for criminals and money launderers. In 2018, the market capitalization of cryptocurrencies is expected to exceed $1-2 trillion. The technology that underpins cryptocurrencies has been believed to have significant applications in a variety of fields, including healthcare.

Cryptocurrencies, on the other hand, remain divisive. While some, like economist Paul Krugman and Warren Buffet, have branded Bitcoin "evil" and a "miracle," others, like venture investor Marc Andreessen, have hailed it as "the future internet." Every person who claims that cryptocurrencies are in a bubble is countered by someone who claims that they are the next wave of financial democracy. At their most basic level, they're just the latest fintech fad; at their most intricate one, they're a revolutionary technology that's shaking society's political, economic, and social foundations.

This article will attempt to deconstruct the appeal of cryptocurrencies, their complex underlying technology, and why a completely digital money can have value. It will also look into the unresolved concerns surrounding space, such as their changing accounting.

What Is a Cryptocurrency and Why Use It?:

Cryptocurrencies are digital assets that are protected by cryptography, an encryption method. Cryptocurrencies are typically used to buy and trade goods and services, while some newer cryptocurrencies also serve as a set of rules or duties for its holders, as we'll see later. They have no intrinsic worth because they can't be exchanged for another commodity like gold. They are not regarded legal money and are not issued by a central body, unlike traditional currency.

The use of cryptocurrencies is mostly limited to "early adopters" at this time. To give you a sense of scale, there are over 10 million Bitcoin users worldwide, with almost half of them keeping the cryptocurrency solely for financial purposes. Cryptocurrencies aren't required because government-backed currencies exist.

PSEUDONYMITY (NEAR ANONYMITY):

Purchasing goods and services with cryptocurrency is done online and does not necessitate the revelation of personal information. However, one of the most widespread misconceptions regarding cryptocurrencies is that they ensure entirely anonymous transactions. They truly provide pseudonymity, which is a state of near-anonymity. They let customers to make purchases without having to give retailers any personal information. A transaction, on the other hand, can be traced back to a person or entity in the eyes of law enforcement. Despite growing concerns about identity theft and privacy, cryptocurrency can benefit consumers.

PEER-TO-PEER PURCHASING:

One of the most significant advantages of cryptocurrencies is that they do not require the involvement of a financial institution as an intermediary. The lack of a "middleman" cuts transaction costs for retailers. If the financial system is hacked or the user does not trust the traditional system, there is a huge benefit for consumers. For example, if a bank's database was hacked or corrupted, the bank would have to rely entirely on its backups to restore any lost data. Even if a piece of a cryptocurrency was compromised, the remaining components would still be able to confirm transactions.

Cryptocurrencies, on the other hand, are not totally secure. The Decentralized Autonomous Organization (DAO), a decentralized fund meant to democratize Ethereum funding, was hacked in one of the "biggest digital heists in history."

PROGRAMMABLE, “SMART” CAPABILITIES:

Other perks, such as restricted ownership and voting rights, may be conferred to holders of some cryptocurrencies. A cryptocurrency-funded organization, for example, may integrate voting rights in the cryptocurrency's software code. Fractional ownership interests in physical things such as art or real estate could also be included in cryptocurrency.

Cryptocurrency Technology:

The innovative technological innovation behind cryptocurrencies is responsible for much of their popularity and security benefits.

Blockchain Technology Explained:

Bitcoin and many other cryptocurrencies are built on the blockchain technology. It relies on a public, constantly updating ledger to keep track of all transactions. Blockchain is revolutionary because it allows transactions to be processed without the involvement of a central authority, such as a bank, government, or payment processor. The buyer and seller communicate directly with one another, eliminating the requirement for third-party verification. As a result, it eliminates costly intermediaries and allows for the decentralization of businesses and services.

Another differentiating element of blockchain technology is the ease with which it can be accessed by all parties involved. It's similar to Google Docs in that many parties can simultaneously access the ledger in real time. When you write a check to a buddy today, you and your friend balance your individual checkbooks.

With blockchain, you and your friend would be able to see the same transaction ledger. Because the ledger is not under your control and runs on consensus, both of you must approve and validate the transaction before it can be added to the chain. The chain is likewise protected by encryption, and no one can alter it after it has been created.

From a technical standpoint, the blockchain makes use of consensus techniques, and transactions are stored among numerous nodes rather than on a single server. A node is a machine that connects to the blockchain network and downloads a copy of the blockchain automatically when it joins the network. All nodes must agree in order for a transaction to be legitimate.

Despite the fact that blockchain technology was created as part of Bitcoin in 2009, it may have a wide range of uses. CB Insights, a technology consulting business, has found 27 methods to radically alter processes as diverse as banking, cybersecurity, voting, and higher education. For example, the Swedish government is experimenting with blockchain technology to record land transactions, which are presently recorded on paper and sent via postal mail. According to the World Economic Forum, blockchain technology will store 10% of global GDP by 2027.

Cryptocurrency Mining:

“Mining” refers to a step whereby two things occur: Cryptocurrency transactions are verified and new units of the cryptocurrency are created. Effective mining requires both powerful hardware and software.

When it comes to verification, an individual computer isn’t powerful enough to profitably mine cryptocurrencies because you’d run up your power bill. To address this, miners often join pools to increase collective computing power, allocating miner profits to participants. Groups of miners compete to verify pending transactions and reap the profits, leveraging specialized hardware and cheap electricity. This competition helps to ensure the integrity of transactions.

The largest pools include AntPool, F2Pool, and BitFury, with AntPool alone controlling over 19% of all mining. Most mining pools are located in China, comprising more than 70% of total Bitcoin mining. China manufactures most cryptocurrency mining equipment and leverages the country’s cheap electricity prices.

Cryptocurrency Exchanges:

Cryptocurrency exchanges are online marketplaces where people may buy, sell, and trade cryptocurrencies for other digital or traditional currencies. Cryptocurrencies can be converted into major government-backed currencies, as well as cryptocurrencies into cryptocurrencies. Poloniex, Bitfinex, Kraken, and GDAX are among of the largest exchanges, with daily trading volumes above $100 million (equivalent). Customers must submit confirmation of identity when creating an account, and almost every exchange is subject to federal anti-money laundering rules.

People occasionally employ peer-to-peer transactions instead of exchanges, such as LocalBitcoins, which allow traders to avoid providing personal information. In a peer-to-peer transaction, individuals transfer cryptocurrency through software without the intervention of a third party.

Cryptocurrency Wallets:

Users need cryptocurrency wallets to transmit and receive digital currency and keep track of their balance. Wallets can be hardware or software, with hardware wallets being the more secure option. The Ledger wallet, for example, resembles a USB thumb drive and connects to a computer's USB connection. While a bitcoin account's transactions and balances are recorded on the blockchain, the private key required to sign new transactions is kept in the Ledger wallet. When you try to make a new transaction, your computer requests that the wallet sign it before broadcasting it to the blockchain. Your bitcoins are protected since the private key never leaves the hardware wallet, even if your PC is hacked. Even still, unless backed up, losing the data is a possibility.
For a deeper dive on the technology powering cryptocurrencies, check out this guide from Toptal’s Engineering blog.

Types of Cryptocurrencies:

Currently, there are two types of cryptocurrencies: those that can be used to buy goods and services and those that can be used to create "smart contracts," which are agreements that are enforced by code rather than through the courts. In this section, we'll go through both of them.

"There won't be one supreme digital money," industry analysts predict.

Crypto-pluralism is gaining traction." Despite the fact that Bitcoin and Ethereum hold the majority of the cryptocurrency market share (see Chart 2), several new technologies have emerged and grown rapidly. In fact, there are over 1,000 cryptocurrencies (also known as "altcoins") in circulation right now, with over 600 having market capitalizations of over $100,000.

Bitcoin:

Bitcoin is the most well-known cryptocurrency, having been released in 2009 under the moniker Satoshi Nakamoto. Bitcoin payment is easy, despite the sophisticated technology that underpins it. The buyer and seller use mobile wallets to send and receive payments during a transaction. The number of merchants accepting Bitcoin continues to grow, with names like Microsoft, Expedia, and the sandwich brand Subway joining the list.

Although Bitcoin is largely seen as a trailblazer, it is not without flaws. It can only process seven transactions per second, for example. Visa, on the other hand, processes thousands of transactions each second. Transaction confirmation times have also increased. Bitcoin is not just slower than some of its competitors, but it also has limited functionality. Its market share has dropped from 81 percent in June 2016 to 40 percent nearly two years later. While Bitcoin's price has typically been rising, it dropped abruptly in early 2018, dropping below $8,000, when rumours of stricter regulation from China and South Korea surfaced (to be discussed in a subsequent section). The price of bitcoin has also dropped as a result of the SEC's announcement.

Investing in Cryptocurrencies:

As mentioned previously, cryptocurrency has no intrinsic value—so why all the fuss? People invest in cryptocurrencies for a couple primary reasons. First, there’s a speculative element to cryptocurrency prices which entice investors looking to profit from market value changes. For example, the price of Ether appreciated from $8 per unit in January 2017 to almost $400 six months later as the Ether market became more bullish—only to decline to $200 per unit in July due to technical issues.

Apart from pure speculation, many invest in cryptocurrencies as a geopolitical hedge. During times of political uncertainty, the price of Bitcoin tends to increase. As political and economic uncertainty in Brazil increased in 2015 and 2016, Bitcoin exchange trade increased by 322% while wallet adoption grew by 461%. Bitcoin prices also increased in response to Brexit and Trump victories, and continue to increase alongside Trump’s political controversies.

Factors Affecting Cryptocurrency Prices:

Supply and Demand. The supply of Bitcoin is limited by code in the Bitcoin blockchain. The rate of increase of the supply of Bitcoin decreases until the number of Bitcoin reaches 21 million, which is expected to take place in the year 2140. As Bitcoin adoption increases, the slowing growth in the number of Bitcoin all but assures that the price of Bitcoin will continue to grow.

Bitcoin is not the only cryptocurrency with limits on issuance. The supply of Litecoin will be capped at 84 million units. The purpose of the limit is to provide increased transparency in the money supply, in contrast to government-backed currencies. With the major currencies being created on open source codes, any given individual can determine the supply of the currency and make a judgment about its value accordingly.

Technology Changes. Unlike physical commodities, changes in technology affect cryptocurrency prices. July and August 2017 saw the price of Bitcoin negatively impacted by controversy about altering the underlying technology to improve transaction times. Once the change was completed, the price of Bitcoin shot up—increasing from $2700 to a record high of $4000 in just over two weeks. Conversely, news reports of hacking often lead to price decreases.

Still, given the volatility of this emerging phenomenon, there is a risk of a crash. Many experts have noted that in the event of a cryptocurrency market collapse, that retail investors would suffer the most. According to Mohamed Damak, S&P Global Rating sector lead, “For now, a meaningful drop in cryptocurrencies’ market value would be just a ripple across the financial services industry, still too small to disturb stability or affect the creditworthiness of banks we rate.” Read more here on the bear case of the cryptocurrency market.