Cryptocurrency - update

Last updated: Mar 15, 2021

The price of Bitcoin rose to a record high $60,000 (15th March, 2021), up 35% since the announcement that Elon Musk's Tesla car firm purchased around $1.5bn of Bitcoin in January 2021. Tesla announced that this was a move designed to build up its reserve of digital assets. This also signals that Tesla are likely to accept Bitcoin as a form of payment for its cars. The purchase of Bitcoins may well provide Tesla with a 'first mover advantage' as private companies are expected to follow suit and increase their invest in digital assets.


Bitcoin value in USD

Cryptocurrency- the future of money

Ever scratched your head at lingo like “Stay strong and HODL”, “It is mooning”, or “There must be a whale behind this” while scrolling through various social media sites or you are in a party and someone starts a conversation on Coins and Cryptocurrencies and you are left feeling inadequate, not knowing how to respond.

If you are wondering what all the hype about Cryptocurrencies (or Crypto for short) is, let me tell you. Fret not, because by the time you are done with this article, you will not only learn about Cryptocurrencies but also hold a party conversation and participate in the chat threads on social media sites.

What is a Cryptocurrency?

Cryptocurrency is a digital currency (an asset used as a medium of exchange) where records of individual currency ownership and transactions are stored on ledgers on a peer to peer network secured by encryptions.

Origin:

David Chaum, in a paper titled “Blind Signatures for Untraceable Payments” published by the Department of Computer Science, University of California in 1982[1] introduced a concept of an untraceable digital payment system which would allow transaction in digital currencies without any third party (issuing bank, government etc.) knowing the details of the transacting individuals.

Normally, the currency of a country is issued, managed and controlled by the Central Bank of that country. A need was felt for a currency that was decentralised with the advantages of lower transaction costs (as intermediaries like banks are eliminated), increased transparency on transactions and exponentially increased difficulty in hacking due to the decentralized nature of the transactions.

Since the introduction of the original concept, individuals and institutions continued to work on developing such a system but were faced with a major road block: Double Spending.

Let's say you have a $20 (or Pound/Rupee etc) note issued by the Central Bank in your country which comes with a unique identification serial number. Once you give away that note in exchange for a purchase, you cannot again spend the same note since you don’t have it anymore. Counterfeiting can be done but it is extremely difficult. However, with digital currency, in its infancy, it was easy to make a copy of your digital currency token and spend it multiple times. This problem is known as Double Spending, and would cause untold problems.

double spending problem

Arise: Blockchain

Digital currency adoption would not proceed until this problem was solved. In 2009, an individual or a group of people under the pseudonym “Satoshi Nakamoto” published a paper titled Bitcoin: A peer to peer Electronic Cash System[2] introducing Blockchain to the world. A Blockchain consists of a series of records called blocks that are linked using cryptographic methods (secret hashes). A hash is a function that converts input of letters and numbers into an encrypted output of a fixed length.

A Blockchain in its bare essence is a ledger.

Here is a Blockchain ledger:

Blockchain ledger example

Each transaction is recorded with timestamps and hashed into an ongoing chain of hash based proof of work which forms a record that cannot be undone without redoing the whole thing. The longest chain not only serves as a proof of sequence of events but also proof that it came from the largest pool of CPU power.

Simply put, Blockchain processes and records transactions using the processing power of its connected network of individual computers spread across the globe. In return for providing the computing power, those providing the power are rewarded with a Cryptocurrency called Bitcoin on successful creation of a block. This action is known as mining.

How a block is created

Blockchain ledger example

Mining

Miners serve the role of auditors who provide their computing power to ensure authenticity of transactions done on the Blockchain. They also serve the role of introducing new currency into circulation. Each block created releases Bitcoin in the system. The total number of Bitcoin in the entire Blockchain system is limited to 21 million[3]. This was designed into the source code. Also the amount of Bitcoin released into the system is halved every 4 years. This has now made mining extremely difficult and power intensive. From mining multiple Bitcoins a day using basic home CPU, it now requires huge farms of high power graphic cards to mine the same amount. This has led to environmental concerns across nations who have now started to put restrictions on mining.

As per Forbes article dated July 2019[4], Bitcoin mining devours more electricity than Switzerland. If Bitcoin were a nation it would be the 41st most energy demanding nation on the planet. On the bright side, there are over 18.5 million Bitcoins already mined and in circulation[5] thus making the mining costs not worth the Bitcoin generated.

Advancements in Blockchain and other Cryptocurrencies

Eventually, with the introduction of different hashing techniques and advancement in technologies, the world saw the introduction of new Blockchains with their own Cryptocurrencies or altcoins as they are called. They range from large serious players like Ethereum to joke coins known as dogecoins. Here are some of them:

Blockchain ledger example

It also happens that sometimes blocks form at the same time (or the same height as they call it). Since only one single chain is allowed, one of the block has to be resolved while the other one vanishes. When that is not possible, a fork is formed. A fork is a split in the Blockchain creating a new series of blocks brought on either by change in protocol or to reverse effects of hacking or catastrophic bugs. Bitcoin has several forks like Bitcoin XT, Bitcoin Core and so on. Forks have also formed in Ethereum.

Use of Cryptocurrencies

Bitcoins were initially used on the dark web for drug transactions. The untraceable nature of the transaction made it very appealing for black market activities. The first known commercial transaction of Bitcoin was in 2010 when programmer Laszlo Hanyecz bought two Papa John’s Pizza for 10,000 Bitcoins[6]. The worth of those Bitcoins is 80 million USD today - talk about an expensive pizza!

Bitcoin’s Price History

Ethereum’s Price History

As time progressed, people and businesses warmed up to Cryptocurrencies and the number of businesses accepting Bitcoins has gone multifold from 4876 in 2014 to 15558 in 2019. (Source: Bitcoin Technology Market Report by Mordor Intelligence).

Such has been the rise of Cryptocurrencies that companies and even countries have come up with their own Cryptocurrencies. Facebook came up with its own Cryptocurrency called Libra.

Not to be left far behind, Venezuela came up with its Crypto called Petro for its oil transactions.

Online Casinos and shopping websites have also begun accepting Bitcoins and other Cryptocurrencies. Shopify was in the news recently for announcing that it will be accepting Cryptocurrency payments[7].

How to transact in Cryptocurrencies?

Cryptocurrencies can be bought or sold on designated exchanges. They are stored in digital wallets where the token hash is stored along with encryptions. For additional safety, hardware wallets are also available which work like hard disk storage devices. Transactions happen online but the tokens are stored on the physical device disconnected from the internet.

The rise of Cryptocurrencies: Effect on Formal Economy

Wider acceptability of a universal currency diminishes the value of the local currency. Currencies and foreign exchange rates depend on demand and supply amongst other factors. In a formal economy, a Central bank controls currency flow to manage the Impossible Trinity (Foreign exchange, Interest rates, Inflation). Each country’s central bank has its own unique mandate to boost one or more of the three and that is done by controlling money flows. With a decentralized universal currency, managing these three parameters is next to impossible leading to unimaginable effects on local economies.

Like any normal currency, a limit on the amount helps control inflation. Unabated printing of money leads to hyperinflation and eventual destruction of economy as seen recently in Venezuela and Zimbabwe. While Crypto protocols so far have limited the amount that the system will release, it is possible and relatively easy to change protocols to allow for mining of more Crypto which will lead to inflationary situations and diminishing value of the currency.

From a tax point of view, countries face a major dilemma. All countries rely on tax income for their expenditures. It is more crucial in developing countries who are often running a fiscal deficit to fuel their growth. A formal economy is designed to keep track of transactions for easy tax collection and audits. Anonymous transactions put a spanner in the works. Without tax collections, economies will grind to a halt. This is also one reason why countries won’t allow Crypto transactions as liberally as is expected. There is massive resistance from world governments against acceptance of privately created Cryptocurrencies.

Everything is not always rosy

Cryptocurrency users have been plagued with several issues after gaining widespread acceptance. Hacking is a major issue for users as coins are stolen from their wallets by hackers[8]. Even exchanges have not been spared and there have been several instances of exchanges being hacked into and millions of dollar worth of Cryptocurrencies stolen[9][10].

Scams are generally the first negative outcome of any new technology especially ones related to finance, and Cryptocurrencies are no exception. According to a Chainanalysis report dated Jan 2020, scammers managed to dupe their victims of 4.3 billion USD in 2019. A lot of them were Ponzi schemes like OneCoin and PlusToken since the technology is relatively new and people are encouraged to believe it to be a “get rich quick” scheme. Another way that people have been scammed is through ransomware. WannaCry in 2017 was a well-publicized global ransomware attack. In it, the ransomware would infect your computer and lock the files. One had to make a payment in Bitcoin Cryptocurrency to purchase the key to unlock the files.

From a legal point of view, there are multiple ramifications of the unique anonymous nature of Cryptocurrency transactions. Drug trade has scaled up massively with law enforcement agencies unable to track money flow[11]. The internet is full of stories of hit jobs, human trafficking and any and every possible illegal transaction being done in Bitcoin on the dark web.

Finally from a country point of view, a lot of countries across the world have expressed their concerns about national security in relation to Crypto Currency. A major concern is with money laundering and money flow for terrorist activity. There have even been bans by some countries on Cryptocurrency trading[13] like India & China.

So what do you do when you can’t fight them? You join them. Countries have now decided to issue their own Cryptocurrencies in order to regulate them better and to introduce them to the formal economy.

Here are a few countries who have announced their Cryptocurrencies:

Even countries like USA, India and China who were initially against Cryptocurrencies have joined the bandwagon and announced their own Cryptocurrencies as well. India has even lifted its initial ban on Cryptocurrencies[14] and now allows for all Cryptocurrency transactions.

What it means for the future?

Cryptocurrencies are here to stay. Widespread availability and acceptance of the major ones like Bitcoin and Ethereum has ensured their survival. Anonymity of transactions ensures they will always be in demand as long as that anonymity is ensured. As with multiple currencies, the weak and unknown ones might disappear as their acceptance reduces.

One hindrance to the acceptability of Crypto is with the older generation who may not be comfortable with digital transactions. This problem may be self-solving as newer generations get savvier with technology and digital transactions become increasingly accepted.

One trend that is still not clear to many, and to advocates of various Crypto is that several countries are coming out with their own Cryptocurrencies. They cheer the move and declare it to be one more step towards Cryptocurrency acceptability and growth. What they don’t realise however is that once a country comes out with its own Crypto, it is likely to automatically delegitimise any other, except its own. The effect of such is that it will replace the local paper currency with a digital one. Eventually the Crypto version of the country’s currency will be brought under Central Bank regulation and it will either merge paper with Crypto running a dual system or simply stop paper currency.

The ambition of Cryptocurrencies to replace world currencies with a decentralized ones will eventually lead to one that is centralized again and run by various countries for their individual mandates. What goes around comes around and this brings the whole story full circle.

That, however, will take time - generations in fact. In the meantime, the near term future is not only bright but infused with optimism. Bitcoin and Ethereum have begun their move upwards as is evident from the price charts and from the strength of their trends, with new highs around the corner.


[4] site-www.forbes.com/sites/niallmccarthy/2019/07/08/bitcoin-devours-more-electricity-than-switzerland-infographic/?sh=593f6be421c0

facebook link logo facebook link logo facebook link logo facebook link logo facebook link logo google classroom link logo