Cryptocurrency and Blockchain Technology
What is cryptocurrency?
Cryptocurrency can be thought of as a digital virtual currency secured by encryption techniques that make it impossible to duplicate or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology – a distributed, decentralized, public ledger.
What is blockchain technology?
Blockchain technology is essentially a collection of digital information (“blocks”) stored linearly and chronologically in a public database (“chain”). Blocks store information about the nature and detail of a transaction as well as participants in a transaction. Each block also stores a unique code called a “hash” once the transaction is verified by a network of computers (the transaction is said to be “hashed”) and this unique ID allows it to be distinguished from other blocks that form the blockchain. The blockchain is a public and continually updating (identical) database distributed across each computer in the blockchain network. As such information transparency is maintained without compromising data security as a hacker would need to manipulate every copy of the blockchain on the network to completely alter transaction data. Due to their transparency, decentralization and improved accuracy, blockchain has the potential to be used in a range of applications including cryptocurrency, banking and health care provider data.
Cryptocurrencies have gained popularity due to the removal of a third-party needed to verify transactions. Funds are transferred directly between two parties and verification is snow using computerised techniques such as Proof of Work or Proof of Stake. Removing the involvement of a third party also allows users to avoid high fees charged by financial institutions for wire transfers. Cryptocurrencies are also outside the influence of central banks and governments and tend to be inflation resistant. The semi-anonymous nature of cryptocurrencies does however make them attractive for illegal activities such as money laundering and tax evasion. Furthermore, cryptocurrencies have been criticised by some economists to be highly speculative experiencing high exchange rate volatility.
The Wide World of Cryptocurrency
Surprisingly, cryptocurrency doesn’t only come in the form of Bitcoin. There are quite a number of alternatives, but none have even come close to having recognition of the likes of Bitcoin. Bitcoin is considered by many as the original cryptocurrency since its inception in 2008, and as of today, there are over 18.5 million bitcoins in circulation. Like in any system that has been proven to function well, many alternatives have emerged. New blockchains such as Ethereum offer the same functionalities as Bitcoin but with different protocols, which will change things like transaction time. These blockchains offer their own cryptocurrency which is categorised into two forms: alternative cryptocurrency coins (altcoins) or tokens.
Altcoins refer to any coin that isn’t Bitcoin, like Dogecoin, Peercoin or Litecoin. Think of this as if Bitcoin were gold, the alternatives would be any different types of metal. However, as these alternatives aren’t as well known or accepted, they may experience low liquidity and extremely volatile price changes.
Tokens are cryptocurrencies that don’t have their own blockchain. Instead, they live off another blockchain. In practice, there aren’t any clear differences between tokens and coins. They both have some sort of value. The general consensus is that coins are equivalent to cash whilst tokens are everything else.
The biggest corporate endorsement of cryptocurrency has come in the form of Libra, proposed by Facebook Inc. It is still currently in the beta stage and is projected to be released in 2020. Unlike Bitcoin, Libra will be centralised, pegged to fiat currencies, and governed by demand and supply, making it a more stable asset.
Case Study
Bitcoin was invented in 2008 as the first blockchain-based cryptocurrency and dominates a large 79% of the cryptocurrency market. Launched in 2009, the price of one bitcoin remained a few dollars for years but has developed a very volatile trading history. In fact, in the fall of 2017, the price of bitcoin began to rise and peaked in December at a staggering $20,000 USD. Many deemed it a bubble and indeed, shortly after in 2018, there was a large sell-off of cryptocurrencies. Known as the Bitcoin crash and Great crypto cash, the price of Bitcoin fell by 65 percent from January to February and by September, the MVIS Crypto Compare Digital Assets 10 index had lost 80 percent of its value. Percentage-wise, this bubble burst was larger than that of the Dotcom bubble in 2002. There were a few catalysts that led to the burst of the Bitcoin and cryptocurrency bubble in 2018.
Many governments were starting to place stricter regulations on cryptocurrencies and some countries were looking to ban ICOs (initial coin offering is an unregulated way of funding using cryptocurrency), which defeats the pseudo-anonymous nature of Bitcoin. There was also a suspicion that much of the rise in Bitcoin’s prices was due to coordinated price manipulation revolving between Bitfinex and Tether. Bitfinex was (and still is) a major cryptocurrency exchange and was a go-to platform for traders which also had control over Tether, a cryptocurrency backed by equivalent fiat currencies. It was suspected that Tether was being used to stabilise and manipulate Bitcoin by pushing the price of Bitcoin up when it fell below certain thresholds. There were also concerns that Tether did not hold enough US dollars to back all its digital coins in circulation. In general, there was just a lot of questionable, potentially illegal activity in cryptocurrencies.
As a final note, cryptocurrency investments have continually been characterised as a speculative bubble, with big investors like Warren Buffet constantly slating cryptocurrencies. As an unproductive asset whose value solely relies on its trades, it is extremely volatile, unsuitable for long term investing and too unpredictable to short. In short, don’t invest in cryptocurrency unless you know what you are doing.