Understanding Cryptocurrencies

The Money of the Future

Arvind Matharu

• Publisher: Business Expert Press
• Year: 2018
• ISBN:
  9781948580663
• Topic: Business
• Subtopic: Trading
• Index: Business

The book intends to provide a high level overview of cryptocurrencies to a new enthusiast by using layman language and limiting many of the technical aspects, providing a very condensed version of this vast development of digital currencies.

Blockchain is the new revolution after the Internet that is going to change how we do business today. Cryptocurrencies are the money of the future. These two statements are a positive affirmation from many corners around the world.

The author provides a balance of introduction and depth regarding blockchain, hot cryptocurrencies, and their comparisons. Bitcoin, being the pioneer, is discussed in greater detail. The reader will gain the basic idea of bitcoin mining, trading, and investing. With special interest in the various usages of blockchain and interest on traditional banking systems are also discussed.

CHAPTER 1

Introduction to Cryptocurrency

What Is Cryptocurrency?

Cryptocurrency is the money of the future. In the current digital era, digital money was already overdue, which makes the arrival of cryptocurrency during the past 9 years as no surprise. Cryptocurrency is a digital or virtual currency that is still in its embryonic stage and has been gaining lots of attention worldwide. It has not replaced the government-issued money yet due to various factors inherent to it. However, the technological advances are filling the gaps and overcoming the current obstacles slowly and steadily.

Remember when the plastic money, that is, credit cards were introduced? Everyone would have thought that time that how a plastic card may be used instead of paper currency. And today, it is unimaginable for a common person to be without credit cards. The initial resistance was overcome by taking care of challenges related to plastic money. On that note, the day is not far when cryptocurrency may remove the need of banks.

The reasons for the attention gained by cryptocurrencies during the past 10 years are multifold. First, it does not exist in a tangible or physical form. It is not a government-issued currency printable on paper. Cryptography is used to ensure its attributes to be used as a currency by which a cryptocurrency can be used as a medium of exchange and perform monetary transactions, in the same way as the printable bills can be used. Cryptography is the science by which intelligible data or information can be scrambled or concealed by using encryption techniques. Encryption is done from the sender side to make the intelligible data into an unintelligible one. Whereas, on the receiver side, the decryption takes place to bring the encrypted data back into an intelligible form again. The processes of encryption and decryption take place via an algorithm. An algorithm stands for a set of instructions in the world of computing. These instructions in a computer programming language perform a specific task.

Cryptocompare.com depicts the process of cryptography in the following diagram:

Cryptocurrency derives its name from two words, namely, cryptography and currency; a digital currency controlled by cryptography. A cryptocurrency has no inherent value; however, its value comes from the people’s belief in it.

Definitions and Attributes of Cryptocurrency

The Merriam-Webster dictionary defines cryptocurrency as follows:

any form of currency that only exists digitally, that usually has no central issuing or regulating authority but instead uses a decentralized system to record transactions and manage the issuance of new units, and that relies on cryptography to prevent counterfeiting and fraudulent transactions.

The definition from online Oxford dictionary is as follows:

A digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a central bank.

From these two definitions, the following conclusions can be drawn:

1. Cryptography manages the cryptocurrency by using encryption and decryption techniques.

2. Cryptocurrency is a digital asset that can be used in place of a printable currency toward monetary transactions.

3. There is no central issuing or regulating authority.

4. A decentralized method is used to verify, record, and monitor all the transactions.

5. The decentralized system manages the issuance of new units; those are generally limited in number by the governing algorithm.

Considering cryptocurrency has no central or regulating authority; its value is defined by consensus from people believing in it. It is a borderless currency with which international payments can be made cheaper than conventional currencies. A conventional currency such as a U.S. dollar is governed by a central bank that defines its value represented by printable bills, coins, drafts, cheques, or other similar banking instruments. The value of cryptocurrency comes from an encrypted code that is difficult to reproduce, making it scarce and limiting its numbers, unless the creator of cryptocurrency decides to change the underlying algorithm to create more units. Being a bank-free or border-free currency, cryptocurrency offers an alternative to conventional currencies.

The basic unit of a cryptocurrency is called a coin that is an encrypted code consisting of a string of characters. A coin is merely an entry in a database available publicly via a blockchain that can be called as a distributed ledger.

A blockchain validates the coins of cryptocurrency. A blockchain is certainly a revolution that is here how we are going to see the world in the coming decades. The blockchain is already in the process of making its place as something much bigger than the Internet itself.

What Are Its Origins?

Bitcoin is generally accepted as the first cryptocurrency that came in the form of open-source code in 2009. As the source code is openly available, there are thousands of variants of the original bitcoin available today. Such variants are also called alternative coins (altcoins) that stand for alternative digital currencies.

In October 2008, Satoshi Nakamoto published a paper titled Bitcoin: A Peer-to-Peer Electronic Cash System. The identity of Satoshi Nakamoto is still unknown, whether Satoshi is an individual or a group of individuals. In this white paper, Satoshi Nakamoto created and developed bitcoin’s original reference implementation. Using the blockchain database, Satoshi released the very first bitcoins in January 2009. Satoshi mined the genesis block of bitcoin, also known as block 0 (zero). Mining is a process by which individuals verify and record the transactions. This set of transactions is called a block, which gets added on top of the past blocks. Altogether, this chain of blocks (of transactions) is known as a blockchain. Miners doing mining are rewarded for their efforts. It is interesting to know that the genesis block had a reward of 50 bitcoins. The genesis block has a timestamp of 18:15:05 GMT on January 3, 2009.

As words such as cryptocurrency, blockchain, bitcoin, and mining will be commonly used throughout this book, these topics will be dealt in more detail in the upcoming chapters.

Why Is It Important to Know About Cryptocurrency?

Cryptocurrencies have seen a significant growth in 2017. There have been wild swings in their value, making these very risky and volatile, due to which these get labeled as a bubble as well. It is very unpredictable when the price continues to rise, and then falls suddenly, only to come back with a newer peak, and so on. People look at cryptocurrencies with various perspectives. Some look at it to perform actual monetary transactions. Some look at it as miners to get rewarded. Some look at it as an investment where retail and institutional investors continue to increase with time. Lot new interest from various other perspectives make cryptocurrency a very interesting digital asset.

What Is the Legal Status of Cryptocurrencies?

The legal status of cryptocurrencies is under radar by most of the countries. The stand varies from country to country. Though their usage may not be illegal and can be used as a medium of exchange in some countries, some countries have taken a hard step to ban or restrict. Countries such as Bolivia, Ecuador, India, Nigeria have declared public statements declaring such restrictions.

Bitcoin being the most popular one, the U.S. Treasury classified it as a convertible virtual currency, and taxed it as a property. Governments worldwide are taking steps to include the transactions using cryptocurrencies into their taxation system.

Is This Not Used for Anonymous Transactions for Illegal Purposes?

The dark side of cryptocurrencies is related to the common notion that these are used for illegal activities, especially on the Dark Web. This leads to continuous rise in the price of the coins. It is unfortunate that more than a quarter of bitcoin usage is linked with criminal activities due to its anonymity. It is important to understand that, just because cryptocurrencies are used by criminals, it should not lead to the conclusion of making cryptocurrency illegal. With the technological advances, and appropriate legislations and controls, it can be better used as a valid and reliable form of currency, making it the future of the money.

CHAPTER 2

Blockchain Is the New Revolution After the Internet

What Is a Blockchain?

The blockchain is the brainchild of Satoshi Nakamoto as referenced in Chapter 1. Satoshi used two separate words, block and chain. With time, the two words have combined into a single word blockchain. Originally, blockchain was devised for bitcoin (cryptocurrency), but it has evolved much bigger since then. A blockchain can be viewed as a publicly available digital ledger that contains a record of the transactions. This kind of database is accessible to anyone, and there is no centralized version of it. In other words, a blockchain is a decentralized technology. It is important to understand that the blockchain technology is not necessarily for financial transactions only, and it can be used wherever any uniqueness of records is required.

A blockchain is presented by Blockgeeks.com in the diagram shown on page 8.

The users of the network participate in the blockchain. This user-to-user (peer-to-peer) participation makes the blockchain centralized. This kind of recordkeeping can be extended to any business domain. The full potential of application of the blockchain technology is still under investigation. The most attractive part of the blockchain is removal of the intermediary party between two users. Currently, finances and identity management are on the top of the applications of a blockchain.

The white paper by Satoshi refers to blockchain as follows:

…system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party…

Currently, most of the systems on the Internet require a third party that blockchain tends to eliminate altogether. This elimination of third-party intermediaries is certainly a threat to the conventional (and expensive) methods.

Accordingly, a blockchain can be considered to have the following attributes:

1. Consider this as a digital ledger available publicly.

2. Records in this shared ledger use encryption and decryption.

3. Timestamped creation, validation, verification, and monitoring of the transactions in a decentralized manner.

It should be noted that a blockchain does not have to exist publicly. In that case, the nodes exist in a private network with access to the distributed ledger. A blockchain is a continuously growing list of records, called blocks, linked using cryptography. A block contains a group or batch of valid transactions. A block in the blockchain has the cryptographic hash of the previous block in the blockchain. A cryptographic hash is equivalent to a digital fingerprint. This linking of the adjacent blocks forming the chain resists the modification of the data contained within the blockchain. The authentication of the records takes place with the mass collaboration by the users. This makes the blockchain a secure database where the records become almost unalterable. Conventional centralized databases have their own challenges related to data integrity and security at very high costs to the businesses that get eliminated with the use of the blockchain technology.

The data integrity of the records is an iterative process tracing back to the genesis block. Consider the genesis block as the very first block of the blockchain, also called as block 0. As mentioned earlier, cryptocurrencies are based on the open-source code that anyone may update to create newer digital currencies. A genesis block is generally hardcoded in the software, that is, already present in the base software. This is the only time, where the genesis block is not linked with any previous block via cryptographic hashes. A blockchain can be visualized as a vertical stack that is ever growing with new blocks, where every new block is back-linked with the previous one. The first block is base of this vertical stack. The latest block is called the top block. The distance between two blocks is called height.

Structure of a Blockchain

A blockchain is a chain of blocks, where a block contains a batch of transactions. A block a...