The world of digital currencies has exploded over the past four or five years. From the inception of Bitcoin in 2009, cryptocurrencies and related technologies have gone from niche interest to booming international business. Here is a brief guide to the main jargon relating to these digital currencies: what they mean, where they come from, and what the risks of investment are.
What is cryptocurrency?
Cryptocurrency is an umbrella term for a range of truly ‘digital’, cryptographically secured currencies. While real-world currencies have long been traded online, the transactions are handled by centralised banks.
The currencies are both heavily regulated and relatively stable. However, the network of individual transactions and processes involved inevitably leads to administrative costs and delays. As a result, coders and researchers have spent many years attempting to devise online currencies, which were essentially self-regulating and free of traditional supply chains.
Until recently, it was impossible to guarantee both the security and integrity of an entirely digital currency. Cryptocurrencies however are highly secure, and boast a tamper-proof paper trail — meaning that their records can be trusted without oversight by a centralised body.
The most significant developments are their ability to log all previous transactions in impervious vaults known as blocks, and the dilution of risk between multiple decentralised sources. While still a niche interest, cryptocurrencies are coming into wider use around the world.
The security of cryptocurrencies has been cited as both a positive and a drawback. While they leave an inscrutable document of transactions, these are not tied to individuals. As a result, cryptocurrencies have gained a (perhaps unfair) reputation as a way to pay for illicit services.
In spite of this, cryptocurrencies are booming, and businesses are beginning to take them seriously. A round of multi-million and even billion dollar ICOs has seen traditional investors gambling on their success, and mainstream businesses taking cryptocurrency payments.
What is blockchain?
Blockchain is essentially a new means of encrypting transactions, such that they cannot be edited or compromised. The transactions are chopped up and parcelled into separate blocks, which are stored on a number of decentralised nodes within a network. Every node has the key to its own block, but one block cannot be edited without the assent of every other block on the network.
Here’s an example. A traditional bank would store your money in a single vault. While it is difficult to withdraw, there are still several access points which could be compromised. So-called ‘dirty money’ is easier to pass into the system, with no record of where the money came from or what it has been used to purchase. Records can feasibly be altered, falsified, lost, or changed through human error — and if you broke into the bank, you could take the money.
Malicious blockchain transactions are harder to initiate, and the only way to illegally obtain money is to steal an entire ‘digital wallet’. Not only is it almost impossible to compromise a blockchain, it also eliminates the issue of duplicate digital files, which can lead to ‘double spending’, where multiple transactions are submitted by accident. With a blockchain transaction, there is always an impervious and timestamped record of every transaction.
While cryptocurrency is the most advertised and moneyed use of blockchain, it is not the only way the technology can be applied. Businesses and governments around the world are exploring the application of blockchain for other means of secure online data transfer, including medical records and online voting.
What is Bitcoin?
Bitcoin is considered the first – but far from the only – cryptocurrency. It was initially developed in 2009 by a mysterious group or individual, known only as Satoshi Nakamoto.
The code which dictates how Bitcoin works is open source, meaning anyone can edit it and produce their own variants. However, any changes must essentially be ratified by every other Bitcoin user. As a result, all Bitcoin offshoots must retain a set of core principles to be accepted as Bitcoin; otherwise they must form an entirely separate cryptocurrency.
Like all cryptocurrencies, Bitcoin is decentralised, meaning all transaction take place on a peer to peer (P2P) basis, directly between users. Transactions are stored in immutable digital ledgers known as a blockchain. Bitcoins are acquired as payments or by ‘mining’ them using special utilities, although a single computer would take multiple years to mine any significant quantity.
The supply of bitcoins is regulated by their code. A set number are released for mining at any one time, currently one block (equal to 12.5 Bitcoins) every 10 minutes. In 2020 this number will halve, with the process repeating every four years. One Bitcoin is currently worth several thousand dollars, although prices fluctuate wildly based on mining trends and market factors.
Bitcoin is the most widely accepted cryptocurrency at the time of writing, with transactions fielded by over 100,000 merchants. Consumers and businesses are drawn to Bitcoin because of its secure, instantaneous payments, fairness of fees, and security. Similar to physical currencies, Bitcoin payments are untraceable, which is seen as both a benefit and a risk.
What is an Initial Coin Offering (ICO)?
An Initial Coin Offering (ICO) is an unregulated digital funding round, seen as an alternative to traditional venture capital. A prospective blockchain or cryptocurrency technology offers percentage shares known as ‘tokens’, usually in the form of the currency it intends to trade. These are purchased with either legal tender or another cryptocurrency, such as Bitcoins.
Investors buy the currency at a set price, with the assumption that the success of the service will drive up the price of their tokens. This has proven to be true for many ICOs; examples include the cryptocurrency platform Ethereum, where the value of their ‘Ether’ tokens rose from $0.40 to $14 within a matter of weeks.
ICOs are currently seen as risky, but potentially extremely profitable. International regulatory bodies have not yet stepped in to impede the flood of ICOs, although China has taken the bold step of banning them, citing disruption to broader economic and financial stability.
Will cryptocurrencies be the end of banks?
This is very unlikely, at least for the foreseeable future. Traditional banking is still the core of global finances and the means by which investments are being made in cryptocurrencies! The highly regulated and secure world of banking is unlikely to disappear, particularly with the uncertainty around these virtual currencies.
Existing, real-world currencies fluctuate far less than Bitcoin is at present, where hundreds of dollars can disappear off the value of a coin in a single day of trading. The Bitcoin futures market can be lucrative for investors, but Bitcoin and other cryptocurrencies are not yet seen as viable means of payment for most goods and services.
There is a chance that this will change, however, with the currency expected to settle down as supply diminishes in the coming years. The increasing adoption of ‘digital wallets’ such as Apple Pay and Android Pay, as well as online banking, may also mean people are more comfortable with the concept of an entirely digital currency.
For more information on starting a cryptocurrency business, investing in cryptocurrencies, taking cryptocurrencies as payment – or any other banking and formation requirements – don’t hesitate to get in touch.