Bitcoin

What is a ‘cryptocurrency?’

What if there was a single coin worth thousands of dollars ($16,000 at the time of writing) that wasn’t made of precious metals? In fact, this coin can’t even be held in your hand or put in a bank. This intangible currency is known as Bitcoin; a type of digital currency.

Unlike recognized currency that we use every day, cryptocurrency – specifically bitcoin – are the first decentralized digital currency, as they’re not connected to the government, banks, credit card companies, or any sort of political system. Therefore, it isn’t vulnerable to any of their failures; for example the 2008 economic collapse.

Made usable in 2009 as a peer-to-peer system for online transactions, bitcoin is simulated money used to buy and sell things online and mimics real world limited resources, such as gold and other precious metals. It is a cryptocurrency, which means it is encrypted in a way that prevents it from being copied – hence why bitcoins are worth so much. Every time a bitcoin transaction occurs it is recorded on a blockchain, or ledger. The ledger is encoded onto the actual bitcoin which prevents people from spending the same bitcoin more than once. This helps control overspending as well as fraud. Since all of the transactions are recorded by the bitcoin users on a peer-to-peer system, it is essentially impossible to try and fool the cryptocurrency community.

A look at Bitcoin

One of bitcoin’s first goals was to decentralize control of the currency, meaning that every member of the community must maintain their own account balance and transaction log. What are the consequences? No privacy. In order to keep ledgers accurate, everyone must see everyone else’s ledger and balance. To send money, you tell everyone by broadcasting a transaction message that has the account numbers of both parties and the transaction amount. If the transaction is deemed valid, everyone that is a part of the global bitcoin community updates their ledger.

Since everyone can see everyone else’s account numbers, what’s stopping someone from stealing money, or using another individual’s account numbers to receive money? Embedded in the design of bitcoin is security. Each time you make a transaction, the system requires a user’s signature, which in the digital currency world is more of a math equation than a scribble of ink. Whenever you create a new account number, you receive a private key which allows you to create this digital signature. Each signature is unique to each transaction, so it can’t be copied or reused in the future. As new transactions are created, they are put into a pool of pending transactions which are then sorted into a giant chain that locks in their order, which is known as a transaction chain. A type of lottery system is used when selecting the next transaction from the chain, which allows the participants to select whichever transaction they want and begin to solve the math problem to verify the integrity of the transaction. The first user to solve and find a solution wins and gets to have their transaction selected as the next in the line.

For many, however, cryptocurrency is more than just a currency – it’s a form of revenue. In the same way that other currencies are bought and sold in an open marketplace, one that is decentralized and lightly regulated, Bitcoin and other cryptocurrencies can be bought and sold at any scale, to any buyer, for any price (typically determined by market forces and large exchanges – see itBit and Gemini). These exchanges imitate other markets, honoring terms such as: bid/ask price (the prices at which buyers and sellers are willing to separate with their coin), spread (the difference between those two prices), and scalpers (bitcoin marketplaces that make a profit by playing this spread, or otherwise manipulating the market). Bitcoin, however, is unique in its production. Most currencies are produced by central banks. Bitcoin is mined, and has an ever-increasing volume.

The mining process is how bitcoin is generated. Although the term ‘mining’ is used, nothing is actually broken down or destroyed. In fact, data is created during mining. Mining creates an incentive to support the blockchain process. In return for miners verifying transactions, bundling transactions into blocks, and distributing blocks to nodes (think of nodes as air traffic control, but for bitcoin miners), they are rewarded bitcoins at a collective rate of 75 bitcoins per hour. In order to process all this data, you’re going to need a very powerful computer, a lot of fast internet, and electricity. Those three factors come with incredibly high costs, limiting the capacity to mine bitcoin that one can have without immense amounts of capital. Thus, if one expects to generate revenue from bitcoin, they need to do it other ways than mining. How, you might ask? Buy low, sell high.

Just like any other currency, it can be bought sold in foreign exchange markets. These markets trade currencies against each other, and speculate on the future of global currencies. When one trades a foreign currency, however, they understand that the foreign currency is backed by something “real”. Behind pesos is Mexico, behind the yen is Japan, and the franc has Switzerland. Bitcoin, on the other hand, does not have a basis in the real world economy. Instead, it relies on the adoption across borders to have a firm basis on which it is assigned value. From a business standpoint, this malleability is incredibly valuable. If you accept bitcoin, you no longer have to deal with currency exchange. If you accept it as a currency, that eighth of a bitcoin is an eighth of a bitcoin in Mumbai, Miami, and Morocco. One could hold their bitcoin in their country of trade and liquidate it into their native currency (either in a formal exchange or selling it to an individual at market prices), or turn around and continue to trade in bitcoin. On the contrary, without a stable economy, the market value of bitcoin becomes incredibly volatile. For example, as valued by coindesk, bitcoin fluctuated from a value of $4500 USD to $6500 USD in October, 2017. This volatility could spell disaster to an individual or firm who opts to trade in bitcoin. In the span of a week, their liquid assets could be devalued as much as 15%.

In the same way that bitcoin is disconnected from a single economy, it also seems to be disconnected from the oversight of a single set of laws. In the United States, it has gained a reputation as a currency that is outside of the law. Taking advantage of its anonymity, criminals are able to buy and sell drugs, weapons, or other illegal goods in much of the same way that torrenting was primarily used by media pirates to distribute illegally copied music, television shows, and movies. This is to say that at its core, torrenting is not illegal, but is instead a technology that could be abused to transact illegal business. Bitcoin must be wary of the image it creates in this same manner. If they fall victim to criminals abusing the anonymity of bitcoin to carry out black market business, bitcoin will always be seen as a currency for criminals.

What could be more valuable to a business, however, is the concept of a blockchain. As mentioned previously, blockchain technology is essentially building a checksum against the previous transaction in every new transaction, chaining every buy/sell/trade together. This eliminates the need to build a large security infrastructure to verify every transaction. Instead, the transactions themselves would serve as security devices to ensure illegitimate transactions are not recognized by the general ledger of transactions. Bitcoin builds their blockchain in the mining process, discussed earlier. Since this process is carried out by anonymous clients around the world, bitcoin is essentially trusting this web of nodes to verify against each other to form a valid blockchain. This poses a security risk to what’s known as a 51% attack, where an attacker leverages the distributed and open topography of bitcoin’s blockchain to modify the general ledger of accounts. In order to carry out an attack like this, one would need to control more than half of the volume of mining nodes, distribute an illegitimate blockchain to these nodes, and bring them online. Once more than 51% of the network has an illegitimate version of the blockchain, the legitimate nodes believe they are in the wrong as they are in the minority of nodes carrying their version of the blockchain. The legitimate nodes then modify their own blockchain, adopting the ‘hacked’ blockchain. In such an attack, one would have full control to modify any transaction or wallet balance recorded in the blockchain.

Ethereum is catching up

Ethereum is another cryptocurrency network that relies on decentralized blockchain technology to post transactions and to store value. Like Bitcoin, Ether is created as a result of mining activities that seek to verify transactions on the blockchain. Not only do miners invest their time in verifying and posting transactions on the public ledger, they also create ether, the actual currency that can be transferred and stored. Ethereum is designed to be mined at a specific rate so only a controlled amount of ether is awarded to combat inflation. As demand for the currency increases and more people with serious processing power begin to mine, there are more players in the game with the same amount of coins to give away. For this reason, mining for Ethereum is becoming less profitable. Not only are there more people mining, but the mathematical problems that must be solved are becoming more difficult in order to keep the amount of ether stable. Making a profit by mining Ethereum is currently easier than with Bitcoin, but that could change soon.

A main difference between Ethereum and Bitcoin is that Ethereum isn’t just a network for digital cryptocurrency; it is a foundation for Smart Contracts. Smart contracts are self executing contracts with the terms of agreement written directly into the code. The code is then stored in the blockchain network. Ethereum can be seen as a network that combines its own blockchain and Smart Contracts to allow for “if-then-else” logic in highly visible and verifiable transactions. We are only now seeing beta applications for this in the business world, but the possibilities of what this system can do is exciting. For example, the Ethereum Blockchain can be used to increase visibility and secure transactions within the supply chain of an organization. It can apply its “if-then-else” Smart Contract programs to make sure that payments are made only when shipments are received. This would eliminate the need of an operations manager needing to verify the status of the shipment and all of the information needed for bill of lading paperwork. This technology is still in beta with the “Supply Chain Tracking System” framework being one of the applications. Once this tech is implemented, firms could boast a competitive advantage by making the transactions that occur within their operations more agile, more transparent, and automated. The Ethereum Blockchain lays the groundwork for companies to develop applications that help them have sustainable profits.

Cryptocurrency in Business

According to Maksim Balashevich -the CEO and founder of the German company “Santiment,” which collects and sells live markets data feeds to crypto traders- cryptocurrency markets follow the Elliot Wave theory. The Elliot Wave theory is a form of technical analysis used to analyze financial market cycles and forecast trends based on extremes in investor psychology. The theory identifies two periods that drive prices; mass pessimism and euphoria. Based on this theory, Balashevich predicted that the altcoin industry would increase to over $6 billion in market capitalization. According to Forbes, not only has this forecast been fulfilled, but the combined market cap is currently in excess of $8.4 billion. Balashevich attributes the massive growth in crypto markets to three factors, fear, greed, and ignorance, saying altcoins exhibit particular “sensitivity to collective emotional impact as participants fear potentially missing out on rapid gains and extreme risks.” This is seen when the price of an altcoin falls, and consumers panic and sell their coins. Alternatively, when the price rises, a flood of greedy new consumers enters the market, fearing they will miss out. As cryptocurrency becomes more mainstream, the price is expected to skyrocket. Two drivers pushing cryptocurrency into the mainstream conscious are smart contract awareness and anonymous blockchain technologies. These two areas are set to benefit the most from the next wave of investment, as other altcoins seek to innovate where bitcoin has failed.

The anonymous blockchain is appealing to consumers because it offers increased security and transparency. Initial Coin Offerings (ICOs) are by far the most democratic and transparent way to fund modern companies. However, Balashevich predicts that establishment of open source environments will be needed to get the most out of ICOs. Blockchain is more secure than traditional firewalls thanks to decentralization. With a global network of computers working jointly to manage the database of bitcoin transactions, it is far more difficult to tamper with transactions or data. If traditional security methods are a wall around a silo, then blockchain is a town with each house containing some of the data, and new houses constantly being built. This makes it much more difficult to hack, and the effort required does not guarantee significant rewards. Blockchain also means that bitcoin is managed by the network of individuals, rather than a central authority, with each transaction verified by the entire network simultaneously. This eliminates fraud, as cryptocurrencies cannot be counterfeited or reversed arbitrarily by the sender (as with credit card charge backs). Another security benefit of decentralized currency is that it cannot be taken away by a central government. In March 2013 in Cyprus, the Central Bank tried to take back uninsured deposits larger than $100,000 and a percentage of deposits below that figure in order to recapitalize itself. With bitcoin and other altcoins, no central authority has control, so a bank cannot seize your funds. In addition to banks, there are also no electronic cash systems in which accounts aren’t owned or controlled by another party. With services like PayPal, the company can freeze an account and assets without consulting the consumer. Cryptocurrency eliminates this with individual cryptocurrency addresses unique to each consumer that cannot be taken away.

Cryptocurrency transactions are also more secure because the middleman is removed. When purchasing property, third parties are typically required (lawyers, notaries, credit card companies). These third parties can cause delays and charge fees. Bitcoin’s blockchain acts as a large property rights database, so contracts can be designed for immediate settlement and assets transferred at a fraction of the cost. Currently when a merchant wants to sell a product, the consumer must provide a credit card. The funds are then “pulled” out of the customer’s account by the merchant. This method is rife with fraud, and exposes the customer to risk of identity theft. Using cryptocurrency, the customer can “push” the funds to the merchant without revealing any other personal information. Not requiring a middleman is not only more secure, but opens up the market to those who do not have access to traditional exchange systems. There are between 2.0 and 2.5 billion individuals who do not have access to traditional banking, but do have access to mobile phones or the internet. These individuals can benefit greatly from cryptocurrency, as recognized by Kenya’s M-PESA mobile money transfer service announcing a bitcoin device. In response to this, one in three Kenyans now owns a bitcoin wallet.

As consumers become aware of the increased security, transparency, ease of access, and reduction of external fees associated with cryptocurrencies, the demand for acceptance of cryptocurrency transactions will increase. Some businesses have already begun to move in this direction. Cyprus’ University of Nicosia is the first accredited university in the world to accept bitcoin for tuition and fees, and also offers a Masters Degree in Digital Currency. Business owners should expect cryptocurrency transactions to become commonplace. Whether compensating employees, creating smart contracts with suppliers, or accepting payment for merchandise, the ability to accept altcoins and navigate their platforms will be pivotal in the marketplace.

Try it yourself

Look online for different bitcoin exchange websites/different crypto currencies/bitcoin transactions. How many different crypto currencies/exchange sites can you find? How many unconfirmed Blockchain/Bitcoin transactions in progress do you see? What does this mean for crypto currencies?
Would you ever consider getting into Bitcoin or another Cryptocurrency? Would you try mining Bitcoin? Why or why not?
How has the exchange rate on various crypto currencies changed over the past several years? What are forces behind these changes? What does this mean for the future of regular currencies?
Bitcoin transactions continue to rise, particularly due to its standardized value. Explore Bitcoin ATMS or the usage of Bitcoin in places outside the US. What is the criteria/medium for obtaining or mining crypto currencies?
How (if at all) will cryptocurrencies affect transactions, savings, accounting practices?
What allows Bitcoin to prosper so much in today’s society? Why now and not earlier? How do you think crypto currencies will change?
Go to Bitcoin’s website and watch the video on the homepage. Select ‘Get started’ once you are finished, and observe all the different avenues one can get take to begin using Bitcoin.
Does your company have any involvement with Altcoin or block-chain? Work with your employer and explore how either of these could improve your company, or its records.