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Friday, June 02, 2017

The new world of Crypto Currencies

Cryptocurrencies are an alternate to the standard currencies that you are used to seeing. Heard of Bitcoin or Ethereum? These digital currencies are a subset of "alternative currencies", or specifically of "digital currencies".....Read more...

Overview
A cryptocurrency is a digital or virtual currency that uses cryptography for security. The underlying technical system upon which decentralized cryptocurrencies are based was created by the group or individual known as Satoshi Nakamoto.


How is this currency created?
  1. Cryptocurrency is produced by the entire cryptocurrency system collectively, at a rate which is defined when the system is created and which is publicly known. 
  2. In centralized banking and economic systems such as the Federal Reserve System or the Reserve Bank of India, corporate boards or governments control the supply of currency by printing units of fiat money or demanding additions to digital banking ledgers. In case of decentralized cryptocurrency, companies or governments cannot produce new units, and have not so far provided backing for other firms, banks or corporate entities which hold asset value measured in it. 
  3. To produce or "mine" a digital currency, the miners (general public) use a special software tool to solve some typical mathematical problems. And in exchange of that, they are issued a certain number of currency coins. The main idea is to create a new block which gets added to the existing blockchain. Each block contains a list of all the recent transactions happened within the network.  And the blockchain is a ledger of every block created since the very beginning of the network.
  4. The miners play a prominent role in the network. The miners not only produce a coin but they also approve the transactions related to the coins. So more miners means a more secure currency network. For instance, whenever you send a coin, the miners confirm this transaction and record the details in a public ledger. For every transaction that they confirm, they are rewarded with a certain amount of currency coins and a transaction fee. The miner who completes a block first and add it to the network, gets additional rewards in terms of more coins.


How is this currency controlled?
  1. Within cryptocurrency systems, the safety, integrity and balance of ledgers is maintained by a community of mutually distrustful parties referred to as miners. Miners are nothing but members of the general public using their computers to help validate and time-stamp transactions adding them to the ledger in accordance with a particular time-stamping scheme.
  2. The security of cryptocurrency ledgers is based on the assumption that the majority of miners are honestly trying to maintain the ledger, having financial incentive to do so.
  3. Most cryptocurrencies are designed to gradually decrease production of currency, placing an ultimate cap on the total amount of currency that will ever be in circulation, mimicking precious metals.


The BIG positives of Cryptocurrencies
  1. A cryptocurrency is difficult to counterfeit because of its inherent security features. 
  2. A defining feature of a cryptocurrency, and arguably its most endearing allure, is its organic nature; it is not issued by any central authority, rendering it theoretically immune to government interference or manipulation. 


Current State
As of March 2015, hundreds of cryptocurrency specifications exist; most are similar to and derived from the first fully implemented decentralized cryptocurrency, bitcoin.


Bitcoin
  1. The first cryptocurrency to capture the public imagination was Bitcoin, which was launched in 2009 by an individual or group known under the pseudonym Satoshi Nakamoto. 
  2. As of 6 February 2016, there are 15.2 million bitcoins circulation of a capped total of 21 million. That means over 72% of all bitcoins are already in circulation.
  3. Currently there are 25 new bitcoins produced (mined) every 10 minutes. That number halves every four years (next halving is July 2016). This logarithmic scale is supposedly to get more coins into circulation in the early years, and reduce the 'reward' for miners as the value (hopefully) increases over time. 
  4. Bitcoin's success has spawned a number of competing cryptocurrencies, such as Litecoin, Namecoin and PPCoin
  5. Although physical forms of Bitcoin exist, the currency's primary form is data so you trade it online, peer to peer, using wallet software or an online service.

What are the other type of currencies?
Bitcoin was the first one to become commercially viable and popular. The scene is, however, changing pretty fast. There are so many cryptocurrencies being created every year, that it is easy to lose track of what is happening in this highly technical and complex world. Unlike the standard currencies - which are limited to one per country - there is virtually no limit to the number of cryptocurrencies that can be created. This brings in competition as well as extreme volatility to any single currency - since the supply demand situation can drastically change with popularity of a specific currency.

Some of the popular cryptocurrencies and their platforms are as follows:
  1. Ethereum
  2. Ripple
  3. Litecoin
  4. Dash (formerly Darkcoin)
  5. Peercoin
  6. Dogecoin
  7. PrimeCoin
  8. Chinacoin
  9. Ven
  10. Bitcoin


Are you too late?
  1. As of July 2016, there were over 700 digital currencies in existence. Entry into the marketplace is undertaken by so many due to the low cost of entry and opportunity for profit making through the creation of coins. Have a look at the complete list of cryptocurrencies here : List of Cryptocurrencies
  2. Since any given currency gains use value as the number of its users increase, popularity of a certain currency is integral in that currency's success. Imagine this to be like a competition of language usage - the more users use a specific language for communication, the more are its chances of success. English continues to dominate as a global language because of its large inherent base internationally. Therefore, large competitors (such as the most popular cryptocurrency: bitcoin) will attract more new users due to the size of their growing exchange pools and as a result will effectively dominate the market.

Can any techie create a new Cryptocurrency?
Yes. That’s absolutely true. Anyone techie enough could create a new cryptocurrency. But just being a cryptocurrency doesn’t make it something valuable. The thing to understand about cryptocurrencies is that every coin out there solves a problem for a large number of people. The coin that serves more number of people is the one that people are going to invest in.

For example, Bitcoin, the very first cryptocurrency solved the problem with fiat currencies by being a encrypted, anonymous and imitating the behaviour of gold, through it’s mining algorithm, encryption, decentralisation and the blockchain technology.

There can be no other coin exactly like Bitcoin, because no one has use for any.

The second largest coin by value, Ethereum has all the features of Bitcoin, but goes steps ahead by constructing a blockchain based platform on which other applications can be developed, like software on Windows OS or Android. That’s why companies like Microsoft and JPMorgan are investing in it.

Another coin Golem is creating the world’s first decentralised supercomputer.


Ignore these Risks at your own peril
  1. The legal status of cryptocurrencies varies substantially from country to country and is still undefined or changing in many of them. Though bitcoins are not illegal in India, but they are not 100% legal either. There have been instances where government officials have made statements in the parliament against usage of such unregulated cryptocurrencies. 
  2. Moreover, these currencies are completely unregulated by any competent authority, and hence risky. 
  3. As the popularity of and demand for online currencies increases since the inception of bitcoin in 2009, so do concerns that such an unregulated person to person global economy that cryptocurrencies offer may become a threat to society. Concerns abound that these may become tools for anonymous web criminals.
  4. Cryptocurrency networks display a marked lack of regulation that attracts many users who seek decentralized exchange and use of currency, however these very same lack of regulations have been critiqued as potentially enabling criminals who seek to evade taxes and launder money.
  5. Transactions that occur through the use and exchange of these altcoins are independent from formal banking systems, and therefore can make tax evasion simpler for individuals. Since charting taxable income is based upon what a recipient reports to the revenue service, it becomes extremely difficult to account for transactions made using existing cryptocurrencies, a mode of exchange that is complex (and in some cases impossible) to track.
  6. Systems of anonymity that most cryptocurrencies offer can also serve as a simpler means to launder money. Rather than laundering money through an intricate net of financial actors and offshore bank accounts, laundering money through altcoins stands outside institutions and can be achieved through anonymous transactions.
  7. Initially, whenever a miner creates a block, he is rewarded a certain set of currencies. But this number is curtailed every few years. So as the time passes, the mining process is going to be even more difficult and less profitable - thus drawing the miners away to new and more profitable cryptocurrencies - thereby bringing down the price of the mature cryptocurrency - which might not remain that popular.

Some recent frauds
  1. There have been arrests in the United States related to cryptocurrency. A notable case was the arrest of Charlie Shrem, the CEO of BitInstant.
  2. GBL, a Chinese bitcoin trading platform, suddenly shut down on October 26, 2013. Subscribers, unable to log in, lost up to $5 million worth of bitcoin
  3. In February 2014, cryptocurrency made national headlines due to the world's largest bitcoin exchange, Mt. Gox, declaring bankruptcy. The company stated that it had lost nearly $473 million of their customer's bitcoins likely due to theft. This was equivalent to approximately 750,000 bitcoins, or about 7% of all the bitcoins in existence. Due to this crisis, among other news, the price of a bitcoin fell from a high of about $1,160 in December to under $400 in February
  4. On August 24, 2016, a federal judge in Florida certified a class action lawsuit against defunct cryptocurrency exchange Cryptsy and Cryptsy's owner. He is accused of misappropriating millions of dollars of user deposits, destroying evidence, and is believed to have fled to China.


Know what you are trying to do
  1. Firstly, you must understand whether you are an "investor" or a "miner" for a specific cryptocurrency. 
  2. Even if you plan to only invest (and not participate as a miner), it is extremely important that you understand the mining process. If you have not understood it fully - being too technical - it is better to avoid such investment, which is not clearly understood.
  3. In the scenario where you decide to go as an investor in cryptocurrencies, understand what you are trying to do. The mark of a successful crypto investor would be to understand the potential of the coins that would go on to solve problems for the most number of people. Without having such intrinsic value cryptocurrencies would be nothing but a ponzi scheme of mega scale. 
  4. When you are investing in Cryptocurrencies, you are trying to do "currency trading" in some sense. It is just like buying and holding US dollars (or any other currency) in the hope that its value will rise in a particular span of time, wrt your base currency - and then you can sell it at a profit. Now, if you have never done such currency trading, then think again before trying to invest in cryptocurrencies. Instead of a physical, regulated and government controlled currency, you are now trying to invest in an unregulated digital currency - with the hope that it will continue to rise against other currencies. 
  5. As a wise investor, one must invest when one understands the investment clearly - and has a sufficiently strong reason to believe that the value of (currency) investment is likely to go up wrt other currencies in circulation as well as those which are likely to come new in the market.


Summary
While these alternative, decentralized modes of exchange are in the early stages of development, they have the unique potential to challenge existing systems of currency and payments. As of May 2017 total market capitalization of cryptocurrencies is bigger than 66 billion USD and daily volume is larger than 2 billion USD. While all this sounds very lucrative and revolutionary, there are just too many risks and unregulated elements involved in this world of digital cryptocurrencies. As a sane investor, I still do not have enough faith and belief in the fact that my investment (cryptocurrency that I choose e.g. bitcoin or ethereum etc.) will continue to rise. I do not have a mechanism in place to be able to rationally predict the future price of any given cryptocurrency - with reasonable accuracy. I, therefore, decided to avoid this astonishingly lucrative but still "not so well understood" mode of investment. 

Cheers

Manoj Arora
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