What is Cryptocurrency and Blockchain Technology?

Discuss about the Cyrptocurrency for Handbook of Digital Currency.

Cryptocurrency is a digital currency that is used as an exchange medium. It is built on top of cryptography, a technology designed to secure and validate transactions (Narayanan 2016). This technology also controls the cryptocurrency units created. In other words, cryptocurrency is limited database entries that cannot be changed.

In the recent past, various cryptocurrencies have emerged and gained popularity. Among these is Bitcoin, one of the most popular cryptocurrencies that has the largest market share. These currencies operate in a decentralized network where all participants have to do their tasks. This is performed through blockchain – a ledger containing all transactions that have occurred within the network. This ledger is public and can be seen by everyone.

Transactions are files which contains public keys of both the sender and recipient as well as the number of coins sent (Surowiecki 2011 pp.106). The sender has to sign off a transaction with his/her private key. This is the basic concept of cryptography. Once a transaction is signed, it is broadcasted on the network but it has to be confirmed first. This is done by miners who confirm a transaction by solving a puzzle. They verify transactions and send them across the decentralized network. These transactions are added to databases of all nodes within the network. When a transaction is completed, it is irreversible and miners get a reward.

Cryptocurrency network can only work is all participants agree to the validity of transactions and balances (Hileman 2017). If any network node does not conform to the others, the network breaks. However, there are pre-built rules in the network that prevent such scenarios from occurring. A consensus among participants is guaranteed by the strong cryptography used in the network which makes third parties completely irrelevant.

Blockchain technology is the drive behind the growth and success of cryptocurrencies. Essentially, it’s a public database with verified and encrypted entries (Crosby 2016 pp.6). It provides a secure and effective way of creating hack-proof activity logs. This technology has come a long way since its entry into the public back in 2005. It was introduced by Wei Dai who proposed the idea of creating money through puzzle solving and consensus in a decentralized network. However, the proposal was not effectively implemented. Later, Hal Finney came up with a centralized cryptocurrency concept based on Wei’s idea and computational puzzles (Zheng 2016).

How does the Blockchain Technology operate?

Blockchain gained recognition when Satoshi Nakamoto wrote a whitepaper outlining a protocol for creating a decentralized currency. He emphasized on operating it in a network based on absolute consensus among participants instead of being controlled by a set of individuals (Wright 2015). Within a few years, the idea became an economic experiment attracting many experts. This led to the emergence of cryptocurrencies such as bitcoin whose value grew rapidly as they gained interest.

While Bitcoin became popular, it had various issues such as wasteful mining hardware which undermined its effectiveness. In 2012, Vitalik proposed an open platform where developers could build a distributed application for blockchain (Buterin 2013). This was the start of Ethereum platform which became wildly popular among entrepreneurs. However, its goals have been tough to meet as its market cap increased rapidly. However, there are projects being experimented that could be integrated into the network in the future to overcome current limitations faced.

In the recent past, newer blockchain technologies have emerged to improve the capabilities of cryptocurrency networks and overcome hurdles faced. IOTA is one of the new blockchain technology that was designed as cryptocurrency platform for the Internet of Things (IoT). It incorporates massive changes to the fundamental blockchain concepts allowing zero-fee transactions and supporting a robust verification process that can resolve scalability problems faced by many cryptocurrency networks. There are some companies that have blockchain technology for specific purposes. QTUM has leveraged Bitcoin’s and Ethereum’s infrastructure to craft a business-centric blockchain. Such kind of development has pushed blockchain technology beyond expectations empowering cryptocurrency.

Cryptocurrency has disrupted financial services industry as more people used it for buying goods and investing. When Bitcoin and other cryptocurrency coins first emerged, very few merchants accepted them. Nowadays, the situation has changed as they’ve become a popular medium exchange. Currently, there are many merchants that accept Bitcoin. They range from e-commerce stores to groceries. Many people are using bitcoin to pay for products and even degrees (Chuen 2015). Other cryptocurrencies such as Ethereum and Ripple aren’t as widely used as Bitcoin but this could change in the near future as more firms start accepting them. Apple has led the way by allowing App Store users to pay with different cryptocurrencies. Also, users have an option to convert their coins for bitcoins. Furthermore, there are websites that sell gift cards in exchange for cryptocurrencies. With gift cards, people can buy anything they need with their digital currencies.

Features of Cryptocurrency

Given the massive popularity of cryptocurrencies, merchants have sought to tap into this opportunity. Many are accepting cryptocurrencies from their customers as a form of payment. With the rising of crypto-ATMs in different parts of the world, more customers are using digital currencies for their purchases (Rick 2014). Businesses are leveraging various services to accept payments. CoinPayments is a great example of one of the services helping businesses to process various cryptocurrencies. In some countries, several cryptocurrencies are legally recognized as convertible virtual currency. This essentially means that payments in form of cryptocurrencies are the same as cash payments.

In the recent past, cryptocurrencies have become one of the best investment opportunity for entrepreneurs. With the entry of the digital currencies into the forex trade market, many people have made investments. Bitcoin is one of the most popular cryptocurrencies whose value shot from $800 in 2016 to over $10,000 in Late 2017 (Caporale 2018). Ethereum which is considered to the second most popular digital currency also recorded a significant increase in value. Since 2016, its value increased by over 2000 percent (Bhosale 2018). The value of other cryptocurrencies such as Litecoin and Ripple has also increased attracting many people to the cryptocurrency forex trade market.

It is worth noting that while cryptocurrencies are high-risk investments due to their volatility, many people are still trading them. They are attractive to many particularly due to few or no regulations which make them more lucrative than fiat currencies. There are also numerous exchange sites for trading the cryptocurrencies. This was not the case a few years ago when acquiring cryptocurrencies was difficult. This situation has changed as major digital currency exchanges have started selling different cryptocurrencies such as Monero, Litecoin, among others. There are also other ways of trading coins such as Bitcoin ATM which has made it possible for more people to acquire and sell cryptocurrencies. Also, all digital currency exchanges offer wallets which is convenient for many. People can store their assets in the wallets which are very secure.

The reason why cryptocurrency has become popular is mainly due to its’ characteristics. First, it is decentralized which means there is no central authority to control the currency. All machines in the decentralized network work together to mine coins and process transactions. This implies that no individual can tamper with the transactions or monetary process. Second, cryptocurrency is easy to set up. Contrary to the traditional bank where account set up can take a lot of time, cryptocurrency accounts can be created within seconds. Users are not asked any questions or pay any fees for their accounts.

Application of Cryptocurrency

Anonymity is another key reason that has pushed cryptocurrency further. Given the rise of online threats, many people prefer being anonymous while using the web to avoid data loss. With cryptocurrency, users can have multiple addresses which aren’t linked to any personal information such as names or location addresses (Al Shehi 2014 pp.1443). This allows users to conduct transactions while being anonymous. This would be impossible with fiat currencies that require personal information for transactions to be done.

Transparency in cryptocurrency network has played a pivotal role in attracting people to digital currencies. In such network, entries of all transactions that have ever occurred in the network are stored in the blockchain. This makes the network tamper-proof as transactions and account balances can be seen by the public (Vigna 2016). While there are still ways to make these details opaque, most cryptocurrencies are built on the principle of transparency which makes them preferable to many as they are unforgeable.

Extremely low transaction fees have made digital currencies an attractive prospect. Unlike fiat currencies which incur high costs for international transfers, most cryptocurrencies have minimal charges (Al Shehhi 2014 pp.1443). People can also send money to any part of the world and the recipient will receive in a relatively short time as soon the cryptocurrency network confirms the payment.

Additionally, cryptocurrency has succeeded due to its broad applications. Since its innovation back in 2009, developers and entrepreneurs have sought to apply digital currencies in different areas such as wealth management, online marketing, crowdfunding, etc. (Allen 2015 pp.60). Some companies have leveraged cryptocurrency-based tokens to manage wealth and eliminate restrictions imposed on traditional wealth management. Digital publishers and advertisers struggling to enhance their relevancy have shifted their attention to cryptocurrency which offers an opportunity to effectively target audiences while minimizing costs. Publishers can eliminate traditional banner ads and get paid via digital currency for valuable ads shown in relevant articles. Also, many startups are using cryptocurrencies to fund their ideas which have revolutionized the fund-raising process. These applications and many others in development have influenced many people to leverage cryptocurrency to unlock new opportunities.

Since its invention, cryptocurrency has gained momentum and disrupted the financial services industry. However, despite its massive growth, it has failed to revolutionize the financial services industry as most people expected. The main reasons that have blunted the success of digital currencies are their lengthy transactions, volatile nature, and strict regulations.

Cryptocurrency and Forex trade market

Transactions on cryptocurrency networks can take longer and cost more (Lansiti 2017 pp.118). For example, people who want to earn bitcoins have to provide computing power to the decentralized network to confirm transactions. This essentially means that when demand rises, users can wait for days for payments to be completed or spend more to get a faster service. When compared to fiat currencies, digital currencies are expensive to be used as a form of payment. This has extensively undermined their use for payment as most people prefer the former to transact. High transactions commissions have made it uneconomical to purchase low-end items with digital currencies. This has led some platforms to drop cryptocurrency payments.

Besides hefty transaction costs, cryptocurrency is volatile. In the recent past, people have witnessed the volatility in the value of major cryptocurrencies such as bitcoin (Fry 2016 pp.343). This made them too risky for businesses and customers that want to use them as a means of payment. Transactions are affected when the value of a currency fluctuates frequently. For example, some users buying a product online may not complete the payment process when the value of currency and transaction costs change. The value of digital currencies is only stable for a limited period of time which makes them ineffective for transactions (Iansiti 2017 pp.118). Given this volatility, many people prefer fiat currencies for payment as they are more stable. 

Additionally, application of cryptocurrency in the financial services industry has been undermined by laws and regulations (Pieters 2017 pp.1). In 2017, China declared that it was illegal to create initial coin offering (ICO). This move was made to prevent fraud companies that swindled people off their money. This curtailed penetration of cryptocurrency into the Chinese finance sector. In the US, businesses that accepted bitcoin are required to apply for a license which ensures they comply with taxation laws. The application costs thousands of dollars and legal paperwork which needs a team of lawyers. For many businesses, this is not worth investing when only a few people will actually use cryptocurrencies for payment. Strict regulations have not only affected merchants but also investors. IRS released a guideline that requires people who profit from cryptocurrencies to pay taxes. Such regulations have pushed people away from the cryptocurrency bandwagon crippling its hold in the financial sector.

Overall, the growth of cryptocurrency has not come without challenges. Its volatile nature has made it a poor alternative to fiat currencies despite the opportunities it offers. Also, emerging regulations have curbed the capability of digital currencies limiting their application in the financial sector.

References

Allen, D., 2015. New money [Book Review]. Institute of Public Affairs Review: A Quarterly Review of Politics and Public Affairs, The, 67(3), p.60.

Al Shehhi, A., Oudah, M. and Aung, Z., 2014, December. Investigating factors behind choosing a cryptocurrency. In Industrial Engineering and Engineering Management (IEEM), 2014 IEEE International Conference on (pp. 1443-1447). IEEE.

Bhosale, J. and Mavale, S., 2018. Volatility of select Crypto-currencies: A comparison of Bitcoin, Ethereum and Litecoin. Studies, 132.

Buterin, V., 2013. Ethereum white paper. GitHub repository.

Caporale, G.M. and Plastun, O., 2018. Price Overreactions in the Cryptocurrency Market.

Chuen, D.L.K. ed., 2015. Handbook of digital currency: Bitcoin, innovation, financial instruments, and big data. Academic Press.

Crosby, M., Pattanayak, P., Verma, S. and Kalyanaraman, V., 2016. Blockchain technology: Beyond bitcoin. Applied Innovation, 2, pp.6-10.

Fry, J. and Cheah, E.T., 2016. Negative bubbles and shocks in cryptocurrency markets. International Review of Financial Analysis, 47, pp.343-352.

Hileman, G. and Rauchs, M., 2017. Global cryptocurrency benchmarking study. Cambridge Centre for Alternative Finance.

Iansiti, M. and Lakhani, K.R., 2017. The truth about blockchain. Harvard Business Review, 95(1), pp.118-127.

Narayanan, A., Bonneau, J., Felten, E., Miller, A. and Goldfeder, S., 2016. Bitcoin and Cryptocurrency Technologies: A Comprehensive Introduction. Princeton University Press.

Pieters, G. and Vivanco, S., 2017. Financial regulations and price inconsistencies across Bitcoin markets. Information Economics and Policy, 39, pp.1-14.

Rick, J., 2014. Bitcoin ATM Dispenses Cash for Cryptocurrency. USA Today, www. usatoday. com/story/news/nation/2014/02/20/bitcoin-atmaustin/5643119.

Surowiecki, J., 2011. Cryptocurrency. Technology review, 114(5), pp.106-107.

Vigna, P. and Casey, M.J., 2016. The age of cryptocurrency: how bitcoin and the blockchain are challenging the global economic order. Macmillan.

Wright, A. and De Filippi, P., 2015. Decentralized blockchain technology and the rise of lex cryptographia.

Zheng, Z., Xie, S., Dai, H.N. and Wang, H., 2016. Blockchain challenges and opportunities: A survey. Work Pap.–2016.