Cryptocurrencies

Each cryptocurrency has its own unique characteristics. In this section, we'll breakdown the difference between popular cryptocurrencies. First, what is the demand for crypto assets?

Cryptocurrencies

What Is Cryptocurrency?

A cryptocurrency, crypto-currency, or crypto is a digital currency designed to work as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or bank, to uphold or maintain it.

A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology—a distributed ledger enforced by a disparate network of computers. A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation.

Key takeaways

  • A cryptocurrency is a form of digital asset based on a network that is distributed across a large number of computers. This decentralized structure allows them to exist outside the control of governments and central authorities.
  • Experts believe that blockchain and related technology will disrupt many industries, including finance and law.
  • The advantages of cryptocurrencies include cheaper and faster money transfers and decentralized systems that do not collapse at a single point of failure.
  • The disadvantages of cryptocurrencies include their price volatility, high energy consumption for mining activities, and use in criminal activities.

Understanding cryptocurrencies

Cryptocurrencies are digital or virtual currencies underpinned by cryptographic systems. They enable secure online payments without the use of third-party intermediaries. "Crypto" refers to the various encryption algorithms and cryptographic techniques that safeguard these entries, such as elliptical curve encryption, public-private key pairs, and hashing functions.

Cryptocurrencies can be mined or purchased from cryptocurrency exchanges. Not all ecommerce sites allow purchases using cryptocurrencies. In fact, cryptocurrencies, even popular ones like Bitcoin, are hardly used for retail transactions. However, the skyrocketing value of cryptocurrencies has made them popular as trading instruments. To a limited extent, they are also used for cross-border transfers.

Individual coin ownership records are stored in a digital ledger, which is a computerized database using strong cryptography to secure transaction records, to control the creation of additional coins, and to verify the transfer of coin ownership. Despite their name, cryptocurrencies are not necessarily considered to be currencies in the traditional sense and while varying categorical treatments have been applied to them, including classification as commodities, securities, as well as currencies, cryptocurrencies are generally viewed as a distinct asset class in practice.

Cryptocurrency does not exist in physical form (like paper money) and is typically not issued by a central authority. Cryptocurrencies typically use decentralized control as opposed to a central bank digital currency (CBDC). When a cryptocurrency is minted or created prior to issuance or issued by a single issuer, it is generally considered centralized. When implemented with decentralized control, each cryptocurrency works through distributed ledger technology, typically a blockchain, that serves as a public financial transaction database.

Bitcoin

Bitcoin is coin centric. It's primary purpose: be an alternative to existing currencies.

Bitcoin is the most popular and valuable cryptocurrency. An anonymous person called Satoshi Nakamoto invented it and introduced it to the world via a white paper in 2008. There are thousands of cryptocurrencies present in the market today.

Embedded in the programming of this first bitcoin was the text "The Times 03/Jan/2009 Chancellor on brink of second bailout for banks." The text refers to a headline on that date from the British newspaper The Times, and is generally seen as proof of the date bitcoin was first mined.

Bitcoin, which was made available to the public in 2009, remains the most widely traded and covered cryptocurrency. As of November 2021, there were over 18.8 million bitcoins in circulation with a total market cap of around $1.2 trillion. Only 21 million bitcoins will ever exist.

In the wake of Bitcoin's success, many other cryptocurrencies, known as "altcoins," have been launched. Some of these are clones or forks of Bitcoin, while others are new currencies that were built from scratch. They include Solana, Litecoin, and Ethereum.

An increasing half-life for bitcoin miners

Miner rewards will be halved every 210,000 blocks

There are roughly ~17 million bitcoin in circulation today

Protocol suggests it cannot be created arbitrarily. But is this inflationary or deflationary?

Benefits of bitcoin

  • Pseudonymous: cryptographic identities allow for accountability
  • Democratic: decisions made through consensus protocol that doesn’t require trust
  • Immutable: ledge of truth
  • Uncensorable: difficult to be controlled by one party
  • Distributed: no central point of failure

Bitcoin is an anonymous service with no central registry. It is inexpensive to create multiple identities. Multiple identities => multiple opportunities to cast votes

  • Tom can perform a Sybil attack, which will allow him to double spend
  • Instead of casting votes with identities, we cast votes with resources
  • Need to solve a problem with brute force (trial and error) Bitcoin assumes an honest majority => a malicious majority can control the network

Bitcoin Nodes

Running a Bitcoin node means using spare computing and bandwidth resources that allow BTC users to send transactions and get notifications for any activity in their digital wallets. Running a Bitcoin node is not the same as mining Bitcoin — there are no block rewards for running a full Bitcoin node.

To run a Bitcoin full node, you must go to the official website of Bitcoin Core and download the implementation software. According to the developer group’s website, certain requirements need to be met before you can become a full node runner.

In the old days, running a Bitcoin Core full node required downloading the entire blockchain. Thankfully, pruning enables individuals to run full nodes without the massive storage requirements. Instead of allocating 350 GB of disk space, full node operators only need to have 7 GB.

Pruned full node requirements:

  • A desktop or laptop that runs recent versions of Windows, Mac OS X or Linux;
  • 7 GB of storage, accessible at a minimum read/write speed of 100 MB/s;
  • 2 GB memory (RAM);
  • Internet connection with an upload speed of at least 400 kilobits (50 kilobytes) per second;
  • At least six hours a day for your full node to be left running.
  • Note that running a Bitcoin node comes with potential risks and additional costs. In some countries, any form of Bitcoin activity, including running a node, is prohibited. Bitcoin nodes are also susceptible to hackers who intend to exploit the network.

Bitcoin was solved for several key technological problems, making it usable. It's unique that the founder is unknown yet the system works fully decentralized at scale.

Ethereum

Ethereum is a blockchain app platform to build smart contracts. The primary purpose of Ethereum is to build a platform for decentralized applications and smart contracts. It is an extension of the original Bitcoin thesis.

Ethereum was built by a team along with Vitalik Buterin in 2013. It is a turing-complete protocol.

Ethereum timeline

  • Late 2013: Ethereum described in whitepaper in Vitalik Buterin
  • July/Aug 2014: Ethereum crowdsale
  • July 30th 2015: Ethereum blockchain launched
  • May 2016: value of Ethereum tokens worth more than $1 billion
  • July 2016: the DAO rise and hack

Ether is the currency used to compensate miners

Ethereum is a decentralized platform designed to run smart contracts

Like a distributed computer to execute code

Account-based blockchain

Distributed state machine – transactions change global state

Transactions = state transaction function

Ethereum has a native asset called ether

Basis of value in the Ethereum ecosystem

Needed to align incentives given as mining rewards

What are Ethereum smart contracts? Smart contracts in Ethereum are like autonomous agents that live inside the network. They react to external transactions are called to perform specific functions. The contracts have direct control over: Internal ether balance, Internal contract state and Permanent storage.

What is the purpose of Ethereum smart contracts? Store and maintain data that represents something useful to useful to users or other contracts. They can Manage contract or relationship between untrusting users like financial transactions (i.e. escrow, insurance). Also Provide functions to other contracts such as serving as a software library. Smart contracts can also require complex authentication such as Multi-signature access.

What is the Ethereum Virtual Machine? Every Ethereum nodes run EVM as part of its block verification procedure. The network consensus removes the need for Trusted Third Party. Anything in violation of contracts requires subverting the entire network. Now secure peer-to-peer agreements that live on the blockchain forever. The Ethereum Virtual Machine runs contract code that gets executed on every node is EVM code.

Ethereum Nodes

In Ethereum, a user can run three different kinds of nodes: light, full and archive. Their differences lie in how fast they can synchronize with the entire network.

There are many ways to run your own Ethereum node, but some popular hardware that can work on the network are DAppNode and Avado. Ethereum nodes have almost the same requirements as Bitcoin nodes, only that the former requires less computing power.

Note that before you run an Ethereum node, it is advisable to check your bandwidth limitations first.

You can find a list of clients you can use in running a node on Ethereum’s website.

Ethereum nodes are essential in keeping its blockchain network secure and reliable, as well as transparent. In fact, anyone can view the nodes and their performances on the network via Etherscan’s node tracker.

In order to receive block rewards, you would have to run an Ethereum staking node.

Ethereum is not about optimizing efficiency of computation. Its parallel processing is redundantly parallel. Efficient way to reach consensus on the system state without needing. Ethereum creates an incentive not to use the blockchain for computation that can be done off chain. Contract executions are redundantly replicated across nodes. The system is expensive but that is the tradeoff for high security between trusting third parties.

Securities Law

What is the Howey test? In the U.S., investment contracts must pass the Howey Test to be considered a security. To pass the Howey Test an investment must meet these four traits: (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profit and (4) to be derived from the efforts of others.

Are crypto an equity or token securities? why BTC/ETH are NOT considered securities. BTC/ETH fail this test. For starters, both applications are decentralized. No one person controls or stands to profit from the sale. Second, these are utility tokens. Ether on the Ethereum network is used for specific applications. It is not designed to make a profit or deliver a return. Third, owners and developers don't have aligned incentives. Token owners can make money but that doesn't mean specific applications will do well or even profit.

Ripple/XRP didn't pass the Howey Test as we mentioned earlier this week. The SEC fined the team $1.3b for selling unregistered securities. The primary reason for this is because the XRP token was used to fund Ripple's payment network.

Are Cryptocurrencies Legal? Fiat currencies derive their authority as mediums of transaction from the government or monetary authorities. For example, each dollar bill is backstopped by the Federal Reserve. But cryptocurrencies are not backed by any public or private entities. Therefore, it has been difficult to make a case for their legal status in different financial jurisdictions throughout the world. The regulatory landscape is constantly changing. Most countries allow the use of crypto as a currency but ban the mining  of crypto.

What is a Crypto Exchanges? A cryptocurrency exchange, or a digital currency exchange (DCE), is a business that allows customers to trade cryptocurrencies or digital currencies for other assets, such as conventional fiat money or other digital currencies. Exchanges may accept credit card payments, wire transfers or other forms of payment in exchange for digital currencies or cryptocurrencies. A cryptocurrency exchange can be a market maker that typically takes the bid–ask spreads as a transaction commission for is service or, as a matching platform, simply charges fees.

Some brokerages which also focus on other assets such as stocks, like Robinhood and eToro, let users purchase but not withdraw cryptocurrencies to cryptocurrency wallets. Dedicated cryptocurrency exchanges such as Binance and Coinbase do allow cryptocurrency withdrawals, however.

What is a Money transmitter license? Money transmitted is an entity that provides money transfer services or payment instruments

What is AML? Anti-money laundering (AML) is the prevention of undetected large flows of money from crossing borders or moving between the underground and legitimate economy.

What is KYC? Know Your Customer (KYC) rules require certain kinds of businesses that handle money to do: Identify and authenticate clients, Evaluate risk of client, Watch for anomalous behavior.

What is the blockchain trilemma? The trilemma consists of three technological challenges: decentralization, scalability, and securability.

Are cryptos really currencies? In some form, yes. Since we moved away from the Gold standard, the U.S. dollar has become the world's reserve currency. The major currencies in the world are traded in the foreign exchange (forex) markets. Currencies are directly related with a country’s interest rates, economic factors (GDP) and policies (monetary/fiscal).

What is the goal of a currency? A currency aims to provide:

  • Scarcity: finite units, for maintaining value
  • Fungibility: interchangeable and identical units, for preserving equal value between all units
  • Divisibility: subunits for every major unit, for ease and precision of payments
  • Durability: long-lasting units, for longevity of each unit
  • Transferability: liquidity, for ease in transacting

What is an Initial Coin Offering? An Initial coin offering (ICO) is a new, unregulated way of raising funds. The crowdsales include details such as how to buy tokens, participating exchanges, token distribution rules and token price. they can align incentives of development teams and early investors. For example, Ethereum had a token sale.

What are the limitations of an ICO? There is no central party (VC/PE) to carry out due diligence on behalf of investors. Due diligence of ICOs is assumed to be done by the crowd itself. Not everyone reads the full whitepaper. Managing thousands of investors can be distracting and overwhelming task for small teams with potential to turn into a PR disaster.

What is the legal uncertainty with ICOs? It determines on the language of the whitepaper, on whether it is a Security or Access token. Not much guidance here yet but we'll discuss how investments have to pass the Howey test to be considered a security in the valuations chapter.

  • Security token: An investment vehicle similar to stock in a company
  • Access token: Allows early access to products and services

Have any countries shutdown cryptocurrencies? In the past 13 years, China has banned Bitcoin 13 times. But you can’t shut down the global computer. Government regulations are not binding online.

What the Famous Blockchain hacks? The major hacks were Mt. Gox and DAOs. In 2014, ~$473 million of customers' bitcoins were lost due to theft on Mt. Gox.  

What you own and how you own crypto is an important truth in crypto. There are new regulations being developed in this space in real-time. Asset security is a critical feature in this industry so make sure it is rock solid when investing.