The world is agog with the idea of cryptocurrency. The uses being promoted are multifarious. Cryptocurrencies are used as a cheap way of money transfer to emerging markets but it remains to be seen what real efficacy they have here. They are talked about as a way of these markets creating cheap workable banking systems. Recently Lendo a new ICO has come up with a way to borrow real money against cryptocurrencies. Which has real implications for the viability of some of these coins.
However opinions are divided between those who think this a bubble akin to the Tulip Bubble of 1637 AD, where tulip prices reached an extraordinary level before collapsing, or the DotCom failure of the 90’s. Others think it's the new financial panacea, a way of getting out from under the hegemony of banks and governments and point to the rise of Bitcoin and the profits taken there. But the truth is that neither is the likely scenario if past events are to be believed. Firstly a lot of money was made in both the Tulip and DotCom era and in the case of DotComs a few of them are still around today and numbered amongst the biggest companies in the world. So views of the DotCom era are clouded by which side of the event you were pitched in, or if you came too late to the party. Also big government and business has a way of co-opting new technologies to take them into the mainstream through regulation and oversight. It’s very often the case that the pioneers are not the winners in this scramble. As an example looking at the fast adoption of blockchain the technology underlying most cryptocurrencies, the global blockchain market is expected to be worth $20 Billion by the end of 2024 as compared to $315 million in 2015. That’s a 57% expected annual growth rate. Source - Transparency Market Research.
Often investors are wooed by fast stories of high returns, they have heard that other players have made great gains and they want a little for themselves. Nothing wrong with that if you know how to play your hand in a volatile market and can come out on the winning side. I sat in the Shangri La Hotel in Bangkok years ago and asked a broker who had sold his clients into DotCom hell why he had assisted them. He said that the market punished those brokers who didn’t comply. If your clients were hearing stories of other brokers who put their friends into DotComs that were making huge gains in value, they would soon leave and take their business elsewhere. But did he put his own money there, not a chance. But let’s take this slowly, knowledge is power and in new markets it’s an absolute necessity.
Russia’s development bank, VEB, and several Russian state ministries are reportedly teaming up to develop blockchain technology. Why? The answer is because they want to create a fully encrypted, distributed, inexpensive payments system that does not rely on Western banks, SWIFT or the U.S. to move money around. This answer is the core of why Blockchain, the underlying technology, is so valuable at least to some; security and independence.
Simply put; a blockchain is a chain of blocks that each contains information. It was originally created so that documents could be created and time stamped in a way that meant that they could not be backdated or tampered with. A blockchain is a distributed ledger, (now often referred to as distributed ledger technology, or DLT). The idea is that once data is recorded in a block it becomes difficult to change it. This is because each block contains a Hash #, plus some data, and a Hash # of the previous block. The hash of the block is unique to that one block, the data in the block could be currency data, personal data, or other data types as required (now even smart contracts). But the thing to remember is that changing any data in any block will cause the hash of the block to change. It will not be the same block. This will mean that any changes are easily detectable. Also because it contains the hash of the block that was created after it, this means that it has a relativistic existence in relation to the one block before it that carries its Hash and the block after it whose Hash it carries. So changing data will also make the block invalid because it is no longer references the preceding block and in essence the chain will be broken. There is also a third level to security called Proof of Work. In order for a block to be accepted by network participants, it must complete a proof of work, which covers all of the data in the block. The difficulty of this work is adjusted so as to limit the rate at which new blocks can be generated by the network to one every 10 minutes in the case of bitcoin blocks. This limits the ability of someone trying to create fake blocks and recalculate every preceding block as it would take far to much time. In addition to these elements, blockchain distributes its data over a P2P network with multiple points (nodes) all containing the whole blockchain. New blocks therefore have to be sent to, and validated over all the points in the network to insure they are not tampered with. All the nodes create a consensus, so to successfully tamper with a blockchain an infiltrator would have to tamper with every block on the chain and redo the proof of work and take control of over 50% of the P2P network. This then is the reason why Blockchain technology is considered to be secure. What’s more any failure of parts of the P2P network would not affect the knowledge of what is contained in the blockchain. But as a potential buyer or instigator of a cryptocurrency, what about all the stories you’ve heard of the theft of currency. If it’s so secure how was it stolen. That brings us to the next point mining and hackers:
Before we talk about theft lets understand mining. This is a process were “Miners” use their computers processing capacity to solve transaction-related algorithms. In return they receive a pre ordained number of bitcoins per block.
“Originally, Bitcoin mining was conducted on the CPUs of individual computers, with more cores and greater speed resulting in more profitability. After that, the system became dominated by multi-graphics card systems, then field-programmable gate arrays (FPGAs) and finally application-specific integrated circuits (ASICs), in the attempt to find more hashes with less electrical power usage.”
This process introduces third parties into the process as the escalation of processing power requires more advanced computers and mining groups. It also allows a space for Agents who can take the toil out of purchasing crypto currency or bringing in new miners. In the case of the NiceHash Bitcoin theft. (NiceHash is a digital currency marketplace that matches people looking to sell processing time on their computers for so called miners to verify bitcoin users’ transactions in exchange for the bitcoin) it’s unclear what happened but somewhere within its systems hackers were able to get in and steal newly minted Bitcoins. Currently one out of every twenty five Bitcoins belongs to someone who stole it. However this has less to do with the security of the blockchain and more to do with human carelessness, bad passwords, easy access to computers and third party agents. A bit like going to the bank taking out your money and leaving it in the window of your car. So lets explain taking bitcoin as an example. I quote:
“The virtual currency is nothing more than a public ledger system, called the blockchain, that keeps track of an ever-expanding list of addresses, and how many units of bitcoin are at those addresses. If you own Bitcoin, what you actually own is the private cryptographic key to unlock a specific address. The private key looks like a long string of numbers and letters. You may choose to store your key, or keys if you have multiple addresses, in a number of places including a paper printout, a metal coin, a hard drive, an online service, or a tattoo on your body. All methods can be protected with various levels of security, but all methods are vulnerable to theft since the robbery simply depends on gaining access to the string. For the average user there are no good options right now to securely store crypto currencies.” The most lucrative attacks are carried out on online services that store the private keys for a large number of users, as Sheep Marketplace did. It seems these attacks are often carried out by insiders who don’t have to do much hacking at all. Just copy the database of private keys and you can gain control of the bitcoins at all those addresses. You, the thief, can now spend those bitcoins whenever you want, as long as the owner doesn’t move them first.”
“Next step, money laundering, is so important. Laundering Bitcoin is done with “mixers,” also called “tumblers,” which randomly crisscross your bitcoins with other users’ bitcoins so that you get a clean address that the blockchain cannot connect with any of the addresses from which the coins were stolen. Most of the time it works basically like this: you transfer your stolen bitcoins to a new address owned by the Bitcoin tumbler. That address is still “dirty” because there is a clear path from the victim’s address, so the tumbler leaves the coins there. The tumbler makes a note to transfer the same amount of bitcoins from other users to a new “clean” address owned by you. But it doesn’t make the transfer right away. Anyone watching would probably notice if the same exact amount of bitcoins — say, 96.1 — were moved into a new address, so the tumbler has you withdraw your coins over time in smaller amounts. When you request 10 bitcoins, the tumbler will transfer 10 bitcoins to your clean address. Extra-careful tumblers may also split these payouts further, especially if it is a noticeably large number of bitcoins. Source THE VERGE
Basically the blockchain system is secure but if you buy a crypto-currency leave your wallet and keys open, or allow insiders to have your key, it defeats the object of buying them in the first place. Don’t believe that just because you bought them they can’t get stolen if you don’t secure them. Protect your keys the same as you would your car keys or bank details or credit cards.
The detractors of crypto currency will have you believe that you are buying thin air. Whilst the evangelists will show you real profits that miners, and buyers have made. Jim Rickards, Financial Guru and global market pessimist states that, “Remember the days (about six months ago) when bitcoin was going to revolutionize banking and disintermediate the mean nasty “banksters?” Well, a funny thing happened on the way to the revolution. Bitcoin itself has hit an air pocket with a 50% price drop since December. Meanwhile, the banks that were supposed to be so dramatically disrupted by bitcoin are taking over the blockchain,” Cue scenes of status quo joy.
Part of what he says it true but as we have seem Bitcoin is already rallying and is trading at around sixty five per cent of its former high already. Rickard seems to suggest buying gold at any level as the safe haven for the Global storms to come, which he says are various. However what seems certain is that cryptocurrency is here to stay, whether in a controlled by the state in a bankered up, regulated format or a wilder independent format. So there is of course room for the less faint hearted to make good returns on the right choices. But at its heart is the question, what is your favoured crypto currency there to do. Market booms are often the result of the kind of hype that ignores the fundamentals. If my neighbour bought a house and made 100% in 6 months, this is when the “so can I” mentality kicks in. But what did they pay for it, was it an exceptional location, what development did they do and how are the market conditions changing since that purchase was made. Even if none of the fundamentals are right the market can still be strong if enough people are also convinced to buy houses who are also looking for 100% returns. In the DotCom revolution people counted users as if they were gold. Not that they were adding any revenue they were just users and if you had them you could multiply your share price exponentially, that is until the crash. The trick with Cryto Currency is not to fall into the same trap. Because it's a new crypto currency doesn’t mean that is has any viability. Ask yourself, what is it backed by? What can you use it to buy? Is there any reason for it? Yes they are currencies but like all currencies they are only as good as the confidence people have in them. I can exchange my dollars for Ethiopia Birr and then do exactly nothing with them. Despite the fact that it is one of the fastest growing emerging markets. But who wants Birr, no one, so I would be left with a currency that I can do little with.
Some cryptocurrencies have built in value. Others are tradable for tangible commodities. For instance Etherium. Ethereum is a digital cryptocurrency exchange. The legal payment system of Ethereum is called Ether. Ethers are the cryptocurrency exchange issued by the crypto solution which is subject to free trade and can be purchased from any of the legit crypto brokers or traded. It has a purpose, It allows for the smooth coding, cryptocurrency exchange, encryption, and deciphering of intellectual property contracts and agreements, company control, crowd-funding campaigns, securing of a domain name, voting, and the conduct of monetary exchange operations. Etherium describes itself as “a decentralized platform that runs smart contracts: applications that run exactly as programmed without any possibility of downtime, censorship, fraud or third-party interference.”
There is a real reason for Ethers and Etherium. It’s smart contracts are good for large numbers of real world applications, it has a, “reason for being” and solves real problems. A cryptocurrency that does this is may be worth looking into.
Is something valuable because it has a value in itself or is something valuable because lots of people have a desire for it?
So let me put this another way, it’s clear that speculation has driven much of the price increases we have seen in the market, however what is not clear is what is the fundamental value underlying the rise of cryptocurrency. There are a number of ways that cryptocurrencies create fundamental value. One way is to represent a traditional asset cryptographically. For example Tether and USDT were created to facilitate the transfer of national currencies. There is presumed to be a direct link between the amount of USDT in circulation, which must always correspond to the amount of USD in the bank account used by Tether Limited to receive and send fiat currency to users who purchase/redeem tethers directly on the Tether Platform. Thereby the crypto currency represents a traditional asset and has a real world use. Although questions have been asked recently as to whether there are sufficient dollars being accounted for against Tethers, but that’s another regulatory matter all together. Another way that cryptocurrencies potentially provide value is via their use as a usage token to provide access to a digital service. So for instance you need Bitcoin to use the Bitcoin blockchain and as long as this remains a sought after resource some value is maintained. However if this resource is superseded and becomes disused the value diminishes exponentially. This is not unlike company shares where a company provides a valuable product for a time that may be superseded by newer market competitors or changes to the market overall. The stock price rising and falling based on the perceived value at any time. Most of the top cryptocurrencies are currently usage tokens. However asset backed launches are on the rise, backed by property, gold, currency or other assets and it remains to be seen what place they will hold in the future market.
Limited availability is an issue, theoretically because these currencies are digital, there is no real limit to amount of currency that can be created. There is therefore the small problem that scarcity is directly linked to value. Bitcoin say that they will only create twenty one million bitcoin to solve this problem, but this is arbitrary and may possibly change. Also if you use this as a currency one that can fluctuate by as much as 10% of more in a day, how do you value transactions. It is probably one of the reasons why few bitcoins are used as currency the volatility puts pay to that. Ether on the other hand was not meant to be a currency and is part of a universal transaction network. In order to use the Etherium blockchain you need to use this to transact. But you can still cash out and exchange for really fiat currency going into the system or cashing out. This brings another issue, currently the prices of the same cryptocurrencies at the exchanges vary greatly. The lack of structure and the time it takes to cash in your currency is still part of the problem that these DLT’s have to solve. However word is that Consensys is working on a Etherium based universal exchange, watch this space. If essence cryptocurrencies are valuable because we think they are, we agree to use them as a way of exchanging value and we limit the amount that is available. The spread will largely be based on habit and general acceptance. Just as registered promissory notes for travellers and traders became bank notes accepted as a promise to pay anyone who held them, it’s likely that the best of these cryptocurrencies will also find their way to acceptance.
Brokers & Agents
Given the time it takes to create a “proof of work,” the demand for crypto currency, the lack of knowledge about the underlying technology, the need to set up unsophisticated buyers with keys and wallets. There was always going to be a space in the market for brokers and third party services. Also because of the way that cryptocurrency works there are services which are built on the back of the blockchain. For instance Etherium allows users to create services using Ether, Crowd Source funding organisations, smart contract services and others. Why do we mention this? Well is where an amount of tension exists. As in any real world transaction it’s important to know who you are dealing with and understand the risks. For instance;
In 2016, something bad happened. A startup working on one particular DOA project, aptly named ‘The DAO’ got hacked. The DAO was a project developed and programmed by a team behind another startup called Slock.it. Their aim was to build a humanless venture capital firm that would allow investors to make decisions through smart contracts. The DAO was funded through a token sale and ended up raising around $150 million dollars from thousands of different people. Shortly after the funds were raised, The DAO was hacked by an unknown attacker who stole Ether worth around $50 million dollars at the time. While the attack was made possible by a technical flaw in The DAO software, not the Ethereum platform itself, the developers and founders of Ethereum were forced to deal with the mess. ..Quote from Blockgeeks
Two issues of note here. It was not the Etherium platform that was at fault, and also all the money lost was returned to the people it was stolen from. But it makes the point that third parties building new services on the back of blockchain systems are not flawless.
Also cryptocurrency exchanges are not part of the regular Stock Market Exchanges like NASDAQ or Wall Street.
There is a great deal of variation in the regulation of cryptocurrencies. The leading global economies have more reasonable attitudes to regulation because of population demand for cryptocurrencies also these countries tend to have better institutions. However South Korea took steps recently to ban certain types of trading, minors, and virtual bank accounts. Some countries in South America have gone for outright bans. And China the largest country for mining crypto currency has a two-speed approach where cryptocurrency can only be used by private individuals. That said the question you need to contend with is, will your purchased cryptocurrency fall foul of any new legislation. This is something impossible to answer. Recently in Korea for instance it banned foreign nationals from trading in cryptocurrency. This left a lot of foreigners in a state of limbo and left foreign holders complaining that:
“I am a foreigner and have crypto in South Korea. If I can't get level 2 approved, the exchange will probably steal my money. Any foreigner will now be victimised if they have funds there. “
Bangladesh Bank issued a warning against conducting transactions in cryptocurrency, and reportedly stated that such use is punishable by up to 12 years in jail.
However in general, governments, at least in ordered societies have to look after their own citizens. But if you are foreigner you can be an easy target. So it makes sense to have a think about the jurisdiction you are buying into and what status you have within it, both for taxation and regulatory purposes.
“Japan, the United States, Canada and the majority of the European countries have favorable regulation of cryptocurrencies. These countries understand that this new asset class is here to stay and have all the prerequisites to become the integral part of the global economy. For example, in the US, bitcoin is considered to be a virtual currency as defined by the Department of Treasury or as a commodity according to Commodity Futures Trading Commission (CFTC). Belgium, for instance, regulates cryptocurrencies under the same laws as digital money”
Where most of the emphasis is, is in secrecy, tax avoidance, money laundering. In November 2017 the U.S. Treasury Department’s inspector general said it planned to review FinCEN’s cryptocurrency practices as they relate to money laundering and terrorism financing risks. FinCEN’s Guidance FIN-2013-G001 declared “virtual currency does not have legal tender status in any jurisdiction.”
Similarly the Bank of France has issued warnings similar to other European nations. There were informal indications that France might have been willing to allow virtual currency companies to operate as payment service providers under French law, and France has now indicated it will implement customer identity verification rules for virtual currency platforms.
James Rickards take on this is that: The U.S. Treasury is concerned that cryptos are the “new Switzerland” where Americans are hiding income and avoiding taxes. The Treasury is probably right about that. Treasury will use the same hardball tactics against the cryptocurrency exchanges they used against the Swiss banks. The IRS is already demanding all records of crypto-currency transactions from these exchanges including name, address, social security number and bank account information about their clients. The bitcoin fans who mock the government and play “catch me if you can” will find out the hard way that the U.S. government has the resources to track them to the ends of the earth.
So be prepared to have a light shone on any transactions you do with cryptocurrencies.