What is Cryptocurrency?
Cryptocurrency is a digital currency that is exchanged between peers without the need of a third party, like a bank. It enables consumers to digitally connect directly through a transparent process, showing the financial amount, but not the identities of the people conducting the transaction. The network consists of a chain of computers, which are all required to approve a cryptocurrency exchange and prevent duplication of the same transaction. Because of its transparency, this type of transaction has the potential to reduce fraud.
Cryptocurrency exchange is somewhat similar to the global online payment system, PayPal, except the currency being exchanged is not traditional money. The cryptocurrency procedure uses digital safeguards to ensure the security of transactions. In addition, each transaction must be confirmed in a digital public ledger, called a blockchain, through a process known as mining.
How do Cryptocurrency Exchanges Work?
An explanation of the following terms may help to clear up any confusion:
- Transaction. This is the transfer of currency between two digital wallets. A transaction is submitted to a public ledger to await confirmation before the exchange can be concluded. During a transaction, an encrypted electronic signature based on a mathematical formula is required as proof of ownership. The confirmation process is conducted by people called miners.
- Public Ledger. Once a transaction is confirmed by a miner, it is stored in a public ledger called a blockchain. The public ledger verifies ownership of the cryptocurrency and ensures the legitimacy of recordkeeping.
- Mining. This is the process of confirming transactions before they may be added to the public ledger. A miner must know how to solve a computational puzzle, called proof-of-work, to prevent exploitation of cryptocurrency mining. Mining is open source, which means that anyone on the network can confirm a transaction before adding the transaction block to the public ledger, or blockchain. Miners receive a fee in cryptocurrency for their work.
In summary, this is how a cryptocurrency exchange using blockchain works in practice:
- 1. “A” wants to send cryptocurrency to “B.”
- 2. The transaction is represented online as a block.
- 3. The block is distributed to everyone on the network.
- 4. A miner within the network will confirm that the transaction is valid.
- 5. The block is then added to the blockchain or public ledger.
- 6. The currency then moves from “A” to “B.”
With traditional banking systems, the sender and receiver of the transaction must trust intermediaries to facilitate centralized transactions. This type of transaction can command large fees and capture the private data of individuals while doing so. On the other hand, cryptocurrency exchange protects individual identities while providing a decentralized, transparent mechanism for transferring value at a lower cost.
In this guide, we will look at the rise of the cryptocurrency market, the types of cryptocurrencies that are available and gain an understanding of initial coin offerings (ICOs).
The Rise of the Cryptocurrency Market
Ten years ago, cryptocurrencies were an academic concept, largely unknown to the world’s general population. This all changed in 2009 with the creation of Bitcoin. Today, most people are aware of cryptocurrencies, although they may not be familiar with how the system works.
The cryptocurrency market continues to gain traction in various facets of government, business and personal financial activities:
— Governments and large corporations are now looking closely at the cryptocurrency market to evaluate how they can adapt the transaction mechanism, specifically blockchain technology, to exchange value.
— Many companies have initiated blockchain projects to assess the feasibility of integrating this technology into their businesses.
— Where the Internet we know connects people around the world and facilitates the exchange of data, experts consider blockchain technology to be a second type of internet: the internet of value.
Our society is increasingly becoming digitally driven. Financial service providers in particular are looking at the cryptocurrency model to ascertain how they may provide secure services in a more efficient and cost-effective manner. Before we consider the potential growth of the cryptocurrency market, let’s look at where it all started.
The Emergence of Bitcoin – the Market Standard
— In the 1990s, many attempts were made at creating digital currencies using centralized control, but they all failed for various reasons.
— In late 2008, Satoshi Nakamoto developed a peer-to-peer cash system, which he called Bitcoin. This was the first time someone was able to build a secure, decentralized digital cash system.
— Satoshi Nakamoto’s system also prevented double spending, traditionally something that only a centralized server could accomplish. Nakamoto’s innovation became the foundation of cryptocurrency.
— A decentralized network operates on a system of checks and balances, where every entity within the network checks to see there is no attempt to spend the same currency twice. No one thought it was possible to reach consensus without central authority, but the emergence of Bitcoin proved it was achievable.
As a decentralized currency, Bitcoin uses the peer-to-peer network and blockchain technology to issue currency, process exchanges and verify transactions. This makes it free of government interference or manipulation, unlike a fiat currency, which is controlled by a nation’s central bank.
Bitcoins are created by the mining process at a current rate of 25 Bitcoins every 10 minutes. The number of Bitcoins in circulation will be capped at 21 million, which is expected to be reached in 2140. The downside to cryptocurrency exchange is that the value of the currency is entirely dependent on demand from investors, and if the market drops, the value of Bitcoin drops as well.
Additionally, cryptocurrencies don’t represent debt, as money can in traditional banking systems. It is hard currency; as valuable as holding gold coins. However, most cryptocurrencies have set a limit on the supply of their tokens. As mentioned, Bitcoin has set their volume at 21 million.
The Transactional Characteristics of Cryptocurrencies
There are a number of characteristics of cryptocurrency transactions that differ from traditional banking
- It is anonymous. Although the transaction process is transparent in cryptocurrency exchange, none of the parties can be identified. This has attracted the attention of U.S. federal agencies such as the FBI and the Securities and Exchange Commission (SEC), which are concerned about the potential for money laundering.
- It is secure. Cryptography ensures that funds are securely locked in the system, and only the owner of a private key to those funds can exchange cryptocurrencies.
- It is fast and worldwide. The network is global, which means that geographical location is not a barrier to enable a transaction. Transactions only take a few minutes to be mined and confirmed, which makes them much faster than traditional banking mechanisms.
- It is irreversible. Once a transaction has been confirmed and added to the blockchain, it can’t be reversed. There is no recourse in the event that cryptocurrency is sent in error.
- It does away with red tape. Permission is not required to use the cryptocurrency exchange system. It is free to download and free to use.
The Future of Cryptocurrencies
Although it’s not possible to predict the future prospects of all of the cryptocurrencies, if the success of Bitcoin is any indication, the cryptocurrency market has a bright future.
— In July 2015, the price of Bitcoin was just over $280; this gradually increased until it reached the $1,000 mark in January 2017.
— Since then, the cryptocurrency has recorded phenomenal growth. By early December 2017 the price of Bitcoin had reached $17,000. The price of another cryptocurrency called ‘Ether’ has also continued to rise in recent months.
Initial Coin Offerings (ICOs) have also played a major role in generating interest in the cryptocurrency market. ICOs use coins or tokens that are similar to shares of a company. These are sold to investors in an initial public offering (IPO) transaction. An ICO can be likened to crowdfunding, using cryptocurrencies as a source of capital for startup companies. Many market experts expect a cryptocurrency crash at some point. With this kind of market volatility, it is inevitable that a regulator like the SEC will want to step in to provide guidance and impose enforcement actions where necessary. We’ll learn more about ICO’s later in this guide.
Types of Cryptocurrency
Cryptocurrencies are considered to be ‘digital gold,’ largely because they are secure investments and free of political influence. Cryptocurrency exchange involves peer-to-peer transactions. This means one person pays another via a desktop or mobile device, using a downloaded or browser-based app to initiate and authenticate the transaction and transfer the funds. Mobile payments, which share some commonalities with cryptocurrency exchange, are gaining in popularity and are forecast to reach $142 billion in the U.S. by 2019.
Apart from their value as payment mechanisms, cryptocurrencies have provided investors and speculators access to a dynamic and fast-growing market. This has given rise to exchanges like Okcoin, Poloniex and ShapeShift. The cryptocurrency market is also being used for crowdfunding projects to fund startups through ICOs.
The Top Five Cryptocurrencies
Apart from Bitcoin, which is almost universally known, there were over 1,300 cryptocurrencies on the market at the end of November 2017. Here we review the top five by market capitalization:
- Bitcoin. Bitcoin was the first cryptocurrency to be traded and today remains the most commonly used. With a market cap of around $180 billion, Bitcoin stands head and shoulders above any other cryptocurrency and is considered the gold standard for this industry.
- Ethereum. Way behind in second place to Bitcoin is Ether. This is the currency token used in the Ethereum blockchain and has a market cap of over $18 billion. Developed in 2015, Ethereum is a Turing-complete programmable currency. This gives it an edge over Bitcoin because it enables developers to build different technologies and apps around it, and it can process complex contracts and programs besides transactions. For these reasons, Ethereum’s blockchain code has been used to launch other cryptocurrencies in 2017.
- Ripple. Ripple has already been used by several banks, including UBS and Santander, because it can track other transactions besides cryptocurrency. Founded in 2012, Ripple has a market cap of $10 billion.
- Litecoin. Litecoin was developed soon after Bitcoin and is similar in form. However, Litecoin has developed new innovations, with a mining algorithm that enables faster payments than Bitcoin and processes that allow many more transactions. Its market cap is in the region of $5 billion.
- Monero. This open-source cryptocurrency has developed an algorithm with enhanced security and privacy features over Bitcoin. Unlike many of the other cryptocurrencies that are based on Bitcoin, Monero was developed using the less transparent CryptoNote protocol. Its opacity and open-source model, however, have counted against it, as consumers are wary that it can be used to cloak the activities of fraudsters and hackers. Accordingly, Monero’s growth has been weak.
These are just a fraction of the cryptocurrencies that currently exist. Indications are that some industries are evaluating the feasibility of developing their own cryptocurrencies to facilitate even faster, more secure transactions. For example, Dentacoin has been developed recently as the first blockchain platform for the dental industry worldwide. However, the rest of the cryptocurrency industry has much catching up to do to emulate the success of Bitcoin.
Understanding Initial Coin Offerings (ICOs)
Initial Coin Offerings (ICOs) have become a popular way to bypass the complex and regulated procedure of raising capital from banks or venture capitalists. As an unregulated process, an ICO has been compared to crowdfunding, where backers of a startup entity are pre-sold their cryptocurrency in exchange for legal tender or other established cryptocurrencies like Bitcoin.
How Does an ICO Work?
The easiest way to understand how an ICO works is to compare it to the traditional method in which start-up companies raise capital from investors.
- Traditionally, a startup company will sell shares to investors in an Initial Public Offering (IPO) transaction.
- A startup in the cryptocurrency market creates coins or tokens to offer investors in an Initial Coin Offering (ICO) in return for legal tender or digital currency.
- So, while IPOs deal with investors, ICOs deal with keen backers of their project, much like crowdfunding.
When embarking on an ICO campaign, a start-up cryptocurrency company creates a plan that outlines the goal of its project. It also gives details on how much money is needed for the project, how many digital tokens backers and investors can retain, the type of currency accepted and the length of the ICO campaign. If after the campaign has run its course, the company has not been able to raise sufficient capital for the project, the money is returned to the backers.
ICO Success Stories
Ripple was probably the first cryptocurrency to raise funding through an ICO. It started to develop its payment system and created 100 billion XRP tokens, which were then sold to fund the development of the Ripple platform.
However, Ethereum is the most prominent cryptocurrency platform to have been involved in ICO funding. Ethereum developed a smart contract system where a simple token may be transacted on the Ethereum blockchain. This concept became the standard for the launch of new and highly successful ICO projects. Some examples of successful ICOs on Ethereum include:
- Augur. Eighty percent of REP tokens were sold to fund the development, which raised over $5 million. Now, these tokens are worth over $100 million.
- Melonport. Melonport’s aim is to develop a platform for the management of Ethereum-built blockchain assets. MLN tokens sold for more than 2,000 Bitcoin in 2016.
- Golem. Golem’s project involved the development of a supercomputer that enabled participants to sell its power. The ICO was restricted to 820 million tokens, and the developers received over 10,000 Bitcoin. Now Golem’s market share is over 50,000 Bitcoin.
- Singular DTV. This venture intends to merge with Ethereum, smart contracts and the production and streaming of videos. 12,000 Bitcoin were raised through an ICO, which are now worth over 40,000 Bitcoin.
- ICONOMI. This is a platform for managing digital assets. Eighty-five million ICN tokens were sold by the developers during their ICO campaign, for which they received over 17,000 Bitcoin. Its market cap today is over 40,000 Bitcoin.
The potential of an ICO is virtually limitless because it enables individuals, not only companies, to release tradable tokens to raise funds. Cryptocurrencies and exchange are now, more than ever, making a greater impact on the future of financial transactions around the globe. Its ability to be secure, immediate and surpass geographical boundaries makes the cryptocurrency model one that can not only keep pace with today’s digital world, but be a driving force of game-changing innovation.