WTH is cryptocurrency?

October 02, 2017 | Ryan Son Kee


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Cryptocurrency, Bitcoin, Blockchain, it’s all greek to me!

Cyptocurrency is headlining the front page newspapers these days. Is there a bubble, isn’t there? What exactly is cryptocurrency?  I’ve kept up to date with what’s happening in the cryptocurrency space from a valuation standpoint, but until now I have not been able to grasp the concept in a clear and concise manner. It seems daunting to understand, very complex and esoteric. This past weekend, I was scrolling through Netflix, and I found some answers from an excellent documentary called Banking on Bitcoin.  I recommend anyone who is curious or wants to dispel the myths of cryptocurrency and bitcoin, to go watch it immediately.

I was amazed at how great the film explained the origins of cryptocurrency and the concepts for a general audience. I will attempt to give you a coles notes view of the documentary, so if you intend on watching it soon and don’t want me to ruin the film, this is your spoiler alert to stop reading.

The documentary starts with the origins of cryptocurrency starting in the late 1980’s through the cypherpunk mailing list. It was about counter-culture, libertarian views and finding ways around regulation and not using a bank or a centralized third party for money. The wiki definition of cypherpunk is any activist advocating widespread use of privacy-enhancing technologies as a route to social and political change.  The cypherpunks mailing list started in 1992 and by 1994 had 700 subscribers, by 1997 the subscribers were estimated to reach 2000.

Below is an infographic from Banking on Bitcoin showing the original group of cypherpunks.

Each of these individuals had a part in the development of what Bitcoin has become today. The cypherpunk movement slowed down in the early 2000’s but came back to life during the 2008-2009 financial crisis.  They questioned why the government needed to control money and when the US banks were failing. They wanted to explore other options using technology. The big issues they had with a centralized third party handling money was privacy concerns on all client information being held in third-party databases that could be hacked and the fees that were charged by these financial intermediaries.

The first Bitcoin was mined on January 3, 2009 and a 9 page whitepaper, Bitcoin: A Peer-to-Peer Electronic Cash System, was published to the cryptocurrency forums by the elusive and unknown Satoshi Nakamoto1.  Bitcoin is based on some properties of gold, where Bitcoins are mined through solving computer problems and as they are mined, the bitcoins become more scarce and increase/decrease in value based on supply and demand.

Other characteristics of Bitcoin:

1 Purely peer-to-peer version of electronic cash to allow online payments and skip going through a financial institution

2 Finite amount of 21,000,000 Bitcoins will be mined by approximately 2040

3 Every transaction is seen in an open public ledger and timestamped, eliminating fraud and fake bitcoins

4 Everything is public information except the identities of the Bitcoin owners

Bitcoins are mined by computers competing to build the blocks for the validation and maintaining of the ledger. As the blocks get built, a bitcoin is rewarded. Each block added to the chain, increases the strength of the public ledger, making it more and more complex so it becomes difficult to hack. As bitcoins get mined, the blocks become more difficult to add and the bitcoins that are rewarded slows down creating scarcity. The ledger that is built is public and distributed across thousands of computers globally which makes it a lot more difficult to hack than one ledger held by one financial institution. The blockchain concept can be used in other financial transactions like banking, originating loans, moving money, derivative trading, contracts and insurance but that’s for another discussion.

As the adoption of bitcoin increased among this small community, issues started to rise in converting Bitcoins into actual dollars. It took weeks for the early adopters to convert Bitcoins into dollars. So a whole ecosystem was built overnight to reduce the transaction times. Entrepreneurs started building companies to help facilitate the exchange of bitcoin into dollars, using credit and storing bitcoins in digital wallets. These Bitcoin exchange companies started growing and increasing mainstream adoption, but went against the very principal of bitcoin being a peer to peer currency and eliminating the need for a third-party. These third-party companies grew larger and larger in an unregulated environment and used private ledgers with client information and were subject to hacks that bitcoin was specifically built to prevent. It was the bitcoin exchanges that created uncertainty, fraud and caused much of the public backlash that bitcoin was bad for the financial markets.

Mt. Gox started in 2010 as a portal to trade Magic: The gathering cards and developed into the largest Bitcoin exchange handling over 70% of worldwide bitcoin transactions by 2014. But the company was mismanaged and hacked due to security breaches and having only one ledger.  Approximately 850,000 bitcoins worth $450 Million was stolen and never recovered.

More bad news for bitcoin hit the press, when another entrepreneur Ross Ulbricht built the website Silk Road in the darkweb which is .onion instead of .com.  He built a free market where users could truly be anonymous by using the Tor browser that hid the users IP address and making purchases using bitcoin. This free market website led to the buying and selling of illegal drugs on the internet. Ross was caught and convicted of money laundering, computer hacking, conspiracy to traffic fraudulent identity documents, and conspiracy to traffic narcotics in February 2015.  He was sentenced to life in prison with no chance of parole.2  BitInstant was another bitcoin exchange built by Charlie Shrem. Charlie was implicated for selling bitcoin to a guy and that guy sold bitcoin to consumers who used bitcoin to purchase illegal drugs on Silk Road. In December 2014, Charlie was sentenced to two years in prison for aiding and abetting the operation of an unlicensed money-transmitting business related to the Silk Road marketplace.

The bad press for bitcoin made the price of bitcoin volatile, transaction volumes took a little dip, but bitcoin kept increasing as the illegal activity associated with bitcoin was only a tiny fraction of the bitcoin economy but got all the front page news. The network effect started to occur in 2013, as Wall Street and Silicon Valley started to take notice. More people got involved with bitcoin and mainstream adoption was here.

Bitcoin Price Chart as of September 25th, 20173

Bitcoin is a battle of ideas, the free handling of money, without borders or regulation. It allows people all over the world to have access to a financial system, send money easily and opens commerce to the entire world. With the adoption of bitcoin, many alternate coins have been launched and developed. There are currently over 1000 cryptocurrencies now and below is a chart of the top 20 cryptocurrencies by market cap as of September 26th, 20174.

With larger adoption the regulators have started to take notice and have views on how cryptocurrency should be handled.  Every bank has a bitcoin/blockchain specialist now and is looking at how to incorporate the technology into their business. We are still in the infancy of cryptocurrency and I’m excited to see what the future holds.

1 https://bitcoin.org/bitcoin.pdf

https://en.wikipedia.org/wiki/Ross_Ulbricht

3 https://www.coindesk.com/price/

https://coinmarketcap.com/