Demystifying Cryptocurrencies, Blockchain, and ICOs
Bitcoin, blockchain, initial coin offerings, ether, exchanges. As you’ve no doubt noticed, cryptocurrencies (and their corresponding jargon) have caused quite the uproar in the media, online forums, and perhaps even in your dinnertime conversations. Despite the buzz, the meanings of these terms still elude many people’s comprehension. Perhaps we could put it as simply as Stephen Colbert does below, but we’ll be a tad more precise.
Originally known for their reputation as havens for criminals and money launderers, cryptocurrencies have come a long way — with regards to both technological advancement and popularity. As of earlier this month, the market cap of Bitcoin exceeded $70 billion, with peak trading volumes around $3 billion per day. The technology underlying cryptocurrencies has been said to have powerful applications in various sectors ranging from healthcare to media.
With that said, cryptocurrencies remain controversial. While critics including economist Paul Krugman and Warren Buffet have called Bitcoin “evil” and a “mirage,” others, such as venture capitalist Marc Andreessen, tout them as “the next internet.” For every person declaring that cryptocurrencies are in a bubble, there’s another insisting that they are the next wave of the democratization of finance. At their simplest, they are merely the newest fintech fad; yet at the most complex level, they’re a revolutionary technology challenging the political, economic, and social underpinnings of society.
This article will attempt to demystify cryptocurrencies’ appeal, its complex underlying technology, and why a purely digital currency is able to have value. It will also examine the outstanding issues surrounding the space, including their evolving accounting and regulatory treatment.
This article was originally published by Jeffrey Mazer at www.toptal.com. Toptal is an exclusive network of the top freelance software developers, designers, and finance experts in the world. Many large companies rely on Toptal freelancers for their most important projects. Check out the top 3% of Blockchain consultants on Toptal.
What Are Cryptocurrencies and Why Use Them?
Cryptocurrencies are digital assets that use cryptography, an encryption technique, for security. Cryptocurrencies are primarily used to buy and sell goods and services, though some newer cryptocurrencies also function to provide a set of rules or obligations for its holders — something we will discuss later. They possess no intrinsic value in that they are not redeemable for another commodity, such as gold. Unlike traditional currency, they are not issued by a central authority and are not considered legal tender.
At this point, use of cryptocurrencies is largely limited to “early adopters.” For scale, there are around 10 million Bitcoin holders worldwide, with around half holding Bitcoin purely for investment purposes. Objectively, cryptocurrencies are not necessary because government-backed currencies function adequately. For most adopters, the advantages of cryptocurrencies are theoretical. Therefore, mainstream adoption will only come when there is a significant tangible benefit of using a cryptocurrency. So what are the advantages to using them?
Pseudonymity (Near Anonymity)
Buying goods and services with cryptocurrencies takes place online and does not require disclosure of identities. However, a common misconception about cryptocurrencies is that they guarantee completely anonymous transactions. What they actually offer is pseudonymity, which is a near-anonymous state. They allow consumers to complete purchases without providing personal information to merchants. However, from a law enforcement perspective, a transaction can be traced back to a person or entity. Still, amid rising concerns of identity theft and privacy, cryptocurrencies can offer advantages to users.
Peer-to-Peer Purchasing
One of the biggest benefits of cryptocurrencies is that they do not involve financial institution intermediaries. For merchants, the lack of a “middleman” lowers transaction costs. For consumers, there’s a tremendous advantage if the financial system is hacked or if the user does not trust the traditional system. For comparison’s sake, if a bank’s database were hacked or damaged, the bank would be completely reliant on its backups to restore any missing information. With cryptocurrencies, even if a portion were compromised, the remaining portions would continue to be able to confirm transactions.
Still, cryptocurrencies are not completely immune from security threats. In one of the “largest digital heists in history,” the Decentralized Autonomous Organization (DAO), a decentralized fund intended to democratize the funding of Ethereum projects, was hacked. The decentralized application (DAPP) built on top of the Ethereum currency was hacked and hackers gained control of one-third of the fund ($55 million). Fortunately, most of the funds were restored. However, the incident shook the community and prompted the SEC’s decision to subject offerings and exchanges to US securities laws.
Programmable, “Smart” Capabilities
Certain cryptocurrencies can confer other benefits to their holders, including limited ownership and voting rights. For example, a cryptocurrency-funded organization can include voting rights in the currency’s software code. Cryptocurrencies could also include fractional ownership interests in physical assets such as art or real estate.
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