Cryptocurrencies were always an inevitable technology and in 2017 they really took off, making initial investors wealthy overnight. But where is its inventor Satoshi Nakamoto and what is a true Bitcoin or a fork.
Quick links to the sections in this post:
Quick links to the sections in this post:
Cryptocurrency is here to stay, it is the future of money. Do you remember when you had to apply for a credit card and then debit cards became the norm. Do you remember when you could pay a cash fare on a bus whereas nowadays you need a debit or oyster card. Trends are just that, they move along regardless, and banks and the banking system have had it their way from day one, up to now that is.
Just like people today prefer using their mobiles over a landline so too are people seeing the convenience of cryptocurrency over traditional banking practices. There are two main differences that distinguish cryptos from banking. Firstly, banks are termed as ‘centralised’ because they control currency from a hub such as the Bank of England whereas cryptocurrencies are de-centralised because they are made up of hubs that form part of a network (or blockchain). The second difference is that cryptocurrency transactions happen much faster, there is no waiting for three days and it’s working all the time, it doesn’t close for bank holidays.
The Bank of England tries to predict what currency will do and how the value may be affected. When they print more money it usually leads to inflation whereby people see that their money is worth less. When this happens they tend to seek higher pay – therefore more money is needed and inflation continues to rise and its value depreciates further. Conversely the bank takes money out of circulation when needed. In effect the government is creating new money in order to cover what it spends in excess of its income.
Banks create money in many ways rather like taxes are collected in many forms. A bank is allowed to offer a certain amount of money for loans that it doesn’t actually own. Think of a bank that has £10 million to offer its customers by way of loans, imagine the law allows it to offer up to £20 million based on its holdings. Now imagine the bank loans out £20 million, when it is only holding £10 million. Interest begins accruing on the full amount even though £10 million of it doesn’t exist, yet the bank will claw back that non-existent £10 million plus interest and fees. You can stop imagining, this is how it really works.
The obvious answer is to eradicate state control of the money supply. Money is the lifeblood of commerce, it is a commodity with a value that stems from its usefulness as a medium of exchange. The power that banks have to arbitrarily increase or decrease the money supply lays at the whims of politicians that do not want to decrease their spending – creating an unbalanced budget. Inflation commonly becomes the answer to deficit financing.
Spending and Taxes are fiscally linked, so in the UK a government that wants to stay in power seeks to spend as much as it can whilst not increasing taxes and this contributes to an unbalanced budget and inflation. All this because a political party wants to remain in power over a different party. In the U.S. it’s the federal government and government recognised banks that can print new money and create credit.
Let’s use the U.S. in an example of how banks create cash indirectly. The Federal Reserve buys government securities on the open market and not directly from the government. It does so using a cashiers check, and the seller in turn deposits it in a bank, thereby increasing the bank’s reserve, and thus enabling it to lend out several times the amount of the deposit. In other words, the Federal Reserve expands the supply of money and credit by enabling banks to lend non-existent money and charge interest on it.
Broadly, inflation can be manipulated for purely political reasons, and when government expands the money supply, this immediately creates benefits for borrowers like the banks and losses for lenders like people on fixed incomes. That’s right, when a political party promises it will find the money to paint all schools yellow, the cost will come from inflation, and your wage will be worth less and costs will rise.
When the government wants to stimulate the economy, it reduces interest rates. To do this, it must create more spendable money and this is done by increasing the supply of loanable funds, which we have just discussed. People see more disposable income because they pay less interest on their mortgage, but the thing about inflation as a result of increasing money supply is that people have more money but that money loses its purchasing power.
In order to limit the scope of those who hold the legal monopoly on the creation of money, the gold standard has been used to tie the value of money to something more constant and stable. Under the gold standard, paper money is redeemable in gold. Governments cannot continue to print money indefinitely if they do not hold the gold to redeem it. It is because of the unlikeliness that everyone would want to convert to gold at the same time, that allows for the creation of credit.
The gold standard aims to provide a stable monetary system. It limits the actions of politicians because they cannot spend more than the gold without raising taxes. Paper money is technically a receipt which is fully convertible into a specific amount of gold. It is because the quantity of gold changes very slowly over time that makes it a dependable medium of exchange, a hard currency.
So gold would appear to be the perfect commodity to control the financial system, but with a twist; due to the success of world markets and growing global trade, the new annual supplies of gold may well be insufficient to accommodate future growth and this would appear to signal the end of a value system based on hard currency.
In the 1980s when IBM computers diversified into business models and domestic PCs along came Microsoft and it turned out that software became more valuable than the hardware, as it remains to this day. Similarly banks, backed by government, backed by gold, are a comforting assurance that things will be stable and will not change drastically bringing the risk of financial loss. However, it turns out there is an alternative, – soft currency.
The hard currency, gold, may not keep up with economic growth but that’s not really the problem because the existing quantity of money is always enough to conduct the existing volume of trade. Some deflation may be inevitable as money creation will be limited by the reducing availability of gold, but that will not be so terrible, it just means prices will fall. The problem is that we cannot keep subdividing paper money to create more, there can be no note that represents one thousandth of a pound.
Soft currency, cryptos, address most if not all of the impending issues that hard currency faces. De-centralisation means money cannot be created or removed from the system, as there is a cap. When more crypto is required, the existing supply continues to sub-divide, so it’s possible to own one thousandth of a pound, or even one millionth of a coin.
We said in the previous section that two main differences between hard and soft currencies were that cryptos are de-centralised and that transactions happen much quicker, but we didn’t mention security because we will discuss that in the next section about the blockchain.
Of course we think of banks as having the highest security, the money is printed and the gold kept secured in vaults. Cryptos differ in that they use cryptography to secure transactions and control the creation of currency. Crypto, from the Greek means ‘hidden’ or ‘secret’ and graphy means ‘writing’ so the meaning of cryptography is ‘hidden writing’.
The printed form that banks produce is referred to as ‘fiat’. It’s a word that means ‘a formal authorisation or arbitration order’. Fiat money is currency that a government has declared to be legal tender, but it is not necessarily always backed up with a physical commodity such as gold.
As we have learned, the fiat system can be inflationary. This is not the case with cryptos that have a market cap. Coins are mined and so new ones are being created all the time which generates interest and financial incentive for services that act as brokers and exchanges, more about these later. The cryptographic financial system is built on a peer-to-peer, open source, and de-centralised network abiding to specifications that have been agreed across the network, i.e. protocols.
In addition, the system works globally without national ownership. No individual or group own or control it, rather like the internet. Compare the cost of a transaction to your bank or something like Western Union and you’ll see the savings. But unlike using those standard services, with crypto the exchange of agreed values happens without the necessity of appending sender/recipient details such as your name. The first line of security is the omission of personal details being transported across the network. All that is required are codes, referred to as addresses and keys.
All of a sudden the benefits of crypto currencies is starting to mount up. We have seen how the technology solves the problems that fiat has and here are some of the others we’ve mentioned:
- It’s cheaper than conventional methods to exchange money
- It’s faster than conventional finance systems
- It’s de-centralised so you own it
- It isn’t inflationary
- The fees involved are low in comparison
And continuing with the security of the crypto technology, when you purchase online you need only be given an address to send the payment to. Unlike credit card transactions there is no form, no bank vetting, no CSV number to enter, etc, nothing that can get into the wrong hands. From the security of your ‘wallet’ you send funds to the given address. The seller simply receives a code from you and that code gives the merchant access to the required amount of crypto.
Cryptos use two keys, a private one and a public one. The public key is your crypto address, so if you want someone to pay you in cryptocurrency they only need to know this address and they can make a deposit. Therefore anyone can see a public key. The private key is your virtual signature and your added security. When you send funds to someone’s address, you will require your own public and private keys to do it.
What happens is that the two keys create a transaction certificate which is your receipt, and proof that the payment could only have been made by you. It is the private key that must be kept secret and anyone that knows it can move your funds. Once a transaction has been made it’s done and cannot be un-made.
As you can see, making a transaction does not require disclosure of personal information, the creation of a mathematically arrived at crypto key is all that’s needed. The mechanics of how it works is handled by the blockchain which we shall discuss in detail further on. The blockchain’s function is to keep track of all the transactions and to maintain an indisputable ledger. It knows where the transaction came from and where it went to, but it does not record who made them, only the date and time when it was added to the blockchain.
The blockchain register is transparent so it’s possible to determine the full activity of any address because it’s an undisputed matter of record, but again, no one knows who holds that currency. And this, is the reason cryptos have been so popular with criminals.
Now we can add to the list of benefits the following:
- It’s simple just requiring keys
- It’s safer not requiring personal data
- It offers a certain level of anonymity
Bitcoin was the first cryptocurrency, it started in 2009. Since then hundreds of other types of coin have been released and are trading quite well.
As of January 2018 there were over 1000 cryptocurrencies of which 626 had listed market caps of at least £72,890 ($100,000). Not all of them mirror the blockchain model, those that do are known as derivatives of Bitcoin, perhaps they have splintered away from the original Bitcoin with what is called a ‘fork’ or maybe they use their own technology but from scratch.On an exchange you will see currencies grouped. For example Bitcoin Cash is a fork of Bitcoin which now trades independently from Bitcoin. Another popular group is Ethereum; Ether and NEON/GAS both types of Ethereum and so on the exchange you might see something like this: NEON listed as NEO/ETH and Bitcoin Cash listed as BCH/BTC.
As the underlying computer code is open-source, it can be modified or tailored to suite another currency type, usually improving upon the original. If the code is modified slightly it can continue to use the same blockchain, this is called a soft fork. If the code strays too far from the original specification it will require its own blockchain, and this is a hard fork. In a soft fork one coin will remain valid and with a hard fork a new coin is created in the new blockchain.
There is a set point when a fork happens, a block is selected from which every transaction after that are handled by both new and old currencies. That block number has a date-stamp when it was created and this becomes the fork date. The result of a coin forking off to form its own system is that there are two of everything at the fork date. Anyone who was holding coins at that time therefore will have the same amount in both currencies. This is what is meant by ‘free coins’.
A fork is agreed upon by coin holders which in reality means the base miners that hold many wallets, and it can happen for any reason. It could introduce new technology and improvements like for Bitcoin Cash, or it might repair damage from a hack as was the case in the creation of Ethereum.
A study in April of 2017 by the Cambridge Centre for Alternative Finance gathered data from more than 100 cryptocurrency companies. It estimated that there were up to 5.8 million active users of cryptocurrencies in the world, with Bitcoin taking a 72 percent share of the market. By January 2018 Bitcoin had dropped to a record low of 36.1 percent.
There isn’t a physical coin as you may have guessed by now, it’s a virtual one. Essentially it’s a ledger that keeps records of transactions. When one person sells a coin the ledger records that amount having moved from one address and to another address. There is no reliance on banking staff and there is no need to know seller/buyer details. De-centralisation means nothing can prevent you buying or selling a coin, not a bank nor a government. The ledger is called the blockchain because Bitcoin was the first crypto and that’s what they decided to call it.
As the level of transactions increase with popularity and acceptance of a coin, that coin should continue to increase in value unlike fiat which loses value each year with inflation. Which leads to the question of where do the coins come from. The answer is that they are mined. When we said above that the blockchain records transactions, there is one step that we haven’t mentioned up to now; mining.
The process of mining is the act of confirming transactions so that they can be added to the blockchain, only then is a transaction completed. Computers on the network use mining software to verify transactions. These confirmed transactions are collected in a group known as a block and this block is then placed in the queue to be added to the ledger, the blockchain.
This work is rewarded with coin. The more that is mined, the more coins come into existence until the cap is reached. Eventually the cap will be reached and there will be no new coins left to mine. At that time the only reward comes from transaction fees. We shall see when that happens with Bitcoin, whether there’s enough interest to maintain it or will miners simply move to other cryptos that are still mining.
We learned earlier that the blockchain was an invention by Satoshi Nakamoto and used for the first cryptocurrency Bitcoin. In the process of developing the core technology to implement the currency, they had also found the solution to the double-spending problem for digital currency.
Double-spending is an issue pertaining to digital currency alone. It describes a risk that the same token can be used twice. So the same token could be moved from your computer to two other computers. The problem to solve therefore, was how to ensure that a file cannot be copied. Satoshi Nakamoto introduced a protocol to verify each transaction before it is added to the blockchain. It’s called a Proof-of-Work (PoW) and it’s what miners are doing when they verify and add to the blockchain.
The PoW mechanism is the necessary step in the cryptocurrency process that solves the problem of double-spending. Once a transaction is confirmed, it’s almost impossible to double-spend it. When you make a transaction sometimes you see a message that it will not clear until it has been confirmed 6 times, or even 100 times. Each further confirmation make counterfeit an impossibility and therefore as blocks are added to the chain each new Bitcoin is unique and its subsequent transactions are legitimate.
The blockchain is maintained by a network of nodes and miners running the cryptocurrency software. For miners, brokers, exchanges and people with wallets to communicate with the blockchain they require compatible software. For example you might use a wallet app on your mobile from Coinbase.Your request to buy, sell or exchange currency is sent to a node. The blockchain network is a collection of many nodes. Each one has a copy of the blockchain ledger, when an update is made it is shared with the other nodes. In this way when a transaction is confirmed and the ledger is sent on to the other node, those nodes confirm the transaction again. The nodes act as the electronic filter and bookeeper for the blockchain.
The blockchain works on open-source software and is transparent. This means that it’s publicly available for anyone to view. All transactions on the blockchain can be viewed if you use a browser known as a ‘blockchain explorer’.
You will not be able to see any identifying details about who made the transactions, so you could not determine who owns a wallet address, but some brokers are compelled to hold the personal information of users, for example in the UK where crypto is traded for GBP, a company like Coinbase would have to hand over your details if asked by HMRC.
There isn’t much UK regulation as crypto trading is still in its infancy. From a tax point of view HMRC do not seek VAT on the value of the coin as it is regarded as private money, but it is interested in charging VAT on the commission i.e. transaction fees.
The talk is all about keeping cryptocurrencies unregulated but the commerce side is arguing that the lack of regulation is preventing start up companies from joining the crypto industry early on, and existing traders wishing to establish in the UK simply do not know how they will be regulated and prefer to base themselves elsewhere, such as Paris over London, that has an active policy to draw business to it and away from other European hubs.
One thing is for sure in the UK, comprehensive regulation will come and likely force companies to have anti-money laundering regulations as a starter. The idea is that there will be an influx in startups due to a stable environment where everyone knows how they are regulated, but in truth regulation is always about the formality of squeezing taxes out of enterprise.
Bitcoin & Mining
The Bitcoin was an invention by Satoshi Nakamoto. At this time it’s not known for sure if this is an individual or a group of people that went by that name. There is no person of that name that has come forward but for this article we shall assume it refers to the team that put the Bitcoin software together.
Satoshi Nakamoto published their invention on 31 October 2008 in a paper called Bitcoin: A Peer-to-Peer Electronic Cash System and the software was released on 3 January 2009. Satoshi Nakamoto worked with developers for a further year, completing all necessary modifications to the software and then handing over control of the source code to developer Gavin Andresen and promptly disappearing.
A finger has been pointed at Jed McCaleb, a lover of Japanese culture and resident of Japan, who created the bitcoin exchange Mt. Gox which ran into trouble losing millions of their customers’ money and then he co-founded the payment systems Ripple and later Stellar. This is one theory of the identity of Satoshi Nakamoto, and there are many others.
The system developed by Satoshi Nakamoto was an electronic payment method based on cryptography and mathematical proof. It was the first de-centralised cryptocurrency. By 2013 some mainstream websites started using Bitcoin and in 2014 companies as large as Dell and Microsoft were accepting it.
It’s thought that SatoshiNakamoto mined many of the early blocks making around 1 million Bitcoins. That’s worth around £10 billion today assuming a coin is worth £10,000, but these Bitcoins have remained untouched and unspent.
One of the last emails Satoshi Nakamoto is known to have sent was to a software developer, dated 23 April 2011, containing this sentence: “I’ve moved on to other things. It’s in good hands with Gavin and everyone.”
Bitcoin was designed to have a maximum number of coins, i.e. a cap. Only 21 million will ever be created under the original specification and once they have all been mined, when enough transactions have been verified by miners and added to the blockchain, there will be no more coins left to buy. When that happens you will only be able to purchase Bitcoin when someone sells some.
However there is a lot of scope in a coin as one Bitcoin can be divided into smaller parts. The smallest divisible amount is a ‘Satoshi’ and one hundred million Satoshis make one bitcoin.
The amount of new Bitcoins that are allowed to be mined is halved every four years along with the reward for mining a block and the rate of mining. This difficulty of mining is intentional to limit the rate of Bitcoin discovery. Even though as of January 2018 we can look at the blockchain and see that 16,800,000 Bitcoins have been mined, that’s exactly 80 percent, the fact that the rate of new coins is determined this way means that it will take until 2085 to reach 90 percent and until the year 2135 to achieve 100 percent.
At present, the amount of new Bitcoins that can be mined as a reward for mining is 12.5 every ten minutes. This ensures that Bitcoins are mined at a predictable rate regardless of how many miners are actively mining the coins. In 2020 this will be 6.25 new Bitcoins every ten minutes and in 2024 it will be 3.12 new Bitcoins and so on.
Transactions of existing Bitcoins are confirmed and added to the blockchain. This work is necessary for the system to work. Miners that do this work group verified transactions into blocks and for each block that is accepted by the blockchain ledger the miner receives a reward in the form of Bitcoin. The miner is now able to sell these Bitcoins as well as make money from fees for buying, selling and transferring amounts.
As more people trade in Bitcoin, the increased demand combined with the fixed supply forces the price to go up. In March 2017 the value of a Bitcoin, also known as the exchange rate, reached U.S. $1,268, exceeding the value of an ounce of gold (at U.S. $1,233) for the first time.
Trading, Investing, & Your Wallet
What you do with your Bitcoin is much the same as for any other currency. You invest it or trade with it. You can buy different currencies at a low price and sell at a higher price. And of course there are ATMs where you can withdraw Bitcoin converted to cash or pay for goods and services at places where Bitcoin payments are accepted.
The first thing to get your head around is that Bitcoin and cryptocurrencies are digital currencies. The Bitcoin is a virtual coin, simply existing as a record on a block in the blockchain ledger. This means when you buy Bitcoin you are not getting a physical currency, instead you receive a receipt to prove that you made that transaction, a transaction that has been verified more than once and leaves no doubt that the person holding the key to that part of the block must be the owner.
The receipt takes the form of a key. When you buy Bitcoin, the seller will need to know the address of your wallet in order to send you the keys related to that purchase. The wallet will store the mathematically generated keys needed to confirm your ownership of that amount of Bitcoin. One or more private keys can be saved in a wallet, but they are of the same denomination. So for Bitcoin you will need to setup a Bitcoin wallet, and if you buy Ethereum you need and Ether wallet, and so on.
The wallets themselves take several forms depending on your preference of security and storage. Print the keys and keep them safe in a paper wallet or download software to your computer if you require a desktop wallet and perhaps use a third party like Coinbase to store your keys with an online wallet.
You can have several Bitcoin wallets, using one for everyday spending and trading and another to hold your longer term investment. You could have an online wallet with a broker or exchange and another on your desktop, if that suits. You do not want to put all of your eggs in one basket.
To recap, Bitcoin uses public-key cryptography, in which two cryptographic keys, one public and one private, are generated. The public key is your wallet address and the private key is the secret one that only you have access to, not the exchange or the broker. Each Bitcoin owner controls their money outright, and is solely responsible for its security and usage.
There is another type called a hardware wallet. It’s basically a USB stick that holds your encrypted information, once you’re done you simply remove it from the computer and keep it in a safe place. There are various hardware wallets around including Trezor, Keepkey, and Ledger. These devices store your private keys and when connected to your computer you can send and receive cryptocurrency. If the hardware wallet is lost it can be restored using a 12-24 word phrase called a ‘seed’.
The first step is to create an account with one of the larger established merchants like Coinbase or Blockchain and you will be able to buy the more popular currencies such as Bitcoin, Ethereum, Bitcoin Cash and Litecoin. When you create your account the wallets for each currency type are automatically created and you can see the public keys that have been generated for them.
When you buy coin, the private key will be automatically moved to your wallet and you will see it as the amount of coin in your wallet and its current value. For example if you bought £50 of Bitcoin at an exchange rate of £10,000 you would expect to see the value of your wallet being £50 and the contents of the wallet being 0.005.
investment divided by price = btc (50 / 10000 = 0.005)
In fact you will see slightly less because the broker takes their fee from your initial payment. Usually the fee is 3 percent for transactions up to a certain amount, after that it drops to 2 percent and then 1 percent as the transaction amount gets higher. Coinbase charge set fees as the transaction amount rises, so the minimum transaction fee of £1.99 is applied for a purchase of £50 in Bitcoin. After deducting the purchase price you have in fact purchased £48.01 in Bitcoin and so your wallet will look like the amount below.
48.01 / 10000 = 0.004801
One other point to consider is the rapid fluctuation of the Bitcoin price, it varies depending on the exchange you’re viewing it on. This is because there’s no established common way to price Bitcoin, so there’s no common way to check what it should be. The price is based purely on trading and therefore prices vary from exchange to exchange depending on its size.
You can compare popular online brokers for example many apps that display the current Bitcoin price take their feed from the Coinbase website. You can compare that price with Blockchain or Kucoin and they will be similar thereabouts but not identical.
When you see the price you wish to buy at, on the system that holds your wallet, you can click on the ‘buy’ button and enter an amount, then click again to confirm the purchase and that’s how simple it is. You will see the wallet populate as described above.
What may happen when you see the amount of Bitcoin in your wallet is that it will often be more or less than you calculated. This happens because in between the time you have clicked to make the purchase and the time it takes for the broker to facilitate that transaction, the price has fluctuated. When you are at the screen to confirm your purchase you will not see the exchange rate you are buying at, because it is fluctuating all the time.
A purchase of Bitcoin made on the 10th of January 2018 when the price fell to £9,500 was listed on the receipt email from Coinbase at the exchange rate of £10,050. The price of Bitcoin had risen £550 at the click of a button. This is something that needs to be looked into during the next year as Bitcoin increases in popularity and cryptocurrency activity becomes more widely used.
Finally, remember that if you choose to keep your private keys online with Coinbase for example, then you are completely at their mercy regarding the security of your keys. If that exchange goes bust then you lose your money. Wallets should allow you to be in charge of your own private keys so look for that service when deciding where to keep your wallets. This way you can have better control.
Battle of the cryptos 2018
2017 was a remarkable year for Bitcoin, it’s price rose astronomically and by the end of year began to settle a bit. January of 2018 saw another dramatic change, this time the price spiralled down after news that China had pressurised cryptocurrencies and South Korea had raided the top crypto exchanges. But dropping as far as £8,200 in January it soon recovered and levelled off around the £10,000 mark.
Having surpassed the value of gold half way through the year and then reaching record highs in record times during the latter part, January saw Bitcoin lose the largest market share in its history. From over 80 percent at the start of 2017 it went to 37.6 percent in June and started 2018 with just 36.1 percent share of all the cryptocurrency market.
As well as Bitcoin being at a market share record low, other cryptocurrencies have seen big price movements. Ripple rose nearly 36,000 percent last year and would only require another rise of 62 percent to surpass Bitcoin for top spot. It would only need to get to £4.79 and on 13 January 2018 it stood at £1.82.
Ethereum would only need to rise 132 percent from its current price to surpass Bitcoin. Ethereum co-creator Steven Nerayoff attributes the increased usage of Ethereum to its ability to process transactions more quickly and cheaply than Bitcoin. Increasing interest in cryptocurrency will stimulate value for Ethereum in 2018, regardless of whether it overtakes Bitcoin.
I believe we’ll continue to see more companies across more industries in 2018 take a look at how blockchain technology can create efficiencies. The Australian Securities Exchange has already tested the blockchain system and stated that it would replace its current post-trade settlement process with it.
Real world commitments like this ensure that cryptocurrencies become more embedded in the business world and remain relevant. This helps to stabilise the currency and hold its value.