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Docid: 00021081
Publication Date: 2303
Report Type: TUTORIAL
Preview
Cryptocurrency is a form of decentralized digital currency for use in electronic transactions. Unlike traditional physical currency, it is not managed by a government, nor is it tied to any central bank. Instead, it is managed and maintained via the use of blockchain technology, a cryptography-based electronic ledger that operates a peer-to-peer system capable of logging all transactions of a given currency type while also tracking and administering all modifications in ownership.
Report Contents:
Executive Summary
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Cryptocurrency is a form of decentralized digital currency for use in
electronic transactions. Unlike traditional physical currency, it is not
managed by a government, nor is it tied to any central bank. Instead, it
is managed and maintained via the use of blockchain technology, a
cryptography-based electronic ledger that operates a peer-to-peer system
capable of logging all transactions of a given currency type while also
tracking and administering all modifications in ownership.
The use of cryptocurrency allows for anonymous, secure transactions to be
completed without the need for regulatory involvement. Therefore, it makes
it possible for users of the global Internet to do business without the
need for currency tied to the payer’s or payee’s nation. While this has
led some to see cryptocurrency as a burgeoning tool for criminals and
malicious parties, it has made others believe that cryptocurrency and
blockchains are the future of not only mediums of exchange but also of
other secure electronic records.
Cryptocurrency began its history in 2008 with the creation of blockchain
technology and the Bitcoin cryptocurrency.1 Adding to the
crypto lexicon, Bitcoin, and all subsequent cryptocurrencies, are
sometimes called “altcoins”.
Digital currency originally seemed like a pipe dream due to something
called “the double spending problem.”2 Simply put, this is the
possibility of spending the same crypto-coin twice by digitally
duplicating it. It is an issue analogous to counterfeiting physical
currency and one that was seemingly unassailable until the creation of
blockchain technology. All forms of currency require a central ledger in
order to keep their existence in check. For traditional currency, that
typically comes in the form of a national or multi-national central bank,
which is tasked with tracking things like exactly how may US dollars are
in circulation or the exchange rate of the Japanese yen versus the euro.
Security measures built into physical currency, as well as regulatory
efforts by central banks and treasury departments, ensure that ledgers
match the real world currency that is being exchanged. For example, the US
government can track things like counterfeit currency by using the unique
serial number assigned to all paper money at the time it is printed. This
provides a safeguard against a bill being physically copied and used while
its original is still in existence. In the digital world, such copies
would have been no more difficult to create than hitting Ctrl+C and
Ctrl+V.
But, the creation of blockchain technology prevents this by implementing
a global, constantly updated central ledger that logs all transactions
from the creation of a given cryptocurrency to the current ownership
status of every single coin. While this may sound like a huge flaw in the
privacy of cryptocurrency users, it is actually just the opposite, with
the entire transaction history of a coin existing solely in an encrypted
form. This data can be used to verify all future transactions using that
coin without the actual details of the transaction ever being available to
human eyes. For example, a given Bitcoin, which was originally created in
2008, has since been used hundreds of times. Each of those transactions
has been logged on the Bitcoin blockchain, giving a full, albeit
encrypted, history of exactly where that coin has been and who should own
it today. If an unauthorized user attempts to spend that coin, the
blockchain knows they do not legally own it and the transaction can be
blocked and reported as fraudulent.
With blockchain technology at work, widely dispersed users with no
legitimate reason to trust each other can collaboratively maintain a
single, peer-to-peer ledger of any cryptocurrency without sacrificing
personal information and without the need for any central authority. Even
the verification of transactions is handled by the blockchain itself via a
process known as “mining”. This system employs a cloud of distributed
computers tasked with the goal of doing the cryptographic math necessary
to verify the ownership and status of all cryptocurrency transactions.3
The owners of these distributed computing systems are then rewarded by the
blockchain with a whole or partial crypto-coin of their own for their
efforts. This creates a self-sustaining system that not only prevents
rampant inflation, due to the lengthy time it take to mine even a single
crypto-coin, but also assigns the work needed to maintain the currency to
those who have a vested interest in supporting its proliferation.
Although still something of a controversial topic for reasons that will
be detailed later in this report, cryptocurrency is becoming more and more
mainstream. It flew under the radar of all but the most tech savvy for the
better part of the decade. Today, some paint cryptocurrency as the wave of
the future, while others decry it as a currency designed specifically for
use by the criminal underworld. As with many new and exciting
technologies, the truth is likely somewhere in between.
Description
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Cryptocurrency is a very misunderstood subject, with few resources that
fully explain some of the most common questions asked by those who are new
to this revolutionary form of currency. In that spirit, the following
section will attempt to answer some of those questions in easily
understandable terms, while also giving a more complete view of just what
cryptocurrency is, why it is important, and why you should care about it.
Where did cryptocurrency come from?
As stated above, cryptocurrency got its start in 2008 with the creation
of Bitcoin and the blockchain technology that powered it. The exact
motivation behind its creation remains as nebulous as the precise identity
(or identities) of its creator(s). However, the primary thrust behind its
existence was to create a currency that was neither tied to nor beholden
to any central bank or government. The currency would, instead, be a
totally self-sustaining financial ecosystem with the stakeholders
themselves (in this case, anyone who owns Bitcoin) controlling its
proliferation and distribution via “mining”. Mining is a process wherein
the owners of distributed computer systems volunteer their processing
power to help process transactions. In exchange for the use of their
systems, these miners are rewarded with some of that cryptocurrency for
themselves at a set rate. For example, a Bitcoin miner may receive
0.00001btc (Bitcoin) per transaction processed. This would allow them to
eventually build up their own cryptocurrency “wallet” (covered in more
detail below), where they can save or dispose of their funds as they see
fit. The rate at which the cryptocurrency is mined can change, but the
relationship between the processing of transactions and the creation of
new currency is the same across all traditional cryptocurrencies.
How much is cryptocurrency worth?
This is a surprisingly difficult and complex question to answer. Not only
are there more than 22,000 cryptocurrencies traded publicly,4
but the prices, in relation to physical currency, can change dramatically
on any single day.5 Such wild fluctuation is one of the primary
facts pointed to by those skeptical of cryptocurrency’s viability as a
whole. Even the oldest, most well established cryptocurrencies still show
a level of volatility that would bankrupt a nation in short order if they
were viewed as a national, physical currency.
What gives cryptocurrency its value?
To put it as simply as possible, cryptocurrency derives its value from
the same place as any other nation’s currency: the willingness of people
to accept that it is valuable. The easiest way to explain this is to look
at a classic economical concept: The gold standard. This model of currency
distribution relies on coins or paper money being disseminated among a
population in lieu of a set amount of the aforementioned precious metal.
The concept that guarantees that the essentially worthless piece of paper
in someone’s wallet has real-world value is the promise that that person
can exchange a note issued by the central bank for an appropriate amount
of gold. Due to the growing population of the human race, inflation, and
other factors, most standards based on precious metals and the like have
long-since been abandoned by the developed nations of the world and their
respective central banks. However, the concept remains the underpinning of
the financial system in many countries, including the US. A US dollar
today has its value guaranteed by the Treasury Department through the
assets and political power of the US government. Should the entirety of
the US government suddenly vanish from the face of the earth, those US
dollars would revert to being worth nothing more than the paper and ink
they are made of. Therefore it is the willingness of all of the
stakeholders involved in the creation, collection, and distribution of a
currency that gives it a set value. Bitcoin became worth $1,000 for the
first time when the first person was willing to exchange $1,000 for a
single Bitcoin. The same went for $10,000 and $50,000 and so on. Much like
any commodity, its worth is determined by what the market is willing to
bear. However, there is one caveat here. Bitcoin, and many other
crypto-coins, were actually designed to have an upward limit on how many
can be in existence at any given time.6 This creates something
similar to the aforementioned gold standard by ensuring that there is a
certain scarcity to the currency, as there is to precious metals. As of
right now, none of the major cryptocurrencies have yet reached a hard cap
of this type.
How is cryptocurrency stored?
As with real currency, cryptocurrency is stored in a “wallet.” However,
unlike the physical item of this name, a crypto wallet is not simply a
place for the money to be kept, but is also a personalized, uniquely
secured digital entity that can only be accessed with the correct
credentials. Wallets store their owners’ private and public cryptographic
keys, the secure data that allows the blockchain to verify their identity
whenever a transaction is attempted.7 These keys are analogous
to a wallet owner’s bank account number and PIN, providing them with the
necessary data to plug into a transaction in order to direct the funds and
to verify they are who they are claiming to be. The public key in this
analogy would be the user’s bank routing number, which can be shared with
other users in order to facilitate transaction, while the private key must
remain secret, like the user’s PIN, in order to prevent unauthorized
parties from accessing that user’s funds. These keys are much too long to
be memorized, and must themselves be stored in digital files. The methods
of storing these keys varies from user to user, with various levels of
security. Some users choose to use a public cryptocurrency exchange to
store their keys in a password-protected account; others prefer air gapped
methods like storing the data in a wallet.bin file on a secured hard
drive. Unfortunately, it should be noted that if a user were ever to
completely lose access to these keys, the funds within that wallet would
also be lost. The hyper-secure nature of the system means that there can
be no equivalent of a “forgot your password” system in place.
How is cryptocurrency used?
This is perhaps the easiest question to answer. Cryptocurrency can be
used in all of the same ways any physical currency, assuming a retailer or
other party requesting funds is willing to accept it. Numerous exchanges
will also accept cryptocurrencies in exchange for physical currencies, as
well as in exchange for other cryptocurrencies. As with speculating on the
fluctuating value of nation-based money, traders will exchange one
crypto-coin for another in the hopes that exchange rates will swing upward
at a later date, allowing them to reverse the trade for a profit.
Lastly, there is some truth to the fact that cryptocurrency can
facilitate payment for illicit goods and criminal services. The very
nature of the currency provides a level of anonymity that most physical
currency exchanges cannot, especially when they must occur over the open
Internet. While some have claimed that only obscure, lesser-known
alt-coins are used for purposes such as these, Bitcoin itself was found to
have been employed for some rather sickening purposes. This was discovered
by a group of researchers at the RWTH Aachen University when they analyzed
the Bitcoin blockchain for non-financial data.8 Due to the
nature of the blockchain, users can insert small bits of data during
transactions which are analogous to the “notes” section of a written
check. This study found the presence of multiple instances of child
pornography and links to related materials within the blockchain, strongly
suggesting that Bitcoin had been involved in such transactions. While some
would argue that such criminals will always find a way to pay for illegal
items on an anonymous basis, it must be said that cryptocurrency does have
the potential to be a great facilitator of such behavior.
Current View
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Currency Options
While the number of publicly-traded cryptocurrencies exceeds 22,000, only
a handful, according to NerdWallet, are widely-circulated.
“Bitcoin is the first and
most valuable cryptocurrency.
“Ethereum is commonly used to
carry out financial transactions more complex than those supported by
Bitcoin.
“Cardano is a competitor to
Ethereum led by one of its co-founders.
“Litecoin is an adaptation of
Bitcoin intended to make payments easier.
“Solana is another competitor
to Ethereum that emphasizes speed and cost-effectiveness.
“Dogecoin began as a joke but
has grown to be among the most valuable cryptocurrencies.
“Shiba Inu is another
dog-themed token with more complex mechanics.
“Stablecoins including Tether
and USDC are a class of cryptocurrencies whose values are designed to stay
stable relative to real-world assets such as the dollar.”9
Legal & Regulatory
Although cryptocurrency had generally flown under the legal and
regulatory radars, at least initially, those days are now over. This fact,
in and of itself, has caused many cryptocurrency mavericks to turn tail
and bail out. However, as was perhaps destined to happen, agencies like
the US Internal Revenue Service have taken notice, and are asking for
their share.
In 2014, for example, the IRS declared that following:
“Virtual currency that has an equivalent value
in real currency, or that acts as a substitute for real currency, is
referred to as “convertible” virtual currency. Bitcoin is one example of a
convertible virtual currency. Bitcoin can be digitally traded between
users and can be purchased for, or exchanged into, U.S. dollars, Euros,
and other real or virtual currencies.
“In general, the sale or exchange of
convertible virtual currency, or the use of convertible virtual currency
to pay for goods or services in a real-world economy transaction, has tax
consequences that may result in a tax liability.”
Public Image
While it is somewhat hard to nail down the global public image of
cryptocurrency, it is possible to parse out a general thrust of the
public’s feelings on the topic of digital currencies, thanks in large part
to fluctuating mainstream news coverage of such matters. By and large,
coverage has shown a public that still does not entirely understand the
origin or nature of cryptocurrencies. Reports have generally painted it as
one might expect a particularly volatile stock or commodity to be
portrayed, as something that made a few lucky souls rich but bankrupted
several others. Those with the technological know-how and bravery
necessary to enter the market themselves have seen results as mixed as the
above spectrum. There are no guarantees in cryptocurrency, as there are no
guarantees in nearly any form of investing. However, in crypto, the highs
are higher and the lows are lower.
Environmental Impact
It’s really simple; cryptocurrency is detrimental to the planet.
As analyst Paul Kim reveals, “The University of Cambridge estimates that
Bitcoin alone generates 132.48 terawatt-hours (TWh) annually, which easily
surpasses the annual energy usage of Norway at 123 TWh in 2020. The amount
of carbon dioxide emitted by this energy usage will vary depending on how
that energy was created. But in 2020, the US – where 35.4 percent of
Bitcoin mining takes place since China banned cryptocurrency mining in
2021 – created .85 pounds of carbon dioxide per kWh. This results in
nearly 40 billion pounds of carbon dioxide produced by US Bitcoin mining
alone.”10
If financial concerns aren’t enough to erode support for cryptocurrency,
perhaps environmental worries will.
Outlook
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The future of cryptocurrency, more than any other single
area of technology, seems impossible to predict. That said, there are some
fairly concrete facts that could influence the trajectory of
cryptocurrencies one way or the other:
Risk Reduction
The risk of investing in cryptocurrency must be significantly reduced
before any significant portion of the population will become interested.
No financial manager in their right mind would suggest that their client
put their hard-earned money into cryptocurrency. The volatility of even
the most well-established cryptocurrency, Bitcoin, is still far in excess
of all but the most disastrous stock market tumbles. Yes, there is a
fortune to be made on a correct guess. But, even those lucky few who
invested in Bitcoin when it was sub-$100 and divested of during any of its
major peaks have generally come forward to say that they would not
recommend that anyone attempt to replicate their good fortune.
Unsavory Reputation
Cryptocurrency needs to shake its image as a money for criminals in order
to succeed. One of the main reasons cryptocurrency was created was the
anonymity and privacy it could provide to its users. Anyone that has had
their identity stolen thanks to an online purchase can appreciate the
promise of such a monetary system, but this level of mystery in online
transactions must bring to mind images of “the dark web” and all of the
inherent evils to which such “dark money” can be put. While Bitcoin and
other cryptocurrencies have verifiably been used in criminal enterprises,
the same can be said of nearly any physical currency in the world.
However, this factor could serve as something of a tipping point for
cryptocurrency. If it were to be sanitized to the point where criminal
uses were no longer allowed, would it, at that point, have lost so much of
its security and privacy that users will no longer see the point in
investing?
Greener Cryptocurrency
The process of mining cryptocurrency needs to be less disruptive. Since
the actual computing process required is only a function of the secured
nature of transacting the cryptocurrency, it would be a huge boon to
digital currencies as a whole if a lighter-weight, less computing
intensive way of verifying and producing cryptocurrency could be found.
Cryptocurrency Armageddon
A single bad day could spell the end for cryptocurrency. Unlike almost
any of the nationally recognized physical currencies currently in
circulation, cryptocurrency as a whole is prone to a single disastrous
moment essentially bringing down the whole concept. While the
aforementioned story of child pornography-related links having been found
in the Bitcoin blockchain has gained widespread coverage, it has not, so
far, resulted in much in the way of dropping exchange prices or legal
action. However, imagine a story with just a bit more bite, or even a lot
more bite.
For example, as analyst Andy Rosen reports, “in November of 2022 the
market took a major hit as the cryptocurrency exchange FTX struggled to
deal with liquidity issues amid a spike in withdrawals. As the fallout
spread, cryptocurrencies both large and small saw their values plummet.”11
As things stand today, cryptocurrency could, in as little as one year’s
time, be nothing more than a technological footnote. Or, it could be on
its way to creating a truly global economy based on an entirely
decentralized currency. Literally no one on Earth could say which
direction it will go for sure. While the most likely scenario is somewhere
in the middle, even the tiniest movement towards one end or the other of
that spectrum could mean the gain or loss of billions of dollars for those
brave enough to believe they know which way the fate of cryptocurrency
will go.
References
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- 1 “The Great Chain of Being Sure About Things.” The
Economist. October 31, 2015. - 2 Chohan, Usman. “The Double Spending Problem and
Cryptocurrencies.” Banking & Insurance Journal. December
23, 2017. - 3 Krishnan, Hari R.; Saketh, Sai; Venkata, Tej.
“Cryptocurrency Mining – Transition to Cloud.” International
Journal of Advanced Computer Science and Application. Retrieved
March 12, 2018. - 4 Rosen, Andy. “What Is Cryptocurrency? A Guide for
Beginners.” NerdWallet. February 14, 2023. - 5 Bagshaw, Rick. “Top 10 Cryptocurrencies by Market
Capitalisation.” Yahoo Finance. October 2019. - 6 Greenberg, Andy. “Crypto Currency.” Forbes.
August 31, 2014. - 7 McGoogan, Sara. “What Is Cryptocurrency, How Does It
Work, and What Are Its Uses?” The Telegraph. March 23, 2018. - 8 Matzutt, Roman, et al. “A Quantitative Analysis of the
Impact of Arbitrary Blockchain Content on Bitcoin.” Communications and
Distributed Systems, RWTH Aachen University, Germany. Retrieved March
13, 2018. - 9 Rosen, Andy. “What Is Cryptocurrency? A Guide for
Beginners.” NerdWallet. February 14, 2023. - 10 Kim, Paul. “What Are the Environmental Impacts of
Cryptocurrencies?” Insider Inc. March 17, 2022. - 11 Rosen, Andy. “What Is Cryptocurrency? A Guide for
Beginners.” NerdWallet. February 14, 2023.
About the Author
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Michael Gariffo is an editor for Faulkner Information
Services. He tracks and writes about enterprise software and the IT
services sector, as well as telecommunications and data networking law.
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