The first cryptocurrency to capture the public imagination was Bitcoin, which was launched in 2009 by an individual or group known under the pseudonym, Satoshi Nakamoto. As of October 2018, there were over 17.33 million bitcoins in circulation with a total market value of around $115 billion. Bitcoin's success has spawned a number of competing cryptocurrencies, known as "altcoins" (alternative variants of bitcoin, or other cryptocurrencies) such as Litecoin, Namecoin, Peercoin, Ethereum, EOS, and Cardano. Today, there are literally thousands of cryptocurrencies in existence, with an aggregate market value of over $200 billion (Bitcoin currently represents over 50% of the total value) (What is a 'Cryptocurrency', n.d.).
According to Jan Lansky, a cryptocurrency is a system that meets six conditions (Cryptocurrency, n.d.):
1. The system does not require a central authority, its state is maintained through distributed consensus.
2. The system keeps an overview of cryptocurrency units and their ownership.
3. The system defines whether new cryptocurrency units can be created. If new cryptocurrency units can be created, the system defines the circumstances of their origin and how to determine the ownership of these new units.
4. Ownership of cryptocurrency units can be proved exclusively cryptographically.
5. The system allows transactions to be performed in which ownership of the cryptographic units is changed. A transaction statement can only be issued by an entity proving the current ownership of these units.
6. If two different instructions for changing the ownership of the same cryptographic units are simultaneously entered, the system performs at most one of them.
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To truly understand how cryptocurrency mining works, you first need to know the basics of Blockchain, which is the underlying technology for cryptocurrencies like Bitcoin, Litecoin, and Ethereum (Clifford Chi, 2018).
Blockchain is like a digital ledger that records each transaction of a cryptocurrency, copies itself, and sends the copies to every computer, or node, in its network. To make sure the ledger’s true state is verified and updated, each node in the network references and communicates with each other to see if all the copies are the same. This decentralizes, secures, and publicizes every single transaction of the cryptocurrency (Clifford Chi, 2018).
If one of the copies isn’t the same, due to a manipulation of a transaction’s record after the fact, the network rejects the transaction. This security protocol halts people from altering the ledger to spend the cryptocurrency more than once or send someone else’s digital funds to themselves (Clifford Chi, 2018).
To update a blockchain with new transactions, a new block, which is a bundle of these transactions, needs to be created and added to the chain. But to create and add the block to the chain, the block needs to be validated by the answer to an incredibly intricate math problem. So individuals, groups, or businesses use mining rigs, which consists of mining hardware and software, to try and solve it. These validators are called miners, and the first miners to solve the problem will be rewarded with a payout of the cryptocurrency (Clifford Chi, 2018).
Once a miner figures out the correct answer to the math problem, which is verified by each node in the network, the new block is created and added to the blockchain and the winners earn a block reward. For Bitcoin miners, the block reward for validating one megabyte worth of Bitcoin transactions is 12.5 tokens (Clifford Chi, 2018).
Validation methods like cryptocurrency mining are called proof-of-work or PoW. Incentivizing miners with payouts of a certain cryptocurrency to validate its transactions makes the cryptocurrency safe, secure, and trustworthy to use. Mining also mints and releases the cryptocurrency into circulation, which increases the odds that consumers and merchants will be more willing to adopt and accept it, boosting the currency’s value (Clifford Chi, 2018).
There is a finite amount of them that can exist as cryptocurrencies must be mined. For example, there are 21 million bitcoins (Steve Fiorillo, 2018).
I’ll use an example to show you how it works using the Bitcoin network (Ray King, 2018):
1. George owes Michael 10 Bitcoin (BTC). George announces that he is sending Michael 10 BTC to the Bitcoin network.
2. Miners take the information and encrypt it. This is called hashing. To this information, they add other transaction information and hash that too. More and more information is added and hashed until there is enough to form a block.
3. The miners now race against each other to guess the encrypted code or block hash that will be given to the new block before it’s added to the blockchain. The lucky miner that guesses the right code gets to add the new block to the blockchain.
4. Now, all the other nodes on the network verify the transaction information in the new block. They check the whole blockchain to make sure that the new information matches. If it does, then the new block is valid, and the winning miner can add the new block to the blockchain. This is called confirmation.
5. Michael receives 10 BTC from George.
In a nutshell, cryptocurrency mining is the way cryptocurrency networks like Bitcoin verify and confirm new transactions (Ray King, 2018).
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Regardless of your method for buying cryptocurrency, you will need a wallet in order to obtain it. A cryptocurrency wallet is a public key and a private key. These digital keys confirm that it is you who is purchasing the cryptocurrency and links you to the blockchain (Steve Fiorillo, 2018).
You have a variety of cryptocurrency wallets to choose from (What Is Cryptocurrency and How Can, 2018):
- Desktop wallets. Software like Cryptonator allows you to send and store cryptocurrency addresses and also connects to the network to track transactions.
- Online wallets. Cryptocurrency keys are stored online by exchange platforms like Coinbase or Circle and can be accessed from anywhere.
- Mobile wallets. Apps like Blockchain store and encrypt your bitcoin keys so that you can make payments using your mobile device.
- Paper wallets. Some websites offer paper wallet services, generating a piece of paper with two QR codes on it. One code is the public address at which you receive cryptocurrency, and the other is your private address you can use for spending.
- Hardware wallets. You can use a USB device created specifically to store bitcoin electronically and your private address keys.
Among the safest are hardware wallets and paper wallets. Hardware wallets can connect to a computer so you can purchase cryptocurrencies, and then be stored offline. Paper wallets are literally just your public and private keys on a piece of paper, meaning they don't connect online at all (Steve Fiorillo, 2018).
Hardware wallets can be expensive, though. Software wallets don't come with the same costs, but run into more security risks, like getting hacked or a computer crash. Still, a reputable software wallet running on a computer with effective anti-virus and anti-malware protection should be able to safely store your cryptocurrency. Often, software and online wallets also have a mobile app available for iOS and Android (Steve Fiorillo, 2018).
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Blockchain refers to the underlying technology of cryptocurrency. Blockchain technology simply stores data on a distributed ledger. Different blockchain projects aim to store different types of data on their blockchains, from real estate details, to contracts, and, of course, virtual currency values. Cryptocurrency is just one type of data that can be stored on a blockchain (Joe Coburn, 2018).
1. Buy Goods
There are a lot of merchants - both online and offline - that accept Bitcoin as the form of payment. They range from massive online retailers like Overstock and Newegg to small local shops, bars and restaurants. Bitcoins can be used to pay for hotels, flights, jewelery, apps, computer parts and even a college degree (What is Cryptocurrency? Guide for Beginners, n.d.).
Other digital currencies like Litecoin, Ripple, Ethereum and so on aren’t accepted as widely just yet. Things are changing for the better though, with Apple having authorized at least 10 different cryptocurrencies as a viable form of payment on App Store (What is Cryptocurrency? Guide for Beginners, n.d.).
Users of cryptocurrencies other than Bitcoin can always exchange their coins for BTCs. Moreover, there are Gift Card selling websites like Gift Off, which accepts around 20 different cryptocurrencies. Through gift cards, you can essentially buy anything with a cryptocurrency. Finally, there are marketplaces like Bitify and OpenBazaar that only accept cryptocurrencies (What is Cryptocurrency? Guide for Beginners, n.d.).
2. Investment
Many people believe that cryptocurrencies are the hottest investment opportunity currently available. Bitcoin is the most recognizable digital currency to date meanwhile Ethereum, perhaps the second most valued cryptocurrency by market capitalization, has recorded the fastest rise a digital currency ever demonstrated (What is Cryptocurrency? Guide for Beginners, n.d.). It’s increased in value by 2,226% in just last year – a huge boon for early investors (Ray King, 2018).
However, it is worth noting that cryptocurrencies are high-risk investments. Their market value fluctuates tremendously. Moreover, it is partly unregulated, there is always a risk of them getting outlawed in certain jurisdictions and any cryptocurrency exchange can potentially get hacked (What is Cryptocurrency? Guide for Beginners, n.d.).
3. Acceptance as Business Payments
If you happen to own a business and if you’re looking for potential new customers, accepting cryptocurrencies as a form of payment may be a solution for you. The number of worldwide crypto-ATMs is growing greatly. Coin ATM Radar currently lists almost 1,800 ATMs in 58 countries (What is Cryptocurrency? Guide for Beginners, n.d.).
As bitcoin is still a fairly new method of payment, offering it as an option for your customers could help you bring in new business. By being an early adopter of cryptocurrency, you can gain a competitive advantage over your competition (Stacey McIntosh, 2018).
First of all, you need to let your customers know that your business accepts crypto coins. Simply putting a sign by your cash register should do the trick. The payments can then be accepted using hardware terminals, touch screen apps or simple wallet addresses through QR codes (What is Cryptocurrency? Guide for Beginners, n.d.).
There are many different services that you can use to be able to accept payments in cryptocurrencies. For example, CoinPayments currently accepts over 75 different digital currencies, charging just 0.5 percent commission per transaction. Other popular services include Cryptonator, CoinGate and BitPay, with the latter only accepting Bitcoins (What is Cryptocurrency? Guide for Beginners, n.d.).
In the US, Bitcoin and other cryptocurrencies have been recognized as a convertible virtual currency, which means accepting them as a form of payment is exactly the same as accepting cash, gold or gift cards (What is Cryptocurrency? Guide for Beginners, n.d.).
For tax purposes, US-based businesses accepting cryptocurrencies need to record a reference of sales, amount received in a particular currency and the date of transaction. If sales taxes are payable, the amount due is calculated based on the average exchange rate at the time of sale (What is Cryptocurrency? Guide for Beginners, n.d.).
The legal status of cryptocurrencies varies substantially from country to country and is still undefined or changing in many of them. While some countries have explicitly allowed their use and trade, others have banned or restricted it. According to the Library of Congress, an "absolute ban" on trading or using cryptocurrencies applies in eight countries: Algeria, Bolivia, Egypt, Iraq, Morocco, Nepal, Pakistan, and the United Arab Emirates meanwhile an "implicit ban" applies in another 15 countries, which include Bahrain, Bangladesh, China, Colombia, the Dominican Republic, Indonesia, Iran, Kuwait, Lesotho, Lithuania, Macau, Oman, Qatar, Saudi Arabia and Taiwan (Cryptocurrency, n.d.).
Various government agencies, departments, and courts have classified bitcoin differently. China Central Bank banned the handling of bitcoins by financial institutions in China in early 2014 whereas In Russia, though cryptocurrencies are legal, it is illegal to actually purchase goods with any currency other than the Russian Ruble (Cryptocurrency, n.d.).
Cryptocurrencies are a potential tool to evade economic sanctions for example against Russia, Iran, or Venezuela. In April 2018, Russian and Iranian economic representatives met to discuss how to bypass the global SWIFT system through decentralized blockchain technology. Russia also secretly supported Venezuela with the creation of the Petro (El Petro), a national cryptocurrency initiated by the Maduro government to obtain valuable oil revenues by circumventing US sanctions (Cryptocurrency, n.d.).
In August 2018, the Bank of Thailand announced its plans to create its own cryptocurrency, the Central Bank Digital Currency (CBDC) (Cryptocurrency, n.d.).
1. Advertising Bans
Bitcoin and other cryptocurrency advertisements were temporarily banned on Facebook, Google, Twitter, Bing, Snapchat, LinkedIn and MailChimp. Chinese internet platforms Baidu, Tencent, and Weibo have also prohibited bitcoin advertisements. The Japanese platform Line and the Russian platform Yandex have similar prohibitions (Cryptocurrency, n.d.).
2. U.S. Tax Status
On 25 March 2014, the United States Internal Revenue Service (IRS) ruled that bitcoin will be treated as property for tax purposes. This means bitcoin will be subject to capital gains tax (Cryptocurrency, n.d.).
Cryptocurrency networks display a lack of regulation that has been criticized as enabling criminals who seek to evade taxes and launder money (Cryptocurrency, n.d.).
Transactions that occur through the use and exchange of these altcoins are independent from formal banking systems, and therefore can make tax evasion simpler for individuals. Since charting taxable income is based upon what a recipient reports to the revenue service, it becomes extremely difficult to account for transactions made using existing cryptocurrencies, a mode of exchange that is complex and difficult to track (Cryptocurrency, n.d.).
Systems of anonymity that most cryptocurrencies offer can also serve as a simpler means to launder money. Rather than laundering money through an intricate net of financial actors and offshore bank accounts, laundering money through altcoins can be achieved through anonymous transactions (Cryptocurrency, n.d.).
Cryptocurrencies have been compared to Ponzi schemes, pyramid schemes and economic bubbles such as housing market bubbles (Cryptocurrency, n.d.).
Many governments have taken a cautious approach toward them, fearing their lack of central control and the effects they could have on financial security. Regulators in several countries have warned against cryptocurrency and some have taken concrete regulatory measures to dissuade users. Additionally, many banks do not offer services for cryptocurrencies and can refuse to offer services to virtual-currency companies (Cryptocurrency, n.d.).
Cryptocurrencies hold the promise of making it easier to transfer funds directly between two parties in a transaction, without the need for a trusted third party such as a bank or credit card company; these transfers are facilitated through the use of public keys and private keys for security purposes. In modern cryptocurrency systems, a user's "wallet," or account address, has the public key, and the private key is used to sign transactions. Fund transfers are done with minimal processing fees, allowing users to avoid the steep fees charged by most banks and financial institutions for wire transfers (What is a 'Cryptocurrency', n.d.).
The blockchain technology is used to store an online ledger of all the transactions of cryptocurrencies providing a data structure that is exposed to a limited threat from hackers and can be copied across all computers running Bitcoin software. Every new block generated must be verified by the ledgers of each user on the market, making it almost impossible to forge transaction histories. Many experts see this blockchain as having important uses in technologies such as online voting and crowdfunding (What is a 'Cryptocurrency', n.d.).
Payments using cryptocurrency can’t be reversed, which means merchants don’t have to worry about stopped payments. The blockchain makes it difficult for you to be defrauded (What Is Cryptocurrency and How Can, 2018).
Paying with credit or debit cards requires submitting sensitive banking information that could be stolen or compromised. As cryptocurrency transactions are anonymous and untraceable, thus cryptocurrency can be sent directly to a recipient without any information other than total amount you want to send (What Is Cryptocurrency and How Can, 2018).
There is a limited and quantifiable supply of cryptocurrency, unlike traditional currencies who's value can be diminished over time through the central bank moves to increase money supply. There can be no increase in the number of units of cryptocurrency, so they retain their value over time (What is Cryptocurrency? n.d.).
Even though cryptocurrency mining is economically beneficial to miners, consumers, merchants, and the cryptocurrency itself, digging for crypto can actually harm the environment (Clifford Chi, 2018).
As more people mine more cryptocurrency, it gets extremely difficult to solve the math problems that validate the cryptocurrency’s transactions. You need massive amounts of electricity to power your mining rigs and solve these complex problems, especially for cryptocurrencies with a limited supply, like Bitcoin. In fact, by the end of this year, Bitcoin miners are predicted to consume more electricity than all of Argentina (Clifford Chi, 2018).
Cryptocurrencies' blockchains are secure, but other aspects of a cryptocurrency ecosystem are not immune to the threat of hacking. Over the past decade, several online exchanges have been the subject of hacking and theft, sometimes with millions of dollars worth of coins stolen (What is a 'Cryptocurrency', n.d.).
In February 2014, the world's largest bitcoin exchange, Mt. Gox, declared bankruptcy. The company stated that it had lost nearly $473 million of their customers' bitcoins likely due to theft. This was equivalent to approximately 750,000 bitcoins, or about 7% of all the bitcoins in existence (Cryptocurrency, n.d.).
Cryptocurrencies is more susceptible to market volatility. The rate at which a cryptocurrency can be exchanged for another currency can fluctuate and vary widely. For example, Bitcoin has experienced some rapid surges and collapses in value, reaching as high as $19,000 per bitcoin in December of 2017 before returning to around $7,000 in the following months. The high volatility of cryptocurrency is thus considered by some economists to be a short-lived fad or speculative bubble (What is a 'Cryptocurrency', n.d.).
A digital cryptocurrency balance can be wiped out by a computer crash if a backup copy of the holdings does not exist, or if somebody simply loses their private keys because cryptocurrencies are virtual and do not have a central repository (What is a 'Cryptocurrency', n.d.).
With an increasing number of Initial Coin Offerings (ICOs) coming out every month, the number of cryptocurrencies in the markets is rising. However, out of the over 1300 existing cryptocurrencies, not all of them are legitimate (Vivek Sancheti, 2018).
Some coins are there in the markets to gather investments and run away with the investor’s money - such as in the case of BitConnect and Davorcoin among many others. Money invested by venture capitals and even regular investors is at a major risk with many ICOs. Many countries are now planning to regulate ICOs, while there are others planning to ban them altogether (Vivek Sancheti, 2018).
Cryptocurrencies offer a new way of storing and spending money anonymously and without the use of a centralized bank or financial institution. The technology is relatively new, and so it’s not yet widely understood or accepted as a means of payment. But it’s growing quickly and could be an important method of financial transactions in the future (What Is Cryptocurrency and How Can, 2018).
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Bibliography
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https://blog.hubspot.com/marketing/cryptocurrency-mining
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https://www.cryptoground.com/a/7-controversies-cryptocurrencies-2018
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Everything You Need to Know About Cryptocurrency
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November 18, 2018
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Reviewed by 浪子
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November 18, 2018
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