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Bitcoin and Cryptocurrency ETFs: Everything You Need to Know
In This Article
For those familiar with cryptocurrency trading, the process of buying and selling digital assets comes naturally. Unfortunately, this is not the case for many others — especially those that do not have the necessary knowledge and/or experience to deal with the security Once you have the freedom of being the sole owner of your money, it’s now your responsibility to ensure the. More issues related to owning cryptocurrency.
Beginners would find existing cryptocurrency ETFs (exchange-traded funds) very appealing, although the heavily unregulated space these funds are operating from offer close to nothing in term of security for the investor that is just starting out. Additionally, they are not real cryptocurrency ETFs as most of them are operating out of their own volition, without support from financial institutions — but both a cryptocurrency ETF and Bitcoin BUY NOW ETF are on the horizon.
In this article, you will be able to learn more about these financial instruments and decide whether or not they are a good choice for you.
- What is a Bitcoin ETF?
- How does a bitcoin ETF work?
- Crypto index fund investment opportunities
- Wholesale investors
- Grayscale Investments
- Retail investors
- XBT Provider
- Wholesale investors
- Investing in ETFs vs buying cryptocurrencies
- Short history of Bitcoin ETFs
- Leadership thoughts on ETFs
What is a Bitcoin ETF?
Exchange traded funds (ETFs) are a type of index fund which provides a way for investors to participate in a portfolio of stocks — or, in this case, cryptocurrencies (or bitcoin specifically) — without actually going through the process of acquiring and securing these assets. Instead, they collaborate with financial entities that hold these assets for them and enable them to buy and sell as they please in exchange for a brokerage fee.
ETFs enable investors to speculate on the price movements and trade the underlying asset with delegated risks, as the entity that is providing investors with the ETF is responsible for maintaining the security of the assets — effectively alleviating the investor from this responsibility.
They can be based either on physical ownership or a futures Futures contracts are literally agreements to buy or sell an asset on a future date and for a fixed price. More contract, which is an agreement between two financial institutions that the assets will be bought at a future price, instead of the current one.
How does a Bitcoin ETF work?
The best way to understand the way that ETFs work is to compare it to company stocks.
ETFs are created based on the asset which the financial organization owns, and it tracks the performance of that particular asset (or asset group).
The price movement of the assets is reflected in the price of each ETF stock, making either profit or losses for investors.
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Crypto Index Fund Investment Opportunities
Many of these bitcoin ETF-like options are only available to wholesale institutional investors, but there are some that are available for individual retail investors. We will cover both in this section — but, before we continue, we need to make a disclaimer.
None of these funds are true exchange-traded funds. They are either exchange-traded notes, futures, or index funds. The U.S. Securities and Exchange Commission (SEC) has not given approval to any organization to provide investors with cryptocurrency securities.
In fact, the SEC is widely recognized by the fact that it has shot down numerous attempts to legalize bitcoin ETFs (and open them up to the New York Stock Exchange) under the statement that none of the applicants have demonstrated the necessary requirements for properly protecting investors and the public.
Still, investing in a basket of digital currency assets is not impossible, although the choices are indeed limited.
The Coinbase Index Fund is open exclusively to accredited U.S. investors. The fund started their operations in March 2020. Since then, it has provided accredited investors the opportunity to expose themselves to all of the assets listed on the exchange for a minimum investment of $250,000.
This Australian cryptocurrency exchange launched the CoinJar Digital Currency Fund, which is an index fund, with two options: The Bitcoin Class, which provides investors easy entry into the bitcoin market, and the Mixed Class, which opens up a variety of the top performing cryptocurrencies — like Bitcoin (BTC), Ethereum BUY NOW (ETH), Ripple ( XRP BUY NOW ), and Litecoin BUY NOW (LTC).
The minimum investment in this index fund is $50,000 and it’s available only for institutional investors.
This investment company also serves accredited U.S. investors through their Bitcoin Investment Trust, and it owns the bitcoin directly. The company also owns different funds aimed at Ethereum and Bitcoin Cash BUY NOW (BCH).
Through their funds, Grayscale enables investors to trade crypto-backed shares in exchange for an annual maintenance fee.
This Swedish exchange trades ETNs (exchange-traded notes) on Nasdaq Stockholm. It began operations in 2020 and offers four investment classes to choose from.
In order to invest in these stocks, you need to have contact with a broker that is connected to the Nasdaq exchange in Stockholm.
Cryptocurrency and Bitcoin exchange Huobi released the first ever cryptocurrency ETF for retail investors, with a minimum entry of just $100. It enables investors to purchase stock from the company’s HB10 index fund, which is traded exclusively on their Huobi Pro exchange.
Although they are calling it an ETF, it cannot be held by traditional brokerage accounts and is not traded on a regulated securities exchange — a fact that disillusions potential investors.
Shortly after Huobi announced its ETF, OKEx took almost immediate action and announced its OK06ETT index fund one month later. It features extremely similar conditions with a minimal entry of $100 and the fund contains Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC), Bitcoin Cash (BCH), EOS BUY NOW (EOS), and Global Utility Token ( OKB BUY NOW ).
Investing in ETFs vs Buying Cryptocurrencies
Any form of investment inherently bears significant risks, and there are benefits and risks associated with investing regardless of the way you look at it.
In this section, we will review what are the reasons you both should and shouldn’t invest in cryptocurrencies through the use of ETFs. By the end of this section, you should have a clear perspective on what to do with your decision to invest in cryptocurrencies.
Investing in cryptocurrencies through ETFs is simple and effective. You don’t need to learn about the process of acquiring and safely storing cryptocurrencies, just like you don’t need to buy-out a vault to store “index” gold. The investment company takes care of all logistical issues.
Creating a diversified portfolio is easier. Doing it yourself would require you to create multiple wallets and exchange accounts, increasing the level of complexity and likely at a great cost of time. ETFs enable you to invest in a portfolio of cryptocurrencies in a simple and effective way.
There is no risk of being hacked. Both exchanges and your personal wallets are a target for hackers. The risk is the same for the fund but, when investing in the ETF, it is not your responsibility to protect the actual cryptocurrency.
Finally, fees are low. Traditionally-managed funds often charge investors premium fees, making it difficult to actually make a profit on your investments, even when things are going well — and some might claim things haven’t been going well in recent years.
ETFs are limited in choice. At the moment, there are no significantly diverse baskets that ETFs support. The overwhelmingly negative SEC stance prevents any form of retail investment opportunities — but this may soon change.
Cryptocurrencies are volatile. Widely recognized as one of the most unstable assets out there, cryptocurrencies have been disregarded by well-known investors (such as Warren Buffet) as a dangerous asset class. The reasoning behind that statement comes from the fact that the value of your ETF funds can rapidly move up or down, and it’s difficult to guarantee a regular return on investment.
Traditional ETFs often include a wide range of assets and securities to prevent the sudden loss of value for the fund. This approach is not available for crypto ETFs, mainly due to the fact that the SEC is not willing to approve any crypto ETF to the traditional market. This prevents investment companies from creating a diverse form of ETF that contains both traditional stocks and bitcoin. (Or any other cryptocurrency.)
The ETF provider needs to secure the cryptocurrency. Hacking can still influence your investment, even if you don’t own the assets. In the case of your ETF provider being hacked, there is no insurance in place to protect your investment.
Of course, fees also apply. Although smaller than traditional exchange funds, annual maintenance fees and brokerage fees are applied any time you buy and sell an ETF.
Finally, if you are buying ETFs from a provider located in another country, you might be held responsible to pay your country’s foreign income tax.
A Short History of Bitcoin ETFs
The SEC has gotten a strong reputation for denying exchange-traded funds for cryptocurrency and bitcoin. The reasons are staggeringly similar. The regulator claims the market is immature and such a financial instrument would cause significant risks for investors.
So far, there have been a total of 15 different proposals for starting up a legitimate ETF, whether they be asset-backed or a derivative-based arrangement. The SEC rejected most of them, but two remain on the table. For both of these, the community has been optimistic regarding their approval, mainly because the SEC has given public claims that their concerns have been answered, specifically for the case of the VanEck/SolidX ETF Bitcoin ETF application.
- Winklevoss Twins, Bats BZX Exchange, Inc. – 2020
- VanEck Vectors Bitcoin Strategy ETF – August 2020
- VanEck Vectors Bitcoin Strategy ETF – December 2020
- Winklevoss Twins, Bats BZX Exchange, Inc. – July 2020
- Bitwise ETF – July 2020
- ProShares – August 2020
- Direxion – August 2020
- Granite Shares – August 2020
- VanEck-SolidX-CBOE ETF – August 2020 (pending)
- Coinbase-BlackRock ETF – September 2020
The SEC’s Stance on Cryptocurrency ETFs
The Securities and Exchange Commission is an organization that has been created to prevent the abuse of investors, and it is their responsibility to take care of all participants on the securities market. Securities are investment products whose performance depends on a third party.
ETFs can be influenced by the performance on the managing fund, and therefore falls under this category. Many of the proposals sent forth to the SEC by companies that want to become a registered fund are denied because of several reasons.
What we know so far is that the SEC believes that the cryptocurrency market is not mature enough to provide open doors for anybody to invest. However, it might make an exception for funds that operate on a higher financial level, as the risks for well-established investors and investment companies are mitigated through their experience and financial capabilities.
The latest pending VanEck / SolidX bitcoin application includes these two companies that have tried to get approval independently, and have been rejected. Now, they are trying to win the approval together — and things might be different. The SEC has delayed its decision and has the ability to do so until February 2020. (The decision may come earlier, but it is unlikely.)
The SEC, in its protective role, wants to avoid making a mistake that would be difficult to rectify retroactively, which is why it is declining most of the proposals sent its way. So far, at least according to VanEck/SolidX leadership, all previous concerns from the SEC have been answered.
The market has evolved, there are community-based funds, and there are regulated futures markets for cryptocurrency. These regulated support structures could potentially help establish the ETF as the primary way that individuals (eventually) get in the cryptocurrency market. This will provide a level of security and reliability that the cryptocurrency space has been lacking, in terms of legal protection.
Leadership’s Thoughts on ETFs
We reached out to Mati Greenspan, an expert market analyst from eToro — a well-known social trading platform offering ETFs ranging from gold and silver to cryptocurrencies — to pick his brain on what financial leaders think about cryptocurrency ETFs. He told BeInCrypto :
“Everybody is waiting on the SEC’s decision regarding the VanEck and SolidX ETF. They are pulling most of the attention. If the decision goes through, both wholesale and retail investors will have an extremely safe and reliable way to invest in cryptoassets.
Crypto ETFs right now are mostly tailored for the professional investors. Institutions have more resources and knowledge, so they are able to perform their own due-diligence.
In the example of VanEck, there are higher barriers for entry, and a minimal contract is worth 25 BTC. It’s a clear sign that the ETF is designed with institutional investors in mind. The entire landscape is looking forward for its approval, as it will enable these institutions to create diversified funds that also include cryptoassets alongside other assets.
The VanEck ETF also comes with 100 percent insurance, as the entire ETF is asset-backed 1-to-1 with Bitcoin. The SEC acceptance, in this case, will open up new opportunities for asset managers around the world to include cryptoassets in a safe way.
[bctt tweet=”ETFs are a multi-trillion dollar market, and at the moment none of that is participating with cryptoassets. @MatiGreenspan” username=”beincrypto”]
If the decision goes through, cryptoassets will be able to enjoy the benefits of this massive market, and this is why the industry is excited about this proposal.”
You can follow Mati Greenspan on Twitter, where he actively shares his thoughts with the general public.
What is the Future for Cryptocurrency ETFs?
Last years cryptocurrency bull run — or bubble — ended up costing a lot of unaware investors, particularly those that bought in when the Bitcoin price reached upwards of $20,000. They did not realize how quickly things can change. Buying cryptocurrency at a premium of that magnitude is a risk. The SEC is obligated to protect investors, so it is not likely to allow cryptocurrency or bitcoin ETFs to be available to individual investors.
Instead, companies themselves are trying to get a foot in the door by creating high barriers of entry — such as a minimal entry fee of $200.000 — instantly disqualifying unaccredited investors.
The SEC is paying an increasing amount of attention to the blockchain technology and cryptocurrency industries to develop an informed opinion on what to do next. It has until Feb 2020 to make a decision regarding the latest VanEck/SolidX proposal.
Most likely, the SEC is going to make a decision after this year ends. It has a significant interest in observing what happens during the end of Q4 and the start of Q1 2020. This will allow the regulator to better consider the practicality of allowing the trillion-dollar securities market to dip into cryptocurrency-based exchange funds.
The cryptocurrency ETF markets are not yet mature enough to provide a compelling and safe experience for individual investors. Institutional, accredited investors have a lot more options for investing in cryptocurrency ETFs, mainly because of their ability to perform due diligence.
In other words, institutional investors know what they are doing and do not need the protection from the SEC to participate in broader, unregulated parts of the market. This makes exchanges exempt from many of the rules that the SEC places over companies that deal with retail investors.
Participating in either Huobi’s or OKEx’s index funds would mean an easy entry to the markets — but, as they are unregulated, they cannot be easily trusted. Price manipulation and fraud are common games in the market world, which is why the authorities look like brick walls and display a limited willingness to budge and provide approval.
With the decision to potentially allow the bitcoin-based VanEck ETF coming up soon, the profit potential for this market may increase — should the SEC decide to grant the first U.S. regulated license to operate an exchange-traded fund after two years of denial.
What do you think about Bitcoin and cryptocurrency ETFs? Are they just what this market needs to pull it out of its bearish doldrums, or will more institutional exposure only hamper parabolic gains in the future? Will a Bitcoin ETF have the same impact as Bitcoin futures contracts? Let us know your thoughts in the comments below!
Disclaimer: This article is not investment advice and is for educational purposes only. BeInCrypto is not responsible for any financial gains or losses made by any readers. Always do your own research and consult with a trained financial professional before investing.
Bitcoin’s Volatility Problem: How ndau, a Buoyant Cryptocurrency, Has Solved it in a Way Stablecoins Can’t
[TLDR: see below – What is ndau and how does it solve Bitcoin’s volatility problem?]
If you follow Bitcoin and blockchain technology, you know Bitcoin was released into the world as open-source software in January 2009 after having been introduced in a whitepaper in late 2008 as “A Peer-to-Peer Electronic Cash System.” Within the whitepaper you’ll see the words “money,” “cash,” “transactions,” and “payments” in several sections.
So we know from the author or authors, under the pseudonym Satoshi Nakamoto, the vision for Bitcoin was digital cash or digital money to be used for peer-to-peer transactions and payments. We have seen money in many forms through the ages, but the ideal characteristics of money are durability, portability, divisibility, uniformity, limited supply, and acceptability. Economists agree money has three primary functions: medium of exchange, unit of account, and store of value.
While the number of participants in the early Bitcoin ecosystem was relatively small, peers began using it to prove out its ability to serve as a medium of exchange. Famously, on May 22, 2020, a programmer purchased two large Papa John’s pizzas for 10,000 bitcoins, worth about $30 in total at the time. While the lucky recipient, if still holding those Bitcoins would now have approximately US $50 million in Bitcoin, this would be more akin to hitting the lottery — as opposed to having “stored” the approximately $30 in value that those Bitcoins were worth when they were used as payment.
According to The Economist in 2020, Bitcoin was functioning best as a medium of exchange. But it had yet to prove itself as a unit of account or store of value. With an average volatility seven times greater than gold, eight times greater than the S&P 500, and 18 times greater than the US dollar, it’s easy to see why it couldn’t be considered a way to store value for future use.
Fast forward to 2020. If you take a survey among Bitcoin enthusiasts about what Bitcoin is and its primary uses, you’ll consistently hear “Bitcoin is digital gold” and “Bitcoin is a store of value.” This narrative began to surface about 2020, gained momentum in 2020 and is widely parroted in the Bitcoin community today. Why are we hearing this so widely referenced today? I believe it’s because Bitcoin has failed to gain wide adoption as a medium of exchange, and people who HODL Bitcoin need a narrative that encourages others to join into the ecosystem. If you don’t personally need Bitcoin to make payments, then why should you own it? Well, if it’s “digital gold” and a “store of value” (that went up 20x in a year) then how could you resist?
As of this writing, Bitcoin is worth approximately US $5,219. However, by the time you’re reading this, its price will undoubtedly have changed. Will it move upward or downward? Nobody knows, but we can be certain it will continue to see plenty of volatility. When it’s up, there’s great euphoria amongst Bitcoin hodlers.
But what happens when the value of an asset goes up in value too quickly? Let’s take a look: following its hyperbolic run-up in price in 2020 from under US $1,000 to nearly $20,000, we’ve since watched it lose over 80% of its value in 2020 — dropping below US $3,200.
How would you feel about your “store of value” if you put US $575,000 into Bitcoin at the end of 2020 because you wanted to store it away to pay cash for your 2020 Lamborghini Aventador right about now? Well that’s not going to work with your Bitcoin currently valued at about $150,000… On second thought maybe you want to “store your value” for another year and save up for a 2021 BMW i8. Hey, it’s a lot better for the environment anyway…
I’m personally a big fan of Bitcoin and probably always will be. While I appreciate it for its revolutionary design, and I’m very bullish about its prospects into the future, I’m going on record now with a position you’ll rarely hear from other Bitcoin enthusiasts:
“Bitcoin is simply NOT a reliable store of value.”
Anyone who claims that Bitcoin is a store of value should simultaneously provide this disclaimer: Don’t rely on Bitcoin as a “store of value” unless you you want a wildly fluctuating market to dictate when you’ll be permitted to access that value.
In today’s crypto ecosystem we see several projects attempting to provide solutions to Bitcoin’s volatility problem. Stablecoins have become all the rage.
To date there have been more than 100 projects which have stated an intention to build out a stable digital currency. As outlined on Stable.Report these projects generally fall into 3 categories:
Asset Backed On-Chain:
Backed by cryptocurrencies such as Ether, it is dependent on the stability of the cryptocurrency on the other side of the equation.
Backed by a “regular” fiat currency such as USD or euro, precious metals or other real-world assets. It requires trust in an opaque and centralized third party to hold the collateral.
Relies on a combination of algorithms and smart-contracts to maintain price equilibrium, it requires continual network growth and investment to provide capital and support a falling currency value.
Each of these constructs are interesting in their own right, and have the potentially to solve the problem of volatility. But at the same time, I’m confident that many will fail, and all that I’ve seen which are intended to maintain a stable value of US $1 (or Euro, etc.) are a lousy store of value due to inflation. Here’s a quick look at how the value of a dollar has performed since the Federal Reserve began helping us with it in 1913. Spoiler alert: your dollar is worth about 3 cents — but you already know that.
So where does this leave us? How can we enjoy the benefits of a decentralized cryptocurrency enabled by blockchain while preserving wealth and giving us a true store of value?
One particular digital asset, ndau, which I first learned about in late 2020, provides holders with several volatility reduction features for the long-term store of value. The ndau project is fascinating and is elegant in its design, but also by necessity it’s complex. It took me awhile to understand it, but I was eager to invest the time because there were several incredibly talented computer scientists, economists, academics and developers involved in the design and creation of ndau. Some of them I’ve known for a couple of decades, and collectively they have authored more than 40 technology patents and built companies valued at more than a half-billion dollars. Ndau is a solid project with a solid team. I had to know how a cryptocurrency could actually be buoyant and I was willing to open my mind and take the time to learn.
The design of ndau provides stability but it can rise in value as demand warrants. Once the price of ndau rises, it resists downward volatility and can rise again. This property makes ndau go beyond the traditional notion of a stablecoin. It represents a new category of cryptocurrency – a buoyant cryptocurrency or buoyant coin .
Ndau isn’t an ICO. The development was funded in early 2020 with a $3 million investment led by Cosimo Ventures in Boston.
Ndau is different than any crypto project I’ve seen in several regards. The proceeds from the sale of the cryptocurrency don’t go to the founders, advisors, marketing expenses, bounties etc. The funds go into a not-for-profit endowment which then has the resources to manage a monetary policy to benefit the holders of ndau. The endowment also enables ndau to have a floor price which is designed to increase based on additional ndau issued along with the financial performance of the underlying investments (which are traditional investments akin to a university endowment — not Ethereum or the like). There are other means by which the ndau price is able to be buoyant. They are varied — ranging from demand-based issuance, incentives to hold, and burning of supply — all of which are embedded into ndau’s blockchain protocol to work in concert. You need to be willing to put in the work and delve into the details to fully understand it. It’s a paradox. If you skim through it and decide to formulate an opinion because your mind isn’t open to something new, then your impression of ndau will be virtually the opposite of what it actually is.
You don’t need to be “highly technical” to understand the ndau whitepaper, you just need to be truly open minded to discovering something you never before would have believed possible — something that initially “sounds too good to be true” — probably just like the first time you heard about Bitcoin and couldn’t contain your skepticism… and If you’re old enough, you can probably remember many other things that sounded “too good to be true” that are now enabled by the internet and are commonplace in our everyday lives.
Once I fully understood understood the design of ndau, the part that was most mind-bending is that an attempt to attack it would actually make it stronger. I’d like to see how George Soros would try to navigate that…
The unique design and the properties upon which ndau has been built, and the way it leverages blockchain technology along with decentralized governance and an endowment, make it unlike any other money in the history of the world — including other cryptocurrencies.
To fully appreciate ndau, read through the ndau whitepaper . Once you “get it” and fully understand how it has been designed to be buoyant, you won’t be able to get it out of your head. Ndau is a revolutionary cryptocurrency — the first of its kind to be designed as a long-term store of value. And the implications are profound.
What is Cryptocurrency? [Everything You Need To Know!]
What Is Cryptocurrency: 21st-Century Unicorn – Or The Money Of The Future?
- Cryptocurrency is an internet-based medium of exchange which uses cryptographical functions to conduct financial transactions. Cryptocurrencies leverage blockchain technology to gain decentralization, transparency, and immutability.
- The most important feature of a cryptocurrency is that it is not controlled by any central authority: the decentralized nature of the blockchain makes cryptocurrencies theoretically immune to the old ways of government control and interference.
- Cryptocurrencies can be sent directly between two parties via the use of private and public keys. These transfers can be done with minimal processing fees, allowing users to avoid the steep fees charged by traditional financial institutions.
Today cryptocurrencies (Buy Crypto) have become a global phenomenon known to most people. In this guide, we are going to tell you all that you need to know about cryptocurrencies and the sheer that they can bring into the global economic system.
Nowadays, you‘ll have a hard time finding a major bank, a big accounting firm, a prominent software company or a government that did not research cryptocurrencies, publish a paper about it or start a so-called blockchain-project. (Take our blockchain courses to learn more about the blockchain)
“Virtual currencies, perhaps most notably Bitcoin, have captured the imagination of some, struck fear among others, and confused the heck out of the rest of us .” – Thomas Carper, US-Senator
But beyond the noise and the press releases the overwhelming majority of people – even bankers, consultants, scientists, and developers – have very limited knowledge about cryptocurrencies. They often fail to even understand the basic concepts.
So let‘s walk through the whole story. What are cryptocurrencies?
Understanding Cryptocurrency Basics 101
- Where did cryptocurrency originate?
- Why should you learn about cryptocurrency?
- And what do you need to know about cryptocurrency?
How cryptocurrency works?
Few people know, but cryptocurrencies emerged as a side product of another invention. Satoshi Nakamoto, the unknown inventor of Bitcoin , the first and still most important cryptocurrency, never intended to invent a currency.
In his announcement of Bitcoin in late 2008, Satoshi said he developed “A Peer-to-Peer Electronic Cash System.“
His goal was to invent something; many people failed to create before digital cash.
Announcing the first release of Bitcoin, a new electronic cash system that uses a peer-to-peer network to prevent double-spending. It’s completely decentralized with no server or central authority. – Satoshi Nakamoto, 09 January 2009, announcing Bitcoin on SourceForge.
The single most important part of Satoshi‘s invention was that he found a way to build a decentralized digital cash system. In the nineties, there have been many attempts to create digital money, but they all failed.
… after more than a decade of failed Trusted Third Party based systems (Digicash, etc) , they see it as a lost cause. I hope they can make the distinction, that this is the first time I know of that we’re trying a non-trust based system. – Satoshi Nakamoto in an E-Mail to Dustin Trammell
After seeing all the centralized attempts fail, Satoshi tried to build a digital cash system without a central entity. Like a Peer-to-Peer network for file sharing.
This decision became the birth of cryptocurrency. They are the missing piece Satoshi found to realize digital cash. The reason why is a bit technical and complex, but if you get it, you‘ll know more about cryptocurrencies than most people do. So, let‘s try to make it as easy as possible:
To realize digital cash you need a payment network with accounts, balances, and transaction. That‘s easy to understand. One major problem every payment network has to solve is to prevent the so-called double spending : to prevent that one entity spends the same amount twice. Usually, this is done by a central server who keeps record about the balances.
In a decentralized network , you don‘t have this server. So you need every single entity of the network to do this job. Every peer in the network needs to have a list with all transactions to check if future transactions are valid or an attempt to double spend.
But how can these entities keep a consensus about these records?
If the peers of the network disagree about only one single, minor balance, everything is broken. They need an absolute consensus. Usually, you take, again, a central authority to declare the correct state of balances. But how can you achieve consensus without a central authority?
Nobody did know until Satoshi emerged out of nowhere. In fact, nobody believed it was even possible.
Satoshi proved it was. His major innovation was to achieve consensus without a central authority. Cryptocurrencies are a part of this solution – the part that made the solution thrilling, fascinating and helped it to roll over the world.
What is cryptocurrency?
If you take away all the noise around cryptocurrencies and reduce it to a simple definition, you find it to be just limited entries in a database no one can change without fulfilling specific conditions . This may seem ordinary, but, believe it or not: this is exactly how you can define a currency.
Take the money on your bank account: What is it more than entries in a database that can only be changed under specific conditions? You can even take physical coins and notes: What are they else than limited entries in a public physical database that can only be changed if you match the condition than you physically own the coins and notes? Money is all about a verified entry in some kind of database of accounts, balances, and transactions.
So, to give a proper definition – Cryptocurrency is an internet-based medium of exchange which uses cryptographical functions to conduct financial transactions. Cryptocurrencies leverage blockchain technology to gain decentralization, transparency, and immutability.
How miners create coins and confirm transactions
Let‘s have a look at the mechanism ruling the databases of cryptocurrencies. A cryptocurrency like Bitcoin consists of a network of peers. Every peer has a record of the complete history of all transactions and thus of the balance of every account.
A transaction is a file that says, “Bob gives X Bitcoin to Alice“ and is signed by Bob‘s private key. It‘s basic public key cryptography, nothing special at all. After signed, a transaction is broadcasted in the network, sent from one peer to every other peer. This is basic p2p-technology.
Blockchain and Cryptocurrency
The transaction is known almost immediately by the whole network. But only after a specific amount of time it gets confirmed.
Confirmation is a critical concept in cryptocurrencies. You could say that cryptocurrencies are all about confirmation.
As long as a transaction is unconfirmed, it is pending and can be forged. When a transaction is confirmed, it is set in stone. It is no longer forgeable, it can‘t be reversed, it is part of an immutable record of historical transactions: of the so-called blockchain.
Only miners can confirm transactions. This is their job in a cryptocurrency-network. They take transactions, stamp them as legit and spread them in the network. After a transaction is confirmed by a miner, every node has to add it to its database. It has become part of the blockchain.
For this job, the miners get rewarded with a token of the cryptocurrency, for example with Bitcoins. Since the miner‘s activity is the single most important part of the cryptocurrency-system we should stay for a moment and take a deeper look at it.
What is cryptocurrency mining?
Principally everybody can be a miner. Since a decentralized network has no authority to delegate this task, a cryptocurrency needs some kind of mechanism to prevent one ruling party from abusing it. Imagine someone creates thousands of peers and spreads forged transactions. The system would break immediately.
So, Satoshi set the rule that the miners need to invest some work of their computers to qualify for this task. In fact, they have to find a hash – a product of a cryptographic function – that connects the new block with its predecessor. This is called the Proof-of-Work. In Bitcoin, it is based on the SHA 256 Hash algorithm.
Image Credit: https://privacycanada.net
You don‘t need to understand the details about SHA 256. It‘s only important you know that it can be the basis of a cryptologic puzzle the miners compete to solve. After finding a solution, a miner can build a block and add it to the blockchain. As an incentive, he has the right to add a so-called coinbase transaction that gives him a specific number of Bitcoins. This is the only way to create valid Bitcoins.
Train to Become A Blockchain Developer
Bitcoins can only be created if miners solve a cryptographic puzzle. Since the difficulty of this puzzle increases the amount of computer power the whole miner’s invest, there is only a specific amount of cryptocurrency token that can be created in a given amount of time. This is part of the consensus no peer in the network can break.
If you really think about it, Bitcoin, as a decentralized network of peers that keep a consensus about accounts and balances, is more a currency than the numbers you see in your bank account. What are these numbers more than entries in a database – a database which can be changed by people you don‘t see and by rules you don‘t know?
Basically, cryptocurrencies are entries about token in decentralized consensus-databases. They are called CRYPTOcurrencies because the consensus-keeping process is secured by strong cryptography. Cryptocurrencies are built on cryptography . They are not secured by people or by trust, but by math. It is more probable that an asteroid falls on your house than that a bitcoin address is compromised.
Describing the properties of cryptocurrencies we need to separate between transactional and monetary properties. While most cryptocurrencies share a common set of properties, they are not carved in stone.
Understanding cryptocurrency properties
1) Irreversible: After confirmation, a transaction can‘t be reversed. By nobody. And nobody means nobody. Not you, not your bank, not the president of the United States, not Satoshi, not your miner. Nobody. If you send money, you send it. Period. No one can help you, if you sent your funds to a scammer or if a hacker stole them from your computer. There is no safety net.
2) Pseudonymous: Neither transactions nor accounts are connected to real-world identities. You receive Bitcoins on so-called addresses, which are randomly seeming chains of around 30 characters. While it is usually possible to analyze the transaction flow, it is not necessarily possible to connect the real-world identity of users with those addresses.
3) Fast and global: Transactions are propagated nearly instantly in the network and are confirmed in a couple of minutes. Since they happen in a global network of computers they are completely indifferent of your physical location. It doesn‘t matter if I send Bitcoin to my neighbor or to someone on the other side of the world.
4) Secure: Cryptocurrency funds are locked in a public key cryptography system. Only the owner of the private key can send cryptocurrency. Strong cryptography and the magic of big numbers make it impossible to break this scheme. A Bitcoin address is more secure than Fort Knox.
5) Permissionless : You don‘t have to ask anybody to use cryptocurrency. It‘s just a software that everybody can download for free. After you installed it, you can receive and send Bitcoins or other cryptocurrencies. No one can prevent you. There is no gatekeeper.
What is Cryptocurrency: Monetary properties
1) Controlled supply : Most cryptocurrencies limit the supply of the tokens. In Bitcoin, the supply decreases in time and will reach its final number sometime around the year 2140. All cryptocurrencies control the supply of the token by a schedule written in the code. This means the monetary supply of a cryptocurrency in every given moment in the future can roughly be calculated today. There is no surprise.
2) No debt but bearer : The Fiat-money on your bank account is created by debt , and the numbers, you see on your ledger represent nothing but debts. It‘s a system of IOU. Cryptocurrencies don‘t represent debts, they just represent themselves.
To understand the revolutionary impact of cryptocurrencies you need to consider both properties. Bitcoin as a permissionless, irreversible, and pseudonymous means of payment is an attack on the control of banks and governments over the monetary transactions of their citizens. You can‘t hinder someone to use Bitcoin, you can‘t prohibit someone to accept a payment, you can‘t undo a transaction.
As money with a limited, controlled supply that is not changeable by a government, a bank or any other central institution, cryptocurrencies attack the scope of the monetary policy. They take away the control central banks take on inflation or deflation by manipulating the monetary supply.
“While it’s still fairly new and unstable relative to the gold standard, cryptocurrency is definitely gaining traction and will most certainly have more normalized uses in the next few years. Right now, in particular, it’s increasing in popularity with the post-election market uncertainty. The key will be in making it easy for large-scale adoption (as with anything involving crypto) including developing safeguards and protections for buyers/investors. I expect that within two years , we’ll be in a place where people can shove their money under the virtual mattress through cryptocurrency, and they’ll know that wherever they go, that money will be there.” – Sarah Granger, Author, and Speaker.
Understanding cryptocurrency: Dawn of a new economy
Mostly due to its revolutionary properties cryptocurrencies have become a success their inventor, Satoshi Nakamoto, didn‘t dare to dream of it. While every other attempt to create a digital cash system didn‘t attract a critical mass of users, Bitcoin had something that provoked enthusiasm and fascination. Sometimes it feels more like religion than technology.
Cryptocurrencies are digital gold. Sound money that is secure from political influence. Money promises to preserve and increase its value over time. Cryptocurrencies are also a fast and comfortable means of payment with a worldwide scope, and they are private and anonymous enough to serve as a means of payment for black markets and any other outlawed economic activity.
But while cryptocurrencies are more used for payment, its use as a means of speculation and a store of value dwarfs the payment aspects. Cryptocurrencies gave birth to an incredibly dynamic, fast-growing market for investors and speculators. Exchanges like Okcoin, Poloniex or shapeshift enable the trade of hundreds of cryptocurrencies. Their daily trade volume exceeds that of major European stock exchanges.
At the same time, the praxis of Initial Coin Distribution (ICO), mostly facilitated by Ethereum‘s smart contracts, gave life to incredibly successful crowdfunding projects, in which often an idea is enough to collect millions of dollars. In the case of “The DAO,” it has been more than 150 million dollars.
In this rich ecosystem of coins and token, you experience extreme volatility. It‘s common that a coin gains 10 percent a day – sometimes 100 percent – just to lose the same the next day. If you are lucky, your coin‘s value grows up to 1000 percent in one or two weeks.
While Bitcoin remains by far the most famous cryptocurrency and most other cryptocurrencies have zero non-speculative impact, investors and users should keep an eye on several cryptocurrencies. Here we present the most popular cryptocurrencies of today.
The one and only, the first and most famous cryptocurrency. Bitcoin serves as a digital gold standard in the whole cryptocurrency-industry, is used as a global means of payment and is the de-facto currency of cyber-crime like darknet markets or ransomware. After seven years in existence, Bitcoin‘s price has increased from zero to more than 650 Dollar, and its transaction volume reached more than 200.000 daily transactions.
There is not much more to say – Bitcoin is here to stay.
The brainchild of young crypto-genius Vitalik Buterin has ascended to the second place in the hierarchy of cryptocurrencies. Other than Bitcoin its blockchain does not only validate a set of accounts and balances but of so-called states. This means that Ethereum can not only process transactions but complex contracts and programs.
This flexibility makes Ethereum the perfect instrument for blockchain -application. But it comes at a cost. After the Hack of the DAO – an Ethereum based smart contract – the developers decided to do a hard fork without consensus, which resulted in the emerge of Ethereum Classic. Besides this, there are several clones of Ethereum, and Ethereum itself is a host of several Tokens like DigixDAO and Augur. This makes Ethereum more a family of cryptocurrencies than a single currency.
While Ripple has a native cryptocurrency – XRP – it is more about a network to process IOUs than the cryptocurrency itself. XRP, the currency, doesn‘t serve as a medium to store and exchange value, but more as a token to protect the network against spam.
Ripple, unlike Bitcoin and Ethereum, has no mining since all the coins are already pre-mined. Ripple has found immense value in the financial space as a lot of banks have joined the Ripple network.
Litecoin was one of the first cryptocurrencies after Bitcoin and tagged as the silver to the digital gold bitcoin. Faster than bitcoin, with a larger amount of token and a new mining algorithm, Litecoin was a real innovation, perfectly tailored to be the smaller brother of bitcoin. “It facilitated the emerge of several other cryptocurrencies which used its codebase but made it, even more, lighter“. Examples are Dogecoin or Feathercoin.
While Litecoin failed to find a real use case and lost its second place after bitcoin, it is still actively developed and traded and is hoarded as a backup if Bitcoin fails.
Monero is the most prominent example of the CryptoNight algorithm. This algorithm was invented to add the privacy features Bitcoin is missing. If you use Bitcoin, every transaction is documented in the blockchain and the trail of transactions can be followed. With the introduction of a concept called ring-signatures, the CryptoNight algorithm was able to cut through that trail.
The first implementation of CryptoNight, Bytecoin, was heavily premined and thus rejected by the community. Monero was the first non-premined clone of bytecoin and raised a lot of awareness. There are several other incarnations of cryptonote with their own little improvements, but none of it did ever achieve the same popularity as Monero.
Monero‘s popularity peaked in summer 2020 when some darknet markets decided to accept it as a currency. This resulted in a steady increase in the price, while the actual usage of Monero seems to remain disappointingly small.
Besides those, there are hundreds of cryptocurrencies of several families. Most of them are nothing more than attempts to reach investors and quickly make money, but a lot of them promise playgrounds to test innovations in cryptocurrency-technology.
What is Cryptocurrency: Conclusion
The market of cryptocurrencies is fast and wild. Nearly every day new cryptocurrencies emerge, old die, early adopters get wealthy and investors lose money. Every cryptocurrency comes with a promise, mostly a big story to turn the world around. Few survive the first months, and most are pumped and dumped by speculators and live on as zombie coins until the last bagholder loses hope ever to see a return on his investment.
“In 2 years from now, I believe cryptocurrencies will be gaining legitimacy as a protocol for business transactions, micropayments, and overtaking Western Union as the preferred remittance tool. Regarding business transactions – you’ll see two paths: There will be financial businesses that use it for it’s no fee, nearly-instant ability to move any amount of money around, and there will be those that utilize it for its blockchain technology. Blockchain technology provides the largest benefit with trustless auditing, single source of truth, smart contracts, and color coins.”
– Cody Littlewood, and I’m the founder and CEO of Codelitt
Markets are dirty. But this doesn‘t change the fact that cryptocurrencies are here to stay – and here to change the world. This is already happening. People all over the world buy Bitcoin to protect themselves against the devaluation of their national currency. Mostly in Asia, a vivid market for Bitcoin remittance has emerged, and the Bitcoin using darknets of cybercrime are flourishing. More and more companies discover the power of Smart Contracts or token on Ethereum, the first real-world application of blockchain technologies emerge.
The revolution is already happening. Institutional investors start to buy cryptocurrencies. Banks and governments realize that this invention has the potential to draw their control away. Cryptocurrencies change the world. Step by step. You can either stand beside and observe – or you can become part of history in the making.
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