In 2009 something unique happened. A new form of currency, a digital currency, a cashless system called Bitcoin was launched. Bitcoin pioneered the era of a truly cashless system. But it simply opened the lid. Between 2009 and 2017, over 1100 cryptocurrencies have hit the market. Call it supersonic speed!
Even as cryptocurrencies grow in popularity, many people rarely understand them. It is not uncommon to hear people asking who prints Bitcoins, DASH, Ethereum or Zcash among other cryptos. We take a deep dive into cryptos to establish what they are and how they operate.
What exactly is a cryptocurrency?
Cryptocurrency is a type of digital currency that is designed to operate anonymously, without a central authority. It is a currency associated with advanced cryptography that involves converting legible info into almost uncrackable codes for tracking cash purchases and transfers.
At this point, it is important to contrast Cryptocurrencies to fiat/conventional currencies. While the fiat currencies such as US dollars or Euros are strictly under the control of central banks that print and release them to control inflation, cryptocurrencies are different. Cryptocurrencies are designed by individuals or organizations but become owned by people (nodes) in their network. Therefore, they cannot be censured, stopped, or controlled by any single authority.
Notably, the definition of cryptocurrency is very complex. In fact, there is none. While the above description captures the core tenets of cryptocurrency, newer versions are depicting a completely new picture. One example is Ripple. While it uses a peer-to-peer network and consensus model that makes it qualify as a decentralized model, the lead team opts to work with banks or gateways that are highly centralized. Though it is still a cryptocurrency, it falls outside the realms of the originally espoused anonymity.
The rise of cryptocurrencies and their popularity
For years, many people can simply watch as banks and central authorities define how currencies work. The governments of the day closely monitor and ensure that inflation is under control through the printing of the right quantities of notes and coins. However, this control has made sending payments complex, lengthy, and very expensive.
The alternatives that emerged, such as Credit Cards, Master Cards, and PayPal among others have not been reliable. In most of the cases, these money transfer methods act as an extension of banking systems and are easy targets by fraudsters. There is no doubt that a new type of currency that could be more reliable and not under any control was desired by many and it was fulfilled with the first crypto debuted.
Though some earlier links to cryptocurrencies existed, it is better to trace it from 2009 when the first cryptocurrency, Bitcoin, was launched by Satoshi Nakamoto. Note that Satoshi Nakamoto is a pseudo name. It is believed that Satoshi Nakamoto is a group of cryptographers and finance experts who masked their identities for legal reasons. Up to now, Satoshi Nakamoto is a mystery.
Bitcoin was launched as a network of sending payments in real-time without involving central authorities. In 2008, Satoshi released a white paper that explained the peer-to-peer cashless system before releasing the Bitcoin Core (code) in January 2009. Following the launch of Bitcoin, a raft of new cryptocurrencies was released based on the Bitcoin core.
In 2011, the second altcoins named NameCoin was released. It used the Bitcoin core programme and became the first decentralized DNS that made internet censorship very difficult. In December the same year Litecoin, the first cryptocurrency to use scrypt as the main hash function, was launched. This was a deviation from the main SHA-256 hashing function in Bitcoin.
Between 2012 and 2017, hundreds of cryptocurrencies, have entered the market. Some of them include Ethereum, Ripple, Dash, Monero, and IOTA among others.
The Dao attack and emergence of crypto forks
One of the top cryptocurrencies that followed Bitcoin is Ethereum. While Bitcoin’s focus was sending payments, Ethereum targeted facilitating the development of distributed apps (Dapps) and use of Smart Contracts. But what highlighted more in the cryptocurrency news was the DAO (decentralized autonomous organizations) attack that resulted in the loss of $150 worth of Ethers in 2016.
The DAO attack which was implemented through a replica DAO that later came to be referred as a DAO Child changed the history of cryptocurrencies. The Ethereum community woke up to the reality that the attacks were still possible. The Ethereum lead team arrived at an infamous decision of implementing a fork (division).
Ethereum was divided into, Ethereum Classic and Ethereum. Though the decision remains a hot debate in the crypto world, it presented cryptocurrencies with a new way of dealing with issues. Between May and October 2017, Bitcoin implemented two forks that yielded Bitcoin Cash and Bitcoin Gold. This is an emerging trend that could shape the future of cryptocurrencies.
Use of blockchain technology in cryptocurrencies
While many people find it difficult to capture the actual definition of digital currencies, how the cryptocurrency works are even more interesting. Cryptocurrencies use blockchain technology that eliminates the involvement of central organizations.
The blockchain technology is an algorithm and carefully distributed data structure for managing the native asset, BTC. The technology allows people to send money directly from one point to another with nodes helping to confirm the transactions.
The blockchain is a public ledger that captures the details of the transactions before adding them as blocks. If a person A in Michigan wants to send Bitcoins to a person B in London, he will initiate a transaction in the network. Then, the Bitcoin network will generate a complex mathematical puzzle that users (nodes) in the Bitcoin network must solve to confirm the transactions. At this point, four things happen;
- The transaction is encrypted.
- The Bitcoin core code generates a mathematical puzzle with adjusted difficulty to help maintain the right number of coins in supply.
- Miners spread in the network try to solve the puzzle. The first to get an answer confirms the network and gets rewarded with some Bitcoins.
- Once a node confirms a transaction, it also adds it as a block to the public ledger.
There are several ways that one can get altcoins. One is buying from a cryptocurrency market such as top exchanges like Coinbase, Poloniex, and CIX.io. These are markets that allow users to exchange cryptocurrencies either for other cryptocurrencies or fiat currencies.
The second and most popular method of acquiring crypto coins is through mining. What is cryptocurrency mining? Is Bitcoin mining profitable? Mining is the process of confirming transactions in a cryptocurrency network and adding new blocks into the public ledger. To put it differently, mining is the driving force in any cryptocurrency network.
Most cryptocurrencies in the cryptocurrency market today such as Bitcoin are mined using the SHA-256. However, there are others such as Litecoin that use Scrypt. Scrypt and other hashing functions such as x11 and Scrypt-N were created to address problems that were noted with the original Bitcoin SHA-256 such as high power requirement and low hashing power.
Mining is profitable if you have a lot of hashing power (the mining scale). Though it was possible to mine crypto coins in the past using a CPU that utilized GPU SHA-256, the mining difficulty has gone up so much such that only specialized ASIC SHA-256 can guarantee profitable mining. A Mining rig with 4 GPU would only generate about 3.4MH/s and use 3600 kw/h compared to an ASIC machine that can generate 6TH/s and only use 2200Kw/H.
The technical background to mining
In every mining process, the mining hardware in a network such as Bitcoin runs a crypto-hashing function called block header. These are two rounds of SHA256. Every time a miner sends a trial, the Bitcoin system replies with a nounce (a random number on the block header). Then, the hashing function generates a hexadecimal number such as this.
To get a new block, in every 10 mins, it is important to identify the difficulty target and ensure to outdo it. Let us say the difficulty looks like this.
Any number starting with a zero means that the difficulty would be below the target. Look at the example.
To be on the route to confirming a transaction, ensure to get about two zeros at the onset of the onset just under it. Here is an example.
Since the main target is a wide figure with a lot of digits, all miners should utilize simpler numbers to demonstrate the current target. The number is called minimum difficulty. This demonstrates the difficulty of mining compared to the first block that was mined when the network was unveiled. For example, if the mining difficulty is a figure such as 80,000 in the Bitcoin network, it means that it is 80,000 times more difficult to mine than it was when Satoshi mined the first block. The Bitcoin system adjusts the difficulty 2016 blocks (approximately 14 days).
Why cryptocurrencies are getting so popular
In the last five years, the types of cryptocurrencies in the market have skyrocketed. Why the high popularity? It appears that indeed, the society was yearning for changes in the finance industry. Three things have been associated with the fast growth and popularity of cryptocurrencies.
- Cryptocurrencies are cheaper and faster to send cash
If you compare sending cash using cryptocurrency networks to using a bank, the cost involved is negligible. This is because the transactions are peer-to-peer. The small fee only goes to support the network as opposed to piling huge profits. Besides, the transactions that would otherwise take days are completed within seconds. It is a true revolution.
- The transactions are anonymous
Many people want to send their transactions in a completely anonymous manner. It is advantageous because a buyer can order products without worrying of chargebacks when his ideologies do not cohere with the seller’s focus. However, this anonymity has also attracted fraudsters, scammers, and cybercriminals to prefer cryptocurrencies.
Earlier on in 2017, the dangerous strain of ransomware called wannacry attacked institutions in Europe. The attackers insisted that they wanted to be paid in Bitcoin because it was anonymous. This has been a major concern by governments with FBI strongly believing that the cryptocurrencies could be used to fuel crime and even terror.
- Users own the cryptocurrency
Though you own the cash in your bank account, the truth is that the legal tender is, in reality, a government property. This is why the government has the sole monopoly of controlling its value through regular printing. However, when you join a cryptocurrency network, you become the owner. For example, if you join the cryptocurrency Ethereum, the ethers (native assets in the Ethereum network), they are yours and cannot be accessed by any other person. Even if you lose the crypto wallet, the ethers will forever remain dormant.
Cryptocurrencies legality and taxes
Yes, currencies are legal. To date, there is no legislation established to regulate cryptocurrencies. However, they are viewed with great suspicion and even blocked from operations in some countries.
From the definition of cryptocurrencies, the main focus is making transactions easy, direct, cheaper, and direct. They mainly involve bypassing banks and centralized authorities. This means three things;
- Institutions that pay taxes such as banks could be at risk of getting closed.
- Cryptocurrencies make transactions anonymous which means there is no way that the government can track users for tax purposes.
- The anonymous nature of cryptocurrencies can be used to propagate crime.
In the US, the Commodities Futures Trading Commission has indicated that cryptocurrencies should be treated as commodities. This means that they are taxable as commodities. In the EU, the Court of Justice ruled that they are digital currencies and, therefore, should not be taxed. This followed the EU Central Bank advisory that traders should avoid dealing with crypto assets.
In China, the Chinese authorities have been very vocal about the discontent arising from the use of cryptocurrencies. In Mid-2017, ICOs were banned from China. Though the administration does not indicate cryptocurrencies are illegal, it points that any indication that they are compromising revenue authorities’ capabilities would result to a total ban.
Tips on staying on the side of the law on taxes
One thing that cryptocurrency users appear to agree is that regulations will finally be drawn. Therefore, it is important to ensure you stay on the right side of the law all the time using the following tips.
- Treat any income from mining or even cryptocurrency trading as taxable revenue.
- Ensure to capture the details of every transaction so that tax returns and proof can be generated if the need arises.
- Ensure to note the currency exchange value at any moment of a transaction. This should be done in fiat currency so that only the right amount is remitted to the tax authorities.
- Do not hesitate to work with a tax expert especially if dealing with a lot of crypto coins.
Today the technology has advanced so much as people move towards higher levels of artificial intelligence with inventions such as Sophia the bot to address issues that arise especially with big data. In the finance sector, the evolution of cryptocurrencies demonstrates it is possible to take financial services to the next level. The blockchain technology has demonstrated that it is possible to address anything by involving experts. The rising popularity indicates that the future lies in blockchain technologies.