Cryptionary

First used in 1990, the word “cryptocurrency” was just officially added to Merriam-Webster’s dictionary in March 2018. Cryptocurrency is defined as “any form of currency that only exists digitally, that usually has no central issuing or regulating authority but instead uses a decentralized system to record transactions and manage the issuance of new units, and that relies on cryptography to prevent counterfeiting and fraudulent transactions.”

History

Prior to anonymous Satoshi Nakamoto’s creation of Bitcoin in 2008, there had been previous attempts at developing a cryptocurrency based on encrypted ledgers, but none succeeded. Nakamoto’s paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System” changed the game and the Bitcoin network launched shortly afterward, in 2009.

2011 brought the emergence of competing cryptocurrencies, each hoping to improve on the original design. Some have had more success than others, but none rivaled Bitcoin until 2016, with the creation of Ethereum and the emergence of initial coin offerings (ICOs). ICOs operate as fundraising platforms for startup companies, offering investors the opportunity to trade shares in the new company.

Bitcoin and other cryptocurrencies continue to grow overall, fluctuate individually, and challenge the global market and regulating authorities. Cryptocurrency and its underlying blockchain technology will continue to shape various industries worldwide.

Popular Cryptocurrencies

• Bitcoin (BTC) was the first and remains the most popular cryptocurrency. Other currencies use bitcoin’s decentralized peer-to-peer model as the standard for the creation of new currencies.
• Litecoin (LTC) “launched in the year 2011, was among the initial cryptocurrencies following bitcoin and was often referred to as ‘silver to Bitcoin’s gold.’” LTC highlights their faster transaction confirmation time as an improvement over BTC.
• Ethereum (ETH) began in 2015 and is currently the second-most popular currency, useful to developers wanting to run applications inside Ethereum.

An exchange is a platform that allows users to trade currency and cryptocurrency for other cryptocurrencies. There exist both centralized and decentralized exchanges.

Centralized exchanges are the most common type, and work as a third party for users looking to trade cryptocurrency. Coinbase, Bitfinex, and Binance are among the most popular and largest centralized exchanges in operation. Instead of doing peer-to-peer trading, users trade directly with the exchange itself.

This places the user’s funds solely in the exchange until the transaction is finished, which can be a problem if the exchange has issues with stability. Maintenance issues, for example, can be a major cost for users if they are unable to access their funds. Security is another major concern: because centralized exchanges hold onto a user’s currency, they may deal with extremely high volumes at any given time, making them prime targets for hacking. The volatility of a centralized exchange is also important—users often prioritize platforms that can make transactions quickly, as market prices can fluctuate immensely from the initiation to the completion of a transaction.

Decentralized exchanges retain the peer-to-peer nature of cryptocurrency and have surged in popularity in 2018. They essentially pair a user with another user looking to make the opposite transaction. Currency and cryptocurrency is only held onto while the transaction is being made, which lessens the risk of a major hack that central exchanges sometimes experience. Likewise, a user’s store of cryptocurrency is not at the mercy of the exchange’s security and stability.

Though they are increasing in mainstream popularity, the appeal of decentralized exchanges is still primarily reserved for more experienced traders. Changelly and ShapeShift have both proven to be very popular among new traders, and IDEX’s beta launch in 2017 boasts an interface with ease-of-use. New users should vet decentralized exchanges before using them due to their lack of regulation and anonymity of ownership. However, the direct transactions and increased security against hacking are widely appealing features, suggesting that decentralized exchanges may be the future of crypto exchanges.

Meta description: A brief overview of centralized and decentralized exchanges, and the pros and cons of using them.

A hard fork in cryptocurrency is a divergence in the blockchain that results in two chains. One chain follows the original protocol, while the “forked” chain follows a new protocol. Like a fork in the road that results in two paths that cannot be crossed, hard forks result in two protocols that are no longer compatible.

Hard forks may occur to “correct important security risks found in older versions of the software, to add new functionality, or to reverse transactions.”

In a hard fork, the developers will take a copy of the blockchain and its transactions and make changes or upgrades. If those changes are not applied back to the original blockchain, a split occurs, and the new chain continues separately from the original. Nodes wishing to follow the updated version must update their protocols or their version of the blockchain will quickly become outdated.

Types of Hard Forks

Planned hard forks are when upgrades are scheduled beforehand and made in an effort to enhance the efficiency and effectiveness of the blockchain. The blockchain’s community would collectively be in favor of the changes and all users would update their nodes upon completion. No one would choose to support the original protocol, and all would follow the new forked chain.

In 2017, Ethereum and Monero both used planned hard forks to upgrade their blockchains for better scalability and to make privacy and security improvements.

Contentious hard forks result from arguments within the community that do not come to a consensus. There may be a split about major code changes, leading one party to follow the new fork and another party to stay with the original.

Bitcoin Cash resulted from a hard fork that attempted to solve scalability by increasing block size from 1MB to 8MB. Bitcoin Cash is a separate currency from the original Bitcoin.

Spin-off coins result when a new coin is created using the protocol of another existing coin. Since protocols are open sourced, anyone can attempt to create a new coin using an existing one as a foundation. Litecoin is an example of a spin-off coin.

Initial Coin Offerings (ICOs) work similarly to Initial Public Offerings (IPOs) by crowdsourcing funds for the launch of a new company or cryptocurrency. The use of an ICO allows a company to sell shares, raise funds, and distribute coins without the overhead of a venture company or bank.

The first ICO was launched in 2013 by Mastercoin. Ethereum quickly followed in 2014, raising 3700 BTC (over $2 million) in the first 12 hours. ICOs can offer crypto coins or crypto tokens depending on the needs of the company.

Crypto Coins are created as a new form of currency with their own blockchain and development. These coins would be like bitcoin and ether in their purpose and use—mainly as a form of payment.

Crypto Tokens are more diverse in their functionality than coins. Investors purchase tokens to work on the project being created by the ICO’s parent company. Ownership of tokens gives them equity in the company.

How It Works

When a startup wants to raise funds for a new project, an ICO gives them the opportunity to share their plan with investors, including:

The purpose and goal of the project

• How the project will meet the needs of the investors and clients
• How much money is required
• The timeline of the ICO campaign

During the campaign, money is raised usually through another cryptocurrency such as bitcoin, and if successful, the company will have the investment needed for development of their project. Anyone who purchased a coin or token will now have an investment in the project.

Increasing Regulations

ICOs are currently a mostly unregulated field, leaving it open to fraudulent activity. Some countries like China and South Korea have outright banned ICOs because of potential scams. The United States has been cautious but open so far in their acceptance of ICOs, but regulations will continue to be implemented as more fraudulent activity occurs and as regulating bodies more specifically define what are securities and what are investments.

Some popular and successful ICOs:

• NEO (formerly Antshares)
• Ethereum
• Spectrecoin
• Stratis
• Ark

Nick Szabo conceived of smart contracts in his 1997 essay “Formalizing and Securing Relationships on Public Networks,” where he described them as “new ways to formalize digital relationships which are more functional than their paper-based ancestors.” Simply put, the terms of a contract are converted into language that can be read and enforced by computers, substituting the need for various middlemen with a digital intermediary. In theory this improves transparency between parties, automates the execution of terms, and reduces the cost of doing business.

A vending machine is an instructive example. To buy a candy bar, we used to hand it to a clerk who would scan it, count our money, make change, and then finally give it to us with a printed receipt. With a vending machine, we simply insert a coin and press a button, the software confirms that the coin’s value matches that of the candy, and then dispenses it with change. We encounter versions of this all the time—auto-debit payments, hotel key cards—but what distinguishes a smart contract is that everything happens on a blockchain, and as a result it is capable of managing terms that are much more complex.

Smart contracts have found their way into the commercial sector, where they automate a range of daily operations as well as allow for more advanced services. Sue Troy, editorial director of TechTarget, reports on a number of use cases: real estate transactions can migrate from traditional escrow accounts to cryptographically-secured blockchains, auto insurers can offer temporal liability insurance dependent on road and weather conditions gleaned from the DMV and Weather Service, and companies like UPS can streamline their supply chains.

Smart contracts can manage payroll, collateral, and bonding, all of which factor into the regular operations of businesses across the globe. They also have significant legal applications.

Although they are still developing, smart contracts have a growing number of uses as blockchain-based technologies become more widely adopted. To quote Szabo, “the entire nature of our business relationships will be altered in ways only partially foreseeable.”