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LeoGlossary: Cryptocurrency

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Cryptocurrency is a digital medium of exchange that allows wallets to engage in peer-to-peer transactions. This is done using encrypted algorithms.

Cryptocurrencies function both as a currency (medium of exchange) and a virtual accounting system. All transactions are logged on a blockchain, most which do not require permission. Anyone is free to utilize the system and post to the ledger.

There is no physical cryptocurrency such as banknotes or coins made from metal. It exists completely in digital (virtual) form.

One of the promising aspects to cryptocurrency is the removal of the banks, central or commercial. The blockchain is responsible for securing each transaction on the ledger. This is done through a variety of methods, depending upon how the system is set up.

Sovereignty

One of the main tenets of cryptocurrency is the idea of financial and monetary sovereignty. There are a couple of ways this comes into the picture.

By having currency that is controlled by a blockchain (i.e. code) and not a central banking system, or governments, individuals can be sure they truly own their money. At the same time, through the creation of decentralized finance, financial intermediaries will be continually pushed aside.

The idea is to build a financial system which is neither exclusionary nor extractive. When people have true account ownership, they can not be prohibited from accessing what is in them.

We also can see a system which is not dependent upon the monetary policy of some outside entity (such as a central bank) or money elasticity provided by the banking system.

Early Days

Cryptocurrency was something that was developed over decades. To find the starting point, we have to go back to 1983 when David Chaum published a paper outlining an early form of anonymous cryptographic electronic money. The idea was that transactions could be untraceable and would require no centralized entities such as banks.

A decade later, Chaum built upon this idea with a prototype called eCash. It required user software to withdraw funds from a bank and required specific encrypted keys before said funds could be sent to a recipient.

Bit Gold

In 1998, Nick Szabo create Bit Gold, which many believe is the precursor to Bitcoin. This required a participant to dedicate computer power to solving cryptographic puzzles, and those who solved the puzzle received a reward.

This is what became the Proof-of-Work consensus mechanism that the early blockchains used. It formed the foundation for distributed ledger technology (DLT). This is crucial for the trust regarding the maintenance of the ledger. We also see how this set the stage of permissionless system which are open to anyone.

The problem was Szabo could not solve the double spend problem without a centralized entity. This was something the anonymous Satoshi Nakamoto was able to do a decade later.

Combine this with eCash and we come pretty close to what Bitcoin ultimately became.

Bitcoin

The best known cryptocurrency is Bitcoin.

This was created by the anonymous Satoshi Nakamoto. Nakamoto introduced the world to Bitcoin by releasing the Bitcoin White Paper on October 31, 2008. It contained an idea for "peer-to-peer electronic cash system". In fact, the paper was called Bitcoin: A Peer-to-Peer Electronic Cash System.

The bitcoin software was implemented as open-source code and released in January 2009. This is when Nakamoto starting mining, creating the genesis block.

When the first block was mined, it had a block reward of 50 Bitcoin. The coins had no value at the time. By April 2010, Bitcoin became tradeable and had a price of around 14 cents for 1 BTC.

Since that time, Bitcoin mining has exploded globally. At the same time, major players got involved with the price being followed by the financial media.

Bitcoin also open people up to the idea that we could eliminate the unbanked and underbanked. There are billions of people who do not have access to adequate financial services. Bitcoin, along with other cryptocurrencies, set out to solve this.

The ultimate step forward over Bit Gold was the solution to the double spend problem. By using miners, Bitcoin was able to decentralize the process. This is something Nick Szabo was not able to do. His system used a quorum of individuals instead of computers like Satoshi.

A Satoshi is the smallest unit of Bitcoin. Each Sat is worth 0.00000001 BTC.

Litecoin

Litcoin was one of the earliest altcoin (see below). It was released in October 2011. This was a fork of the Bitcoin software.

The challenge was that Bitcoin was being mined by GPUs, concerning many that CPU mining was becoming obsolete. This caused increased use of energy.

Charlie Lee took the code from another project that had a pre-mine and released it in a fair way. The genesis block went live on October 13, 2011.

Litecoin mirrored Bitcoin in the limited money supply. It also was able to produce blocks at a faster rate (2.5 minutes) with lower transaction fees.

LTC was positioned as "silver to Bitcoin's gold".

Consensus

The three most common consensus mechanisms are:

Each has it pros and cons. Bitcoin has come under attack for the amount of energy used as a result of the Proof-of-Work mechanism. Since its inception, Ethereum utilized PoW but is switching to the Proof-of-Stake consensus.

Many view the non-PoW system as lacking in security. Of the three, DPoS offers the greatest scaling capabilities.

Conditions

According to Jan Lansky, there are six conditions that must be met:

  • The system does not require a central authority; its state is maintained through distributed consensus.
  • The system keeps an overview of cryptocurrency units and their ownership.
  • 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.
  • Ownership of cryptocurrency units can be proved exclusively cryptographically.
  • 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.
  • If two different instructions for changing the ownership of the same cryptographic units are simultaneously entered, the system performs at most one of them.

Cryptocurrency differs from electronic money. The latter is simply money in digital form. Cryptocurrency, on the other hand, is not back nor associated with any government or central bank.

The introduction of blockchain also brought the idea of triple-entry accounting. This is viewed by many as kicking off the next evolution of money.

Monetary Evolution

Cryptocurrency has the ability to tokenize most asset classes. Many are projecting that stocks, bonds, real estate, and an assortment of other assets will end up tokenized. Synthetic Assets are derivatives that mirror other financial products but reside in the world of decentralized finance (DeFi).

All of this comes under the heading of digital assets. It is also most often run on open-source software.

Anyone with the ability can create new tokens. This is because of the premissionless nature of the networks. This is different from central bank currencies which are overseen by a central authority.

Some examples are:

Since cryptocurrency is built on blockchain technology, it is decentralized to the degree that the ledger is distributed.

Alt-Coins

Anything other than Bitcoin is called an alt-coin.

There are now thousands of alt-coins. The most best known of these is probably Ethereum which introduced the smart contract. This is the ability to program instructions which allows for the creation of all kinds of applications. It is the core of what brought forth decentralized finance (DeFi).

One of the most promise areas is stablecoins. These are tokens that have a peg. So far, the most common is tied to the USD. Since this is the global reserve currency, it makes sense that people try to ride the coattails of the efforts and monetary policy of the Fed.

Stablecoins that are tied to the US Dollar yet are not backed by it allow for the money supply to effectively expand without the banks creating more dollars through loans. This is where stablecoins, especially the algorithmic ones, could really serve a vital role going forward.

ICO Craze

During 2017, there was a new funding mechanism that went crazy and, ultimately led to the bull market at the end of that year.

With the evolution of the Ethereum chain, especially the smart contract platforms, a new money raising model was introduced. This was called the Initial Coin Offering which was an offtake of the IPO that Wall Street utilizes for stocks.

Project team would set up a website that most likely contained little more than a white paper. After paying themselves a nice pre-mine, they sold the rest of the tokens into the open market. Since Ethereum smart contracts where utilized, ETH was one of the most heavily used currencies for ICO payments.

Obviously this environment was ripe for fraud. Even the projects that had true intentions found difficulty fulfilling what they laid out. In the end, much of the ICO craze ended up worthless.

One offshoot of this is the Securities and Exchange Commission started to sue many of the individuals behind these projects. Two of the most notable were Ripple and Block.One. The latter settled and paid a $20 million fine while the former is still fighting in court.

Non-Fungible Tokens (NFTs)

There is another category that fall under the digital assets known as cryptocurrency. These are non-fungible tokens (NFTs).

Most cryptocurrency is fungible. When one has Bitcoin, the actual unit in one's wallet is the same as all others. There is no way to distinguish between them.

Non-Fungible Tokens (NFTs) are individual in nature. They are all unique similar to a serial number. These can be tied to many different types of assets, both digital and physical.

The industry is still rather new. In 2020-2021, there was a huge bubble in the NFT market. This ended up the same as the Dotcom Bubble and Tulip Mania which imploded, the former as the Internet was being developed. Like that time period, innovation has not stopped.

Many industries can be disrupted by NFTs. The include:

  • music
  • art
  • real estate
  • stocks

NFTs can be thought of as Web 3.0 ownership tokens. Instead of titles, a NFT will be created to show who is in possession of the asset.

CryptoKitties and Splinterlands were two of the earlier games that had success which incorporated NFTs.

The ownership model is going to be completely changed by NFTs. Presently, it is denoted either by paper or, if digital records, it is run by a centralized entity, usually the government. With NFTs, we can establish digital record keeping on a decentralized, permissionless blockchain which the data is immutable.

Decentralized Finance (DeFi)

Cryptocurrency is one of the pillars of what many are hoping evolves into a completely different financial system. For this to be achieved, decentralized finance (DeFi) has to expand.

Again, we take the main tenet of cryptocurrency and expand it outward. Without financial institutions acting as intermediaries, we see the potential of a system that is inclusive and non-extractive.

Thus far, we see projects such as Metamask giving people ownership over whatever is in their account (wallet). Over time, the idea is to provide different financial services, further replacing the present banks and financial institutions.

Some of the areas that people are focusing upon:

Essentially people are looking at replacing Wall Street with a decentralized version. Some of this played out with ICO craze in 2017. This naturally ran into a legal issues as the present regulatory environment forbids most financial applications outside of the existing structure.

DeFi is simply another evolution of FinTech meaning regulation will have to adapt.

Wallets

Digital wallets are a central part of cryptocurrency. Since there is no centralized control of the ledger, each individual is responsible for the safety all funds. This is done through the use of a wallet along with the associated keys.

Each address has a public and private key. The owner has to provide the private key each time in order to transact. Without that, the coins or tokens are not moving.

Securing one's keys (and seed phrases) is vital. Losing the key means the wallet is lost forever, along whatever is in it.

A digital wallet is a threat to the traditional banking system. It serves the purposes that most people find with a bank account. The ability to send, receive, and store money is possible with a digital wallet, the same services a bank account provides.

Blockchain

Cryptocurrency exists on blockchain. Even when using a digital wallet, the cryptocurrency is not actually housed there. Rather, the private key is what allows access to the distributed ledger and alert the network that a transaction is being made. Once consensus is reached, the different nodes will update the ledger.

A blockchain is essentially a growing list of records. The data is records in blocks which then are linked using cryptography. Each block has a hash pointer to the previous one, joining them together.

The timestamp and transaction data is also contained in the block.

Wall Street's Interest

A number of corporations and institutions showed an interest in cryptocurrency. While regulation is still full of uncertainty, Wall Street is interested.

The best known entrant is Michael Saylor of Microstrategy. His company has amassed a large holding of Bitcoin. The former CEO of the corporation is fully committed to trying to maximizing the potential of its holdings.

Tesla and Elon Musk is another who entered not only Bitcon, but also DOGE.

Many of the banks and other financial institutions are in the process of setting up to be custodians of digital assets for their clients.

Regulation

Countries throughout the world are wresting with how to regulate cryptocurrency. The unique nature of the asset class makes it difficult to apply older regulations to.

In the United States, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) are at odds over where it is a security or commodity.

Governments of the world take different positions regarding cryptocurrency. One example is El Salvador which made Bitcoin legal tender. Other have taken the approach to trying to ban it.

The next couple years will see the government entities working on establishing regulation for their countries.

Comparisons to the Eurodollar System

Some feel that cryptocurrency, if constructed on a properly decentralized system, is beyond regulation. Much of this stems from the Eurodollar System which operates outside the realm of governments and central banks.

Like cryptocurrency, Eurodollars exist mostly in digital form. The market is made up of participants who are using nothing more than collateral on a balance sheet. None of this is backed by actually Eurodollars sitting as vault cash in banks.

The Eurodollar System is one that is entirely based upon "ledger technology". Blockchain and cryptocurrency can be thought of an the next stage in the evolution of that.

Infrastructure

One of the biggest challenges before those who are involved in the cryptocurrency world is infrastructure. Being relatively new, there is a lot to build out before this becomes a viable, functioning financial system.

Few take the time to consider how much Wall Street, the banks, and other financial institutions built out. To be a viable alternative, cryptocurrency is going to require similar infrastructure, especially if decentralized finance (DeFi) is to be a player.

Most of the blockchain work is trying to scale the base layers. This is a problem that the earlier chains like Bitcoin and Ethereum ran into. However, a lot of focus is being applied to the construction of decentralized layer 2 node systems.

Stablecoins

The early 2020s saw the rise of stablecoins. These are tokens and coins that are pegged to another asset. We are seeing more of them being tied to the USD.

When it comes to the characteristics of money, we see stablecoins attempt to act as both a medium of exchange while also being a store of value. The reality is most cryptocurrency had too much volatility to be used for payments. This is compounded by the speculation that accompanies most of the industry.

Therefore, another method is needed if we are going to see a massive rise in commerce.

We see two basic types of stablecoins:

  • reserve - a coin is backed by some asset that is held in reserve, typically USD and US T-Bills (most stablecoins fit into this category)
  • algorithmic - a coin can be converted to a certain amount of another asset which is not held in reserve (Hive Backed Dollar is an example of this)

In 2022, the entire cryptocurrency market was thrown for a loop by the implosion of UST, a stablecoin built on LUNA. This was also an algorithmic stablecoin that has few protections in place. At one point, the market cap of the stablecoin exceeded the backing agent.

Tether - USDT | USD Coin - USDC | Binance USD (BUSD) | DAI | FRAX | Pax Dollar (USDP) |TrueUSD (TUSD) | USDD | Gemini Dollar (GUSD) | Tether Gold (XAUT) | Euro Tether (EURT)

Gaming

Blockchain gaming is something that is really starting to garner a bit of attention. Due to the success of games such as Splinterlands and Axie Infinity, we see a new genre forming. It is called Play2Earn and it is aligning gaming with blockchain.

This is a natural combination when you think about it. Gaming has long been involved with digital assets and tokenization. This is nothing novel in this realm. What is different is the concept of actually owning said assets and them being available outside the game.

Through the use of cryptocurrency (fungible tokens) and non-fungible tokens (NFTs), it is now possible to incorporate ownership into gaming. The process is similar to what is already taking place. The one difference is the assets reside on a blockchain, most likely with some type of smart contract (at least for the NFTs), are accessed through a wallet using a private key system, and has an external or secondary market to trade on.

There are a number of ways that games can be incorporated into blockchain. In addition to the wallet system, there is also account management. On a system like Hive, the base layer is responsible for all account, operated in a decentralized manner. Thus, we see true account ownership.

Games with any type of battles can also use the blockchain are a decentralized database. Hence, all results can be posted via custom JSON. This makes the result immutable along with being censorship resistant. This is important for contests and tournaments if disputes should arise.

So far the major gaming companies have resisted embracing this model. Thus far, the development is from independent entities. We will see if this changes over time.

If this is something that catches on, we could see developers really starting to focus upon the game economies they are creating.

Web 3.0

Cryptocurrency is vital to the foundation of Web 3.0. While most look at this as a speculative asset, there is a core role for it in the next iteration of the Internet.

Incentivization is a vital component of things going forward. One of the challenges with Web 2.0 is the servers are controlled by the companies behind the platforms. Whether it is Amazon, Spotify, Google, Facebook (Meta), or Twitter, users are on their network. This gives them control of not only account but the data.

A basis of Web 3.0 is to have decentralized node systems. To successfully achieve this, a new incentive system must emerge. Here is where cryptocurrency enters the picture.

Under the present system, the selling of data and advertising are the main business models. It is why the users ultimately end up as the product. With Web 3.0, incentivizing people to run infrastructure without the benefit of data collection and advertising is crucial.

Currency Settlement

Cryptocurrency is digital in nature. Since it is built blockchain providing distributed ledger technology, it immediately alters settlements as compared to the existing financial system.

Under the current system, we see trades happening immediately but settlement, depending upon the security can take a couple days. Blockchain offers atomic settlements which can handle the Delivery vs Payment (DvP) issue that can often result in default due to counterparty risk.

Currencies tend to fall under Payment vs Payment (PvP), similar to the FOREX market. Essentially, we are dealing with multiple legs to a trade, increasing the risk due to the fact there are different intervals to settlement. Cryptocurrency can settle instantly, without any intermediaries, as the blockchain simply executes an atomic swap. This is done by linking the different assets together via smart contract. Hence, if one leg trades and another does not, the first fails to execute also. Settlement has to occur simultaneously or it does not happen.

Gresham's Law

Many wonder if cryptocurrency will except itself from Gresham's Law. While this theory itself is still debated, many are curious how cryptocurrency will affect the notion of good versus bad money.

When coinage was the main form of currency, we saw debasement when governments had the mint produce coins using alloys. This ended up reducing the commodity value of the currency causing people to hoard the older money while the circulating supply became filled with the newer coins.

Since the newer money was overvalued, this, according to Gresham, was bad money. Effectively, this is a way for the government to tax the citizens while also paying its debt back in debased currency.

One of the keys to this equation was the idea of legal tender. Since governments were able to name currency as such, the possibility of the good money being forced out is possible.

If cryptocurrency is driven by the free market, then it stands to reason this will no longer be a situation occurs. The entire premise of blockchain is that it operates outside the scope of governments.

Operation Choke Point 2.0

This is a targeted move by the United States Federal Reserve and the Biden Administration to try and drain access to cryptocurrency. The goal is to drive cryptocurrency out of the financial system. One of the main avenues is to close accounts for businesses related to cryptocurrency . Some employees of these firms are also finding the same thing done to their accounts.

Many view this as the supervisory authority to weaponize the banks against a legal industry. It was something the United States did in the past. Then it was the e Federal Deposit Insurance Corporation (“FDIC”), the Office of the Comptroller of the Currency (“OCC”), and the Board of Governors of the Federal Reserve System (“the Federal Reserve”) conspired with the Department of Justice against gambling, cannabis, and gun companies.

List of Top Cryptocurrencies

Bitcoin - BTC | Ethereum - ETH | Tether - USDT | USD Coin - USDC | Binance Coin - BNB | XRP - XRP | Binance USD - BUSD | Dogecoin - DOGE | Cardano - ADA | Polygon - MATIC | TRON - TRX | Bitcoin Cash - BCH | DAI - DAI | Litecoin - LTC | Polkadot - DOT | Solana - SOL | Shiba Inu - SHIB | Uniswap - UNI| Avalanche - WAX | Wrapped Bitcoin - WBTC | Monero - XMR | Ethereum Classic - ETHC | EOS - EOS | Bitcoin SV - BSV

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