What is a Cryptocurrency?
A “cryptocurrency” is a medium of exchange which exists solely online, in the digital world. In other words, it’s a digital currency; it does not have a physical, tangible existence. This is not to say that it’s a way to pay for something online – cryptocurrencies are more than that. While PayPal and Apple Wallet allow you to purchase goods and services without taking cash or a credit card out of your wallet, cryptocurrencies are actually forms of money, like dollars or euros.
What makes a cryptocurrency different from a dollar or a euro? U.S. dollars are issued by the U.S. federal government, and they are backed by that government. Cryptocurrencies, to date, are not issued or backed by any government. Instead, they are issued by platforms, such as Bitcoin or Ethereum. These platforms are often decentralized, meaning no one person or entity is in charge of issuing the currency, but rather a network of computers maintains a public ledger of transactions. Those computers process and verify transactions and, in doing so, they “mine” the currency.
Cryptocurrencies actually have their own market exchanges, similar to the New York Stock Exchange, Coin Market Cap https://coinmarketcap.com/ ranks the currencies in order of popularity. As you can see – while the top 5 currencies remain pretty steady, the lower 5 can fluctuate.
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4) Bitcoin Cash
4) Bitcoin Cash
Bitcoin – One of Many Cryptocurrencies
You’ve probably heard of a specific cryptocurrency called Bitcoin. As you can see on the list above – it’s #1, and has been for a while. It’s the oldest, decentralized cryptocurrency – it was introduced to the world on October 31, 2008, when Satoshi Nakatomo posted a link to the whitepaper “Bitcoin: A Peer-to-Peer Electronic Cash System”. Nakamoto went on to create the “genesis block” of Bitcoin on January 3, 2009, which allowed 50 Bitcoins to be put into circulation.
Nakamoto though that capping the number of Bitcoins that could ever be in existence would be one way to maintain the integrity of the Bitcoin. Thus, there are 21 million Bitcoins in existence – but only about 17 million Bitcoins have been mined and are in circulation.
How does a Bitcoin get into circulation? Unlike U.S. dollars, which are printed and regulated by the Federal Reserve system, Bitcoins are “mined”. Anyone can mine, if they’ve got the right heavy-duty, power-hungry computer processing hardware (and cheap electricity) to do it.
Explaining how Bitcoins are mined involves a lot of technical mumbo-jumbo, but here goes my attempt to simplify the explanation before your eyes glaze over reading this post:
Seller sells something, Buyer offers to buy it and pay in Bitcoins. Buyer authorizes the transfer of X amount of Bitcoins from her “wallet” (think of a virtual bank account) to the Seller’s wallet. The exchange of Bitcoins between wallets is a “transaction”. It takes a few transactions to happen before the transactions become bundled into a virtual “block” which miners all over the world work to “verify”. Why does Buyer’s transaction need to be verified? Because, with cryptocurrencies, since there’s no hard physical representation of the money, it’s very easy to spend it twice. Buyer’s wallet may only contain 2 Bitcoins, and Buyer may have offered those same Bitcoins to several Sellers.
So, back to the block – without getting too much into “hashcash”, “proof of work”, “mathematical algorithms” and “mining difficulty” – a miner will verify a block of transactions by figuring out the hash value. The hash value is proof that the miner got the right answer, thus the block s/he mined is valid. That block is then added to the Blockchain – the digital ledger (like a checkbook register) which shows all the Bitcoin transactions — the miner is paid 12.5 Bitcoins for having mined the block, and those 12.5 Bitcoins are now in circulation, for the miner to save, exchange for other currency, or spend as s/he desires.
Interesting to note that when Bitcoin was first mined in 2009, one block mined produced 50 Bitcoins. In order to slow down the rate at which all 21 million Bitcoins got into circulation, the Bitcoin reward is halved for every 210,000 blocks mined. This is a handy countdown clock showing when Bitcoin will go from 12.5/block mined to 6.25/block mined: http://www.bitcoinblockhalf.com/
So that’s essentially how a Bitcoin transaction happens and how Bitcoins end up in circulation. It’s as if Buyer A pulled cash out of her wallet to give to Seller, in exchange for goods or services. However, the cash and the wallet exist only on network wires, and there’s no need for Buyer to ever meet Seller, or even know Seller’s name, really. This is a “peer-to-peer”, “trustless” transaction – no middleman banks, governments, or credit cards, and you don’t need to trust that the government or banks are doing what they should be doing (is it just coincidence that Nakamoto, in his genesis block for Bitcoin, embedded the text: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”?!).
What Can I Buy With Bitcoin?
Getting down to the nitty gritty – can I buy a house (or other real estate) with Bitcoin. Of course! If you can find a title company who will underwrite and close with Bitcoin, that is…
Stewart Title does not currently accept Bitcoin or underwrite transactions where the Buyer or Seller are using Bitcoin. However, Bitcoin has been used in real estate transactions – Manhattan, California, Florida, and even a residential home in Texas. While these transactions are not without complications –, as the market evolves to meet technological advances, real estate partners to a transaction will change to meet the needs of consumers. Other things you can buy with Bitcoin include furnishings for your house at Overstock.com, a trip away from your real estate on Expedia, Microsoft products and services, accounting services at PwC, and Dish services.
Cryptocurrencies – the Cons
Peer-to-peer transactions, trustless environment, a Blockchain ledger that is, at the same time — public so everyone and anyone can see it, but encrypted so not everyone and anyone can read it. If Bitcoin sounds so great, then why aren’t we all using it?
While the fans of cryptocurrencies enjoy is the lack of government and central banking regulation or interference in the platforms, the skeptics of cryptocurrencies dislike the lack of government and central banking regulation or interference in the platforms. A few other not-so-great items on cryptocurrencies are:
- Cryptocurrencies may not be legal in certain countries (although that may change).
- In the United States, the IRS considers Bitcoin to be property and not currency (See Notice 2014-21), and therefore conversions of Bitcoin to US dollars may be subject to capital gains taxes.
- Cryptocurrencies make money laundering and Darknet transactions In fact, the founder of the notorious Silk Road took inspiration from Bitcoin (which was the exclusive currency of the Silk Road).
Finally, when discussing computers, networks, code, and money, we need to address hacking. Can cryptocurrency platforms be hacked? While the Bitcoin code proved difficult to hack, with determined hackers – where there’s a will, there’s a way. Hackers have hacked into computers and taken control of the computers, and whatever is in them; wallet hacking happens, and transactional malleability – messing with a transaction before it’s verified, can occur.
Cryptocurrencies certainly are the topic du jour but will they last? With the amount of buzz generated around them, cryptocurrencies aren’t going away any time soon. Governments are already looking at how cryptocurrencies may be regulated[i], which should get interesting. Also exciting to watch will be how markets and offerors of goods and services adapt to cryptocurrencies.
Thanks for reading, and stay tuned for the next blog which will discuss the Blockchain.
[i] https://www.ccn.com/monsieur-bitcoin-to-head-frances-cryptocurrency-task-force/; https://www.ccn.com/china-restrict-cryptocurrency-otc-trading-mining-no-definite-plans-yet/; https://www.ccn.com/russias-finance-minister-confirms-upcoming-bitcoin-regulations/