Blockchain

Understanding Blockchain

2016 was regarded as the ‘coming of age’ of Blockchain and cryptocurrencies, with a big rise in the profile of Blockchain technology and cryptocurrencies like Bitcoin and Ethereum. This year has seen them get a lot of serious attention from the financial sector and some high profile individuals like Russian President Vladimir Putin. One of the reasons is that these virtual currencies have leapfrogged ahead of stocks, bonds and most other investments in their level of return.

The price of Bitcoin has tripled since the beginning of the year, rising above US$3,000 for the first time, before dropping back slightly. Ethereum, a not as well known – but quickly growing – cryptocurrency has shown even more dramatic gains. It shot up nearly 5,000 percent in June, up to a record price of US$407, before also settling back down.

The total value of these virtual currencies has grown incredibly too. The market capitalisation shot to more than US$110bn in June, from US$20bn at the beginning of the year. Although some financial analysts warn of a crash in cryptocurrencies – along the lines of the dotcom bust – it’s becoming very clear that they are providing a new global market for assets similar to stocks, bonds, mutual funds and government-backed currencies.

Related: The importance of mobile security [infographic]

What are Bitcoin, Ethereum and cryptocurrencies?

Although those in the investment and financial services industries are close to the cryptocurrency market and the Blockchain technology they reside upon, most people don’t really understand what they are and how they work. For more about Fintech visit our previous article 'Disruption Series: Fintech & The Future of Money', otherwise, here is a useful summary about cryptocurrencies.

1. This is an online, digital currency – a ‘virtual’ version of money. The name comes from the cryptography used to encrypt transactions and control production of the currency. It is a strictly monitored process, using Blockchain. It is not issued by any central authority, rendering it theoretically immune to government interference or manipulation.

2. This technology is a distributed (in different locations) database that’s used to manage and maintain a growing list of data blocks, using a peer-to-peer (P2P network). In a Blockchain, once a piece of data is recorded, it cannot be edited or changed.

3. Cryptocurrency mining. This is the process of creating new units of a cryptocurrency. To do this, you need a powerful hardware and software combination. Since the value of a currency depends on the number of units available in the market, this process should be carefully monitored to make sure the value of the existing units doesn’t depreciate.

4. Cryptocurrency price. This depends on supply and demand. If more people demand a specific cryptocurrency and it’s short in supply its value increases and more units are mined to meet the increased demand. However, many choose to restrict this number. For example, the number of Bitcoins is currently restricted to a maximum of 21 million.

5. Cryptocurrencies list. While there are many cryptocurrencies to buy, here are some of the main ones:

  • Bitcoin. This is the most well known and currently the highest rated cryptocurrency. Interest in the market peaked when its rate surged suddenly earlier this year. To invest in Bitcoins costs about US$2,500 and it has a market capitalisation of around $42 billion.
  • Ethereum. This cryptocurrency is responsible for diluting Bitcoin’s dominance in the market. Launched in 2015, it is being touted as the cryptocurrency of the future. It is decentralised, secure, and could be used to trade almost anything. Buying Ethereum costs about US$37 and it has a market capitalisation of around $34 billion.
  • Litecoin. This is based on the same common P2P Blockchain system, but with big technical improvements. It has substantially reduced the time for transactions to be completed.
  • Ripple. This cryptocurrency allows banks around the world to directly transact with each other.
  • Dash. Otherwise known as ‘DarkCoin’, this is a highly secretive cryptocurrency. It’s almost impossible for anyone to trace where it has been routed and it is used mainly on the Darknet.

Should I buy Ethereum or invest in Bitcoin?

While the cryptocurrency market is definitely on a bull run, much like the stock market, values can also drop at short notice. It’s hard to tell whether the current surge is due to historical precedent, a monopoly on investment, or simply an easily swayed investor pool. Irrespective of the reason, it seems likely that the recent rise of cryptocurrencies will lead to some sort of drop.

However, experts note that while drops in value are likely, they don’t signal an end to cryptocurrency by any means. Brian Kelly, CEO and founder of global investment management firm BKCM, said recently that Bitcoin is in the first years of what is likely to be a multi-year bull market. He explained that while there will be corrections, and even crashes along the way, Bitcoin is here to stay.

Interestingly, Blockchain – the technology supporting these digital currencies – may be even more worthy of investment than the cryptocurrencies themselves. A recent Reuters report pointed out that Blockchain – and the underlying technology – is probably more interesting and has more potential than Bitcoin does itself.

Blockchain technology and digital currencies explained

A key attribute of Blockchain is that it allows digital information to be distributed but not copied. Originally devised for investing in Bitcoins, Blockchain technology is no longer being seen as just an incorruptible ledger of economic transactions, but a record for almost anything of value. Here are some insights from website blockgeeks as to why it holds such promise for the future.

1. Durability and robustness. Blockchain technology is like the Internet, in that it has a built-in robustness. By storing blocks of information that are identical across its network, the Blockchain cannot be controlled by any single entity and has no single point of failure. Technology futurist Ian Khan says as revolutionary as it sounds, Blockchain truly is a mechanism to bring the highest degree of accountability. No more missed transactions, human or machine errors, or even an exchange that was not done with the consent of the parties involved. The most critical area where Blockchain helps is to guarantee the validity of a transaction by recording it not only on the main register but a connected distributed system of registers, all of which are connected through a secure validation mechanism.

2. Transparent and incorruptible. The Blockchain network lives in a state of consensus; it’s a self-auditing ecosystem where the network reconciles every transaction that happens in ten-minute intervals. Each group of these transactions is referred to as a ‘block. This has two important results.

3. Data is embedded within the network as a whole; by definition it is public.

4. It cannot be corrupted. Altering any unit of information on the Blockchain would mean using a huge amount of computing power to override the entire network. In theory, this could be possible. In practice, it’s unlikely to happen. Taking control of the system to capture Bitcoins, for instance, would also have the effect of destroying their value.

5. By design, the Blockchain is a decentralised technology. Anything that happens on it is a function of the network as a whole. Some important implications stem from this. By creating a new way to verify transactions aspects of traditional commerce could become unnecessary. Stock market trades could become almost simultaneous on the Blockchain, for instance. Or it could make types of record keeping, like a land registry, fully public. Other areas that could potentially harness Blockchain technology include legal contracts, the sharing economy (think Uber and AirBnB transactions), online shopping, crowdfunding, governance (voting and other polls), file storage, protection of intellectual property and identity management.

Are cryptocurrencies a safe bet? What about the ethics?

However, while Blockchain and cryptocurrencies have the potential to become the future of transactions, there is growing resistance from government and traditional commercial and financial institutions. For example, banks fear money transactions moving online, and in the U.S attempts are being made to stop this. Recently, the U.S Congress submitted a bill to make cryptocurrency illegal on the grounds that it could fund terrorism and corruption.

The anonymous nature of cryptocurrency transactions does make them well suited for a host of illegal activities, such as the purchase of weapons, drugs and other illegal goods, as well as money laundering and tax evasion. And cryptocurrency hasn’t been without controversy, according to website mic.com. Some suggest that by bypassing more established transactional methods, buying cryptocurrencies is somehow contravening the establishment to the detriment of the greater good.

But, despite a rocky start, including the bankruptcy of Mt. Gox – the world’s largest Bitcoin exchange in 2014 – buying cryptocurrencies has arguably entered the mainstream. For one, you can actually use it to buy stuff now. Many retailers, like Microsoft and Overstock, have started accepting Bitcoin directly, and for the retailers that don't — notably Amazon — proponents have found a workaround by buying gift cards with their Bitcoin and making purchases that way.

Numerous stock and commodities exchanges are also now prototyping Blockchain applications for their services, including the Australian Securities Exchange (ASX), the Deutsche Börse (Frankfurt’s stock exchange) and the JPX (Japan Exchange Group). And many observers look to buy cryptocurrencies with the hope that a currency can exist that preserves value, facilitates exchange, is more transportable than hard metals and is outside the influence of central banks and governments.

In short, mic.com suggests that if you still feel like investing a small amount of money in cryptocurrency, be sure not to dip into your emergency savings. It's rarely a good idea to buy something when its price is at its all-time high. And remember that there are a lot of horses in this race. In addition to Bitcoin, Ethereum, and Litecoin there's also Ripple, Namecoin and Peercoin.

If you have some ‘play’ money and want to make a bet on cryptocurrency, you should absolutely feel 100 percent comfortable with the idea of losing all that money. Cryptocurrencies have crashed before, often, and probably will again in the future. They're also historically expensive — if you must buy some, you might be served by waiting a bit for prices to drop, so you're more likely to get a deal.