A lot has been talked about the Cryptocurrencies that are in vogue today however an average person has absolutely no idea about the currencies, the technology and an investment opportunity in these if there is any. To evaluate long-term investment potential, investors need to understand the function Cryptocurrencies serve, the underlying technology and their governance structure. With this article we are trying to demystify the jargon and present an objective overview of the whole concept.
What is a Cryptocurrency
A crypto-currency is a medium of exchange of a digital asset using cryptography which is created and stored electronically in the blockchain (The underlying technology behind all digital currencies). The process uses encryption techniques to secure the transactions and to control the creation of monetary units of the currency. There is no central or mid-way authority like Central or Reserve Banks that control the flow of these currencies. This decentralization perhaps is the allure behind Cryptocurrencies and a potential hazard too. Bitcoin and Ethereum are two prominent platforms, with their respective currencies: Bitcoin and Ethers, having the largest market cap among Cryptocurrencies.
Market share of various Crypto-Currencies
When did the first Crypto-Currency (Bitcoin) Originate.
Bitcoin is the first crypto-currency that was conceptualized and created by Satoshi Nakamoto, who published a research paper on 31 October 2008 called “Bitcoin: A Peer-to-Peer Electronic Cash System”. In January 2009, the Bitcoin network came into existence with the release of the first open source Bitcoin client and the issuance of the first Bitcoins, with Satoshi Nakamoto mining the first block of Bitcoins ever (known as the genesis block), which had a reward of 50 Bitcoins.
What is the technology behind Cryptocurrencies?
Blockchain is the technology framework under which the current Cryptocurrencies are formed and transacted. Essentially blockchain is a shared public ledger that can be programmed to record not just financial transactions but virtually everything of value. It?s the digital ledger that forms the backbone of Bitcoin and Ethereum . All confirmed transactions are included in the blockchain.
Instead of storing data in one central location, the crypto-currency data is distributed it among a network of users running the crypto-currency software. A complete history of every crypto-currency transaction is stored on the blockchain, and all of these recorded transactions are open to public scrutiny.
Before a digital transaction is approved and processed by the network, it is verified using a cryptographic algorithm that checks the transaction against the histories stored on every computer in the network. This process is complex, but it has one big advantage as it ensures digital security and prevents hacking attacks.
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Source:- http://ordina-jworks.github.io/blockchain/2017/05/10/Blockchain-Introduction.html
How is new Crypto-currency Created?
Here we use the example of Bitcoin and describe the process of its creation all other Cryptocurrencies are also created in a similar process called mining. In simple terms Crypto-Currency mining is similar to solving a puzzle using complex algorithms and hardware and if you are able to solve it you get a unit of Cryppto-Currency in reward. As an example Bitcoins are generated by a competitive and decentralized process called “mining”. This process involves that individuals are rewarded by the network for their services. Bitcoin miners are putting in their effort in processing transactions and securing the network using specialized hardware and are rewarded for doing the same by getting Bitcoins in exchange.
The Bitcoin creation protocol is designed to regulate the creation of Bitcoin at a fixed rate thus making Bitcoin mining a competitive and tedious task. This in a way is disadvantageous to individual miners as group effort is rewarded in a much better way. When more miners join the network, it becomes increasingly difficult to make a profit and miners must increase efficiency and focus on cutting their operating costs. Bitcoins are created at a decreasing and predictable rate. The maximum number of Bitcoins to be ever created is restricted to 21 Millions therefore they are created at a decreasing and predictable rate. The number of new Bitcoins that would be created each year is automatically halved over time until Bitcoin issuance would stop when the maximum allowable threshold is reached. At that point no mining of Bitcoins would be possible and the miners will be rewarded in the form of processing charges.
Comparison of Bitcoin With its Leading Peer Ethereum-
So far Bitcoin is the most popular Crypto-Currency however Ethereum its closest competitor is catching up fast, both these currencies have inherent advantages and some disadvantages that?s what we are evaluating here.
In terms of the scripting language Ehereum has a clear advantage, the language that is used to create Ethereum is more advanced that makes it possible to write advance and complex programs around Ehtereum much easier and makes it more useful and enhances its overall utlity. Bitcoin on the other hand depends on a more traditional scripting language and hence it?s somewhat restrictive.
The other advantage that Ethereum clearly holds over Bitcoin is the ease of mining which is the major incentive for more people to get engaged with the currency. Whereas Bitcoin mining is primarily performed by specialized ASIC devices at speeds of 10 minutes per block using SHA-256 hashing, Ethereum uses a different algorithm that allows blocks to be mined at much faster speeds: one block per 15 seconds.
In terms of Blockchain security which is the backbone of any crypto-currency, Bitcoin, has a clear advantage. Most of it however can be attributed to its longer period of existence. Over a period the Bitcoin ecosystem has gotten sophisticated hence it is much harder to attack it. Ethereum on the other hand is still in its nascent stage and therefore its prone to more attacks.? A recent attack on the Ethereum ecosystem also known as the infamous ?The DAO attack? of June 18, 2016 lead to a heist of approximately 3.6MM ethers.
Most of the crypto-currency popularization and acceptability is dependent on the community support it receives. Crypto-Currency ecosystem require constant coding and development activity , supplementary to development, the ecosystem also requires a supportive community which drives public support and makes it more mainstream, enhances liquidity and hence the transactability. It is clear that the Bitcoin ecosystem is much more advanced and developed compared to Ethereum because of a longer duration of existence and a first mover advantage.
Scalabiity which is another aspect to compare crypto-currency is in favor of Ethereum, it is much easier and faster to scale up the Ethereum ecosystem because it depends on smaller block sizes. This translates to creation of Ethers at a much faster and cost effective way. Overall however at this stage we can say that because of a longer tenure and a greater acceptibilty Bitcoin has a definite advantage however this advantage would be nullified or significantly reduced by Ethereum or some other currency with more novel technology.
Crypto-Currency as an Investment Grade Asset-
Crypto-Currency as their name suggests can really be a replacement to normally accepted currencies? This is a fundamental question that needs to be answered before any investment related decisions can be made in these assets.? As a legally acceptable currency all crypto currencies should serve the purpose of a medium of exchange for goods and services and in this regards at some level cryptocurrencies currently are serving as a medium of exchange albeit with limitations
Other aspect to be looked at while evaluating a virtual currency is that does this currency acts as a store of value. In other words can a Bitcoin or an Ether can be exchanged for dollar or some other currency. The answer is no at this point, maybe one day it would get there, at present a value of a Bitcoin or an Ether is what the market decides it should be on a given day.
Another question that needs to be answered while evaluating a crypto-currency as a substitute of a real one is that can a crypto-currency be used to measured goods and services in standardized units. For e.g.? A gallon of Gas at 3.5 Bitcoin or a packet of cookies for 2 Bitcoin, the answer again is no and the reason is the extreme volatility in the values of these currencies make it impossible to standardize goods and services on them in addition these Cryptocurrencies trade at different prices at different exchanges which makes standardization even more hard.
Therefore at this juncture it can safely be concluded that Cryptocurrencies in their current form and exchange mechanisms do not meet the criterion of a legal tender therefore they do not qualify for an investment grade asset theoretically.
Should Bitcoin or Ethereum be part of one?s Investment Portfolio-
We don?t think Bitcoin or for that matter any other cryptocurrency as an investment asset as of now, perhaps one day they will be but not at this point. The reasons for our circumspection are as follows:
? The intrinsic value of these currencies are hard to assess as they are not backed with any underlying asset and there is no centralized authority that will vouch for it to be a legal tender
?Existing cryptocurrencies are extremely volatile and this lack of stability makes it unsuitable for investment purposes
? Crypto-currenices are not regulated as of now and this lack of regulation leads to volatility and lack of investor confidence.
? These currencies lack transparency and the longeivity of the concept in itself is in question may be one day this idea would be replaced by a newer idea
?Their functioning is highly dependent on IT and developer community support which makes it prone to hacking, technological malfunction and if the currency loses its community support future upgrades and network upkeep will cease to exist.
? The possibility of these Cryptocurrencies to be used for illegal activities is huge because of the anonymity in the economic transactions and the agents associated with it.
Conclusion-
To summarize what we have tried to elaborate in the article. The concept of crypto-currency is alluring but a sound legal framework is needed for this concept to be formally accepted. As of now it has mostly become a speculative tool with huge gyrations in the valuations which is highly unsustainable. We are however optimistic on the underlying technology that is blockchain because we find that this technology can be put to good use in every industry or sector. Therefore companies built around implementation and usage of blockchain technology would be a good alternate investments rather then investing in Bitcoin or an Ether.