Wednesday, 12 June 2019

What is Cryptocurrency

What is Cryptocurrency


The price of Bitcoin hit an all-time high of $19,000.00 on December 17, 2017, sending the world into a frenzy about Bitcoin and cryptocurrency in general. Interest groups, media circles, and populations of people that appeared so far away from the discussion were now participating, driving the world into a state of frenzy concerning the cryptocurrency phenomenon. As many will discover, cryptocurrency is beyond a phenomenon. It is an innovative mode of conducting business that is here to stay. This staying power will be driven by reputable sovereign states, such as Bermuda, developing the legal framework for a working model to domicile initial coin offerings (ICOs) and by the prospect of the approximately 2 billion adults without traditional bank accounts discovering the virtues of cryptocurrency to perform everyday transactions through their mobile phone. Globally, approximately 1.1 billion unbanked have mobile phones that represent about two-thirds of the unbanked population.

Cryptocurrencies are digital money created by software programming using encryption technology. The digital coin is generated within a domain that connects a network of peer-to-peer computers. 1 These digital domains implement an immutable, distributed database called the blockchain which acts as the accounting system or official book of records for all transactions. The network utilizes a form of consensus model to verify transactions. What makes this model unique is the decentralization of the accounting system. The model relies on cryptography (and unique digital signatures) for security based on public and private keys and complex mathematical algorithms. It runs on a decentralized peer-to-peer network of computers and “miners” that operate on open-source software and do “work” to validate and irrevocably log transactions on a permanent public distributed ledger visible to the entire network. This solves the lack of trust between participants who may be strangers to each other on a public ledger through the transaction validation work. The model enables the transfer of ownership without the need for a trusted, central intermediary, as exists in current financial systems. The incredible software engineers and mathematics, encryption, and engineering professionals who contributed to making such a platform should be applauded for laying the foundation for the innovation to come.

It should be noted that although Bitcoin is the first cryptocurrency to have achieved critical success, it was not the first cryptocurrency. The first digital cash platform to gain traction was DigiCash, founded by David Chaum, which relied on a system of “Blind Signatures” designed to ensure the privacy of users conducting online transactions. Chaum closed DigiCash in the late 1990s because he was unable to get enough merchants to accept DigiCash in order for consumers to use it. There are more contributors in this space beyond the group associated with the David Chaum camp and the circle of cypherpunks. Recognizing some of the well-known pioneers brings insight into the conception and direction of where cryptocurrencies are derived from and where they can evolve in the future in their current form or as derivatives.

Legal and policy developments in the 1980s around encryption also contributed to the birth of internet money. Prior to the 1980s, spy agencies were the primary users of cryptography. The internet is an open space with both private and public access resulted in the expansion and use of public key encryption technology. Two publications contributed to this expanded use of encryption tools: the US government “Data Encryption Standard” and “New Directions in Cryptography” by Dr. Whitefield Diffie and Dr. Martin Hellman, which set the process in motion to allow a framework for the government to allow access and use of cryptography for sectors outside the spy agencies.

Development of Cryptocurrency

These contributions and events laid the foundation for Bitcoin for Satoshi Nakamoto to revisit and inspired him to create a decentralized, immutable payment technology, free of double spending and providing privacy and anonymity to the users thereof. Users provide an encrypted address protected by public and private keys to maintain personal holdings, using the sophisticated network to transact and mint new coins through a software protocol.

Bitcoin or Cryptocurrency Versus Fiat

With what can be implied as a ceremonial, symbolic, and successful launch of Bitcoin by one of its most prominent and mysterious pioneers, the infamous but never discovered, Satoshi Nakamoto, cryptocurrency achieved what would be the equivalent of landing a man on the moon in the cyber world, as the statement revealed and embedded into the Genesys block of the blockchain “The Times 03/Jab/2009 Chancellor on the brink of second bailout for Banks.” The timing of the Bitcoin launch appears strategic and poses a direct jab at the modern-day banking systems as it comes on the heels of the near collapse and failure of large financial institutions such as Lehman Brothers and Bear Stearns. As pointed statements such as the Genesis block comment highlight, there is a competing relationship between centralized payment systems owned by the banks and decentralized payments owned by no one but managed by a peer-to-peer network of computers.

The natural comparison of crypto currencies to fiat currencies 2 always occurs. These comparisons do not have to be contentious in nature, with renowned banking executives denouncing cryptocurrencies a “fraud,” only to later ignore earlier statements as they implement initiatives to include technologies powering cryptocurrencies for the strategic development of their own corporate strategy. That is why it is always important to separate the technology from those that run the technology. The technology that underlies fiat currencies is printing technology going back to the early days of fiat currencies during the colonial period. It was the technology of the printing press to generate notes that were backed by the land of the issuing colony.

History of Fiat Money

A formal comparison of the evolution of fiat versus cryptocurrencies reveals that, from a compliance, governance, and control standpoint, cryptocurrencies’ governance framework could mature much faster. Fiat currencies in the US started when the colonies began to print money to pay for debt owed as a result of the French and Indian wars. There was no oversight by the Royal parliament, and colonies created their own terms for delivering on the promise backed by these fiat currencies. The currencies also served as a means for a huge loss of revenue for the Royal government as colonists used it to pay Caribbean merchants directly, cutting out completely the tax revenue workflow implemented on goods by the parliament. Consequently, after a period of 30 years, Parliament issued the Currency Act of 1754, which nearly crippled the use of fiat currencies and almost made it impossible for colonists to do business and repay any debt, public or private.

Cryptocurrencies and digital currency technology are now becoming part of the global community and have a significant impact on developing countries. These include cases where the general welfare of communities and groups of people is improved, and they are a strong endorsement for the need of
alternative financial mechanisms beyond the formal banking systems that primarily utilize fiat currencies as a medium of exchange. The financial digital frontier, initiated by the efforts of cypherpunks, is rapidly expanding and should be taken seriously by many sectors of society. For example, sovereign countries like Venezuela are exploring cryptocurrency backed by oil as an option to aid in providing a way out of the financial crisis. 

When anyone compares the evolution of fiat currency and crypto currency there are strikingly similar phases that both monetary systems went through. When one carefully examines the origins of the system of fiat currencies it is easy to conclude colonists were printing money that had little real value to pay for the debt that was incurred by the British and American colonies to weaken the French power in Europe and expel the French from the American and Canadian colonies.

War was raging on both sides of the Atlantic in the late 1600s and into the mid-1700s with the official end recognized by the Royal Proclamation of 1763. The French had conceded defeat and the Native Americans who were allies of the French during the French Indian wars were subdued. The treasury coffers of the British were severely depleted. Collecting debt from the colonies and exacting taxes were a means of revenue to replenish those coffers. As a means to overcome and deal with the mounting debt from the war, the colonists printed money.

In those colonial times and early years leading to the formation of the US, there were three primary mediums of exchange: commodity-based systems, species-based systems, and fiat systems. In commodity-based systems, colonists used the staples from the land as currency for business transactions. States that produced commodities that had a higher utility value, such as tobacco, had an advantage over states whose land did not yield such valued commodities. Virginia was one of those states that had such advantages, whereas states like Rhode Island did not. Species currency, a system that used gold and silver as the item of value, was greatly desired. However, species were scarce. Buying imports using species led to a flight of assets away from the commodity and depleted the supply. International factors limited the global supply and consequently led to a tightening of species as a means of exchange for business transactions.

The limitations of commodity-based and species-based monetary ultimately led to the increased practice of printing money and the development of the fiat system in the colonies. This practice started with Massachusetts in 1690. By 1715, 10 out of the 13 colonies were actively printing money and using paper currency as a form of payment. It was so widely used that economist Stanley Finkelstein stated the advantages by saying “that unless it is backed by species it is the cost-free currency.” The practice of indiscriminately printing money is problematic. It leads to hyperinflation and severe depreciation of the currency. That was the experience of the British merchants and creditors at the time who were paid for their goods and service with this depreciated currency, which they were not willing to accept. The mounting resentment of the British business community put increased pressure on the practice of the colonies printing these bills of credit to pay for a debt, forced Parliament to declare the Currency Act of 1751, and led to a revision to the action 1764.

During this nascent period of the fiat monetary system in the colony, Parliament, which was the central government during that time, permitted the colonies to implement an alternative monetary system outside of the British pound. This went on for about a 30-year period, where the colonial fiat system acted independently with no official oversight or rule. Apparently, the colonies did not seek input from parliament or any formal counsel to assist in advising to create rules of engagement for their alternative form of currency.

The colonists had created an alternative mode of conducting business using ink and the printing press, the technology of the time, to create paper notes of bills of credit. Now that they were able to conduct business and generate revenues, even though this was considered an illicit activity by the imperial government, the colonists were able to subvert the tax placed on sugar through the use of fiat money, thereby paving the way to create money by means of technology.

The printing press was the tool of liberation for the colonialist. Where the early settlers could use ink, the cypherpunks can use the internet as the technology of choice to produce an advanced form of money. The motive and spirit of the colonists and cypherpunks are similar, but the tools are different. It is safe to say that Parliament or any central authority was excluded from the initial implementation of the fiat monetary system. This exclusion could have been a contributing factor to why the Currency Act was enacted severely against the colonial state governments. The colonies were prohibited from printing any money. The practice was discontinued and the colonies could no longer pay for private debt using fiat currency or bills of credit.

This declaration and issuance of the Currency Act resulted in a tightening of the money supply, which the colonists strongly opposed. Benjamin Franklin and other colonial agents went to London and opposed this act. Years had gone by without any acknowledgment from the imperial government. After years of lobbying by colonial agents, parliament issued amendments to the Currency Act of 1764 allowing certain states like New York to issue currency up to a designated limit. There was another subtle by-product of the colonies’ ability to print their own money: they could now pay vendors directly, subverting taxes imposed by the British. Goods like sugar could be bought directly from the Caribbean bypassing the British taxing agent. This flight of funds from the tax revenues was of serious consequence to the imperial power. All of these issues became factors that contributed to the revolutionary war. There were acts that were considered to be major grievances: three major ones were the Sugar Act of 1764, the Currency Act of 1764, and the Stamp Act of 1765. These acts guaranteed the enforcement of a policy that violators would not be tried by a jury of your peers, but by the Royal parliament.

The First Continental Congress issued a Declaration of Rights that enumerated colonial objections to certain acts of parliament, and declared and labeled the Currency Act “subversive of American rights.”

How Cryptocurrency Can Change the Existing System

Technology directly challenges the government. It may for a time reduce some tax revenue streams as is evident by studying the evolution of fiat currency. However, the government will catch up after carefully studying and instituting policies that will correct and bring in alignment all perceived lost revenues and will also protect the public from any threats that result from its use or practice. This is not the case for banks. The technology is disruptive to the business model of the banking industry. Therein is the bone of contention between cryptocurrencies and the fiat centralized systems. Cryptocurrencies have a long way to go before they can compete at that level, where the market size ranges in the low hundreds of billions in daily transactions and fiat currencies are in the tens of trillions. However, it is something that cannot be ignored, as the public awakens and momentum gains. The modern-day banking systems left the door open for these currencies, which appeal to large groups of populations not able to participate within the purview of the traditional banking system.

Another subtle point not to be lost in the early period of flux in the evolution of the fiat system. The major benefit of the fiat system was provided to the Anglo-Saxon landowners. There were a little under 4 million people in the US by 1790. People enslaved represented a little more than 14% of the population stands at 690,000. The census count did not include Native Americans who accounted for about 600,000 people in the continental US, dramatically down from the approximately 7 million estimated about the time of Columbus in 1492. The fiat monetary systems in the early days of its existence excluded about 1.29 million people, who received little or no benefit from the system. It could be stated that the current fiat system started with a large underbanked or no-bank population. It is easy to understand theoretically why the virtues of the digital coin, inclusion principle, and democratization would resonate with a certain segment of society, in particular, the underbanked. It is obvious that certain segments of society were left out from directly participating in the fiat monetary systems, whether intentional or unintentional, and a large number of individuals received little or no benefit and that number significantly grew until the Civil War, when anticipated inclusion was a perceived promise.

In 1860 just before the beginning of the Civil War, the US population grew to approximately 31,500,000, and the number of people enslaved represented 12% of the population with a census count of slightly more than 3.9 million, which is a significant number. The time right after the Civil War was a significant time of transition and promise. The hope of inclusion was symbolized by the creation of the Freedman Bank by Abraham Lincoln. A bank created to alleviate the struggles faced by formerly enslaved people, it helped to create a pathway of inclusion into the monetary system and capital markets of the time. However, that symbol of hope became a source of tragedy as congress voted to shut it down seven years after the assassination of Lincoln. One can observe that the fiat monetary system has the ability to isolate and exclude segments of society because of the role given to banks to administer the execution of financial services to the consumer base. The pre-Civil War times and post-Civil War times are critical for the fact that there was no national system of banking implemented until the National Banking acts of 1863 and 1864 were issued by Congress.

Banks were regulated by the states and there was no standardized system. The Polk administration started the movement toward a national system as public funds were taken out of private banks in 1846 and deposited into treasury branches. The establishment of a national banking system was just getting off the ground at the same time the slaves were being freed. There was no better time to establish a policy of inclusion and have a national monetary system that provided a venue for banks to grow and cater to all facets of society than immediately after the Civil War. The opportunity was extremely evident and there was no better time to unite the whole country. The failure of Freedman Bank and the consequent loss of hard-earned savings among the formerly enslaved caused deep distrust.

Cryptocurrency allows these issues to be brought to the table to heal and get rid of the glaring elephant in the room when referring to the unbanked and those excluded from access to capital and denied basic financial services because of policies of exclusion that have become endemic within corporate banking institutions. Cryptocurrencies have not been free from their own share of controversies, especially surrounding the issue of Silk Road. The Silk Road case highlighted the fears of those critical of cryptocurrencies, is the means for criminals and illicit activity to run completely wild. The cryptocurrency world would insulate the so-called Den of Thieves with the promise of total anonymity and privacy free from any central authority. The Silk Road became an egregious marketplace where some criminal vendors had the audacity to display bricks of cocaine openly on the website.

Innovation can never be an excuse for allowing rampant criminal activity to be openly displayed in the face of any prosecuting agency. No society can survive with the exorbitant level of corruption that the Silk Road marketplace at that time offered with no oversight over any activity at all. Ross Ulbricht indeed created a mechanism to facilitate illicit activities, such as narcotics deals, murder for hire, money laundering, wire fraud, and many other violations that could be charged in a federal court. Ulbricht was handed down five sentences served concurrently. Two were life sentences without the possibility of parole. Ulbricht did not personally commit the alleged crimes; however, his providing an enabling technology that leveraged Bitcoin as a medium of exchange allowed the prosecutor and the legal system to make him a poster child for the judicial system and for government officials to send a strong message that any violation involving cryptocurrency would be dealt with severely.

Severe prison sentences are usually enough to dissolve movements. This black cloud that was cast over cryptocurrencies was a correction and a catalyst for further innovation, adding revolutionary features of smart contracts to the already revolutionary and disruptive technology of blockchain.

The ominous cloud of criminality was blown away by the collaboration of technologists, finance professionals, and legal professionals that created the framework of laws to prosecute violators that used cryptocurrency, moving into advisory positions to assist entrepreneurs that are involved with cryptocurrencies as their core business. The crypto movement picked up a strong crosswind with the collaboration, advancing the movement and intensifying the acceptance of cryptocurrency in cultural and retail communities. Cryptocurrencies have evolved in the investment arena with some hedge funds taking strategies with the volatility of the price of Bitcoin and many of the popular crypto currencies.

The journey of understanding cryptocurrencies also involves the reason why currency fiat or crypto is used in general. People do not want to carry large quantities of species like gold or silver around every time they want to do a simple transaction at the merchants as it would increase the chance of robbery. Fiat and cryptocurrencies solve this issue. However, fiat is still physical in some situations, especially for the unbanked. In many instances, they face being robbed and in harm’s way when criminals know the cycle of when physical checks are cashed at non-bank entities they are forced to use. The unbanked appears to be a growing population that will continue to benefit and build economies that do not exist today under a modern banking society as cryptocurrencies offer the alternative. Examining the reasons for using currency and focusing on three primarily: 
• Medium of exchange
• Store value
• Use the money to make money 
are areas that cryptocurrency will continue to evolve.  Digital currencies will continue to grow in user experience from the marketplace offered by the Silk Road to mobile user experiences that will offer payment services from mobile phones. End users in remote areas will benefit using their phone and cryptocurrencies as the form of payment for daily transactions.

With respect to the store of value, volatility is a major issue of concern with crypto currencies. One factor that will take shape as ICOs are on-boarded through foundations is that the use of the data from the blockchain which powers the technology will become of great value. The utility of the tokens along with the commercialization of the data which will contain transaction data makes it possible for a model to be created in conjunction with the foundation, thus begin to reduce volatility with certain digital currencies.

Using digital currencies to make money involves trading and having a professional background and qualifications to do so. This is where things become dangerous as some individuals get caught in the hype surrounding price growth of cryptocurrencies over the last four years, such as the increase in the price of Bitcoin, Ethereum, Litecoin, Ripple, and many more. There are more than 300 different currencies available. However, trading cryptocurrencies or any other asset or security, although the cryptocurrency is technically not security, requires professional training. It is easy to be enticed with the practices of “fear of missing out” and “pump and dump” that happen in the equity trading space and FX space in cryptocurrency.

To protect the public, government regulators are actively building legal and working frameworks to manage these innovating digital technologies. The first set of policies involves putting procedures around money service businesses (MSBs) to curb money laundering or fraudulent activity to protect public interests. Government agencies will conduct workshops and employ consultants to build internal knowledge banks around the subject matter, which involves hiring specialized consultants and training to help design effective working frameworks that will not hinder innovation of the technology, but bring a compliance structure to protect against anti-money laundering (AML), and limit criminal activity and suspicious activity such as payments to terrorist organizations.

Governments along with the banking industry are upgrading their talent pool and hiring resources that are experienced with the underlying technologies that power cryptocurrencies. The Island of Bermuda is an example of a sovereign government that has been proactive in creating laws and a working framework for defining cryptocurrencies and conducting a cryptocurrency business; the country has instituted a reasonable and strict compliance program to deter any AML and fraudulent transaction activity. Premier David Burt met with the executive team of Digital AIR Technologies & Analytics to discuss blockchain, cryptocurrencies, and artificial intelligence. Bermuda has created a legal framework that streamlines the ICO process as it looks to create the “Gold Standard” in domiciling ICOs.

Governments will have an instrumental role in managing the engagement between centralized and decentralized payment networks. Displacing the banking system is not realistic in any sense. Central banks have a role to play with the economic health of any society. However, technology and software have created an option for certain segments of society to supplement or in certain cases to become their primary choice for a medium of exchange when central banking is not feasible or at their disposal. As governments gain more knowledge and discover how digital currencies are positioned to complement the formal monetary system of the sovereign state, they will institute compliance frameworks that do not impede innovation. However, consumer protection against corruption, AML, and fraudulent activity will not be compromised.

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