Cryptocurrencies

In this article we will examine:

– What Bitcoin is and what influences its value
– Blockchain technology that underpins cryptocurrencies
– Bitcoin alternatives, known as “altcoins”

Once obscure and poorly regarded, Bitcoin and other cryptocurrencies have now cemented themselves as legitimate assets for trading portfolios.

This ‘digital revolution’ is comparable to the gold rushes of the 19th century, with values soaring as global interest intensifies.

Bitcoin

Bitcoin (BTC) is open source software code that implements a decentralized, peer-to-peer digital cash payment system that does not require any trusted intermediaries to operate (e.g., banks or other financial institutions).

The Bitcoin Whitepaper was published in 2008 by a developer (or development team) under the pseudonym Satoshi Nakamoto, and was soon followed by the first ever “coin” created in the form of a digital record in 2009.

While central banks can print more money, Bitcoin has a finite amount: by 2040 there will only be 21,000,000 Bitcoin in circulation. As with gold, Bitcoin is limited, and is often referred to as “digital gold”.

Bitcoins that go into circulation are a reward for “miners”, but the reward decreases in a predetermined manner. Every 210,000 blocks (4 years), the reward for miners falls by half. The term miners is a reflection of the gold mining boom of the 19th Century.

At first they received 50 BTC, then 25 BTC, then 12.5 BTC, then 6.25 BTC. This is known as Bitcoin “Halving”.

The pioneers of Bitcoin mining earned the most, and at the least cost. Supply to circulation is diminishing, which is an important deflationary factor for this cryptocurrency.

Bitcoin Versus Banks

Bitcoin’s design aimed to solve the inherent inefficiencies and agency problems arising from the intermediated and centralized banking model. Typically, to make an international wire transfer between, say, Canada and China, the money goes through four different banks (including two “correspondent” banks), two national payment systems, and an international settlement service (e.g., SWIFT).

A standard international payment takes between 3 and 15 business days to complete, depending on the destination country, and involves multiple agents such as bank tellers, employees, managers and compliance staff from these financial institutions. Expensive bank fees and exchange rates apply.

By contrast, Bitcoin is distributed in cyberspace across thousands of network nodes, and is inherently borderless. Payments are validated and updated by the network every ten minutes. Intermediaries are not required (e.g., no correspondent banks are required).

There are no bank fees for transactions, but users typically pay a small fee to payment validators (the miners).

In the case of an international transfer of $5,000 from the US, a bank wire might incur a fee of around $125.

A fee of around $1 would be expected for a Bitcoin transfer.

For this reason, Bitcoin (and other cryptocurrencies) is seen as a potentially significant
disruptor of the current banking and financial system.

Blockchain

A blockchain is a list of records, called blocks, that are linked using cryptography and can be added to on an ongoing basis. It is similar to a database, but each block contains a cryptographic hash of the previous block, a timestamp, and transaction data. This prevents the erasure of old data, because new data cannot be added until older data is first validated.

This method of recording is known as an “open, distributed ledger” and records transactions between two parties in a verifiable and permanent way.

Blockchains are managed by a peer-to-peer network collectively adhering to a protocol for inter-node communication and validating new blocks. Once recorded, the data in any given block cannot be altered retroactively without alteration of all subsequent blocks, which requires consensus of the network majority.

Although blockchain records are not unalterable, blockchains are considered secure by design. Like Bitcoin, blockchain was also invented by Satoshi Nakamoto in 2008 to serve as the public transaction ledger of the cryptocurrency.

Bitcoin Price

The price of Bitcoin is an extremely complicated topic, and there is no consensus among experts on what the price of Bitcoin will be in a given time frame.

However, the following factors have proven to be useful in the past.

Psychology

Psychological and emotional factors drive investor decisions. The term “animal spirits”, was coined by the famous British economist, John Maynard Keynes, and refers to investors making decisions based on the behaviour of other market participants and their own intuitions, rather than hard analysis.

This particularly seems to be the case in the price of Bitcoin over the last few years and may be driven largely by Millennials, who have exhibited similar investment patterns on stock trading platforms like Robinhood. Millennials are regarded by analysts as a key driver of Bitcoin price over the coming years.

Additionally, analysis of the price of Bitcoin shows that positive media coverage is one of the main factors driving the price.

Positive media coverage of Bitcoin and other cryptocurrencies causes a hype cycle – a peak of hype is followed by a “trough of disillusionment”. This is commonly referred to as the “FOMO” stage – Fear of Missing Out, followed by periods of “FUD”, or Fear, Uncertainty and Doubt.

Political Risk

Political risk around national currencies can also affect the price of Bitcoin, as people use it to hedge against price movements in a particular currency, or they need to quickly move large amounts of value out a country or currency.

The economic crisis in Greece in 2015 was followed by reports of increased buying of Bitcoin by Greek citizens wishing to protect their wealth, although this did not affect the price of Bitcoin globally.

However, nervousness about the Brexit referendum in Britain in 2016 did lead to an increase in the price of Bitcoin, along with a decrease in the value of the British Pound.

Regulation

Regulators around the world have had to play catch-up in regards to Bitcoin and altcoins. For instance, how should cryptocurrencies be treated in regards to tax, should they be regulated and if so, what regulations might apply?

Two events in particular highlight the impact regulations can have on Bitcoin price.

The announcement that Bitcoin would be considered legal tender in Japan pushed the price of Bitcoin up by 2% in just 24 hours, and the price globally by 160% for the next two months.

Conversely, China’s decision to shut down several Bitcoin exchanges and ban Initial Coin Offerings (ICOs – a launch of a new cryptocurrency similar to a stock Initial Public Offering – IPO) sent the price of Bitcoin plummeting by 29% in 24 hours.

Governance

Although Bitcoin is a decentralised currency, some decisions about how it will work in future need to be made from time to time. These decisions have an impact on price.

The software used to verify Bitcoin transactions is created by developers and is run by miners (who also verify Bitcoin transactions).

To change the software used to mine and authenticate transactions, developers need more than 50% of the global network of miners to agree with the proposed changes. If and when they get that support, they can create what is known as a “fork”.

In 2017 Bitcoin underwent a “hard fork”. A new cryptocurrency – Bitcoin Cash – was created and given to everyone who owned Bitcoin. Bitcoin cash software can process 30 transactions per second, around four times faster than Bitcoin.

Not many investors in Bitcoin are coders, however, or knew what the fork would entail. There was a period of uncertainty before the fork, and a period of rapid price rises afterwards.

Institutional Acceptance

The financialisation of Bitcoin has also been on the rise over the past few years. In 2017, LedgerX launched a physically-settled Bitcoin futures platform and CME launched their own Bitcoin futures market.

In 2018, Intercontinental Exchange (ICE), the parent company of the New York Stock Exchange (NYSE), partnered with blockchain technology company Blockstream to create a cryptocurrency data feed and announced their Bitcoin futures platform, BAKKT.

Additionally, 2018 was the year Goldman Sachs invested in cryptocurrency asset custody solution BitGo and TD Ameritrade backed a Bitcoin futures platform known as ErisX.

As financial institutions begin to accept Bitcoin as a legitimate asset, this should mean higher public confidence and more market participation, which should ultimately lead to higher prices in future.

Other Cryptocurrencies

There are now thousands of other cryptocurrencies. The success of Bitcoin has led to the development of many alternative cryptocurrencies, often called “altcoins”. Many of these altcoins are similar to Bitcoin, although many are interesting in their own right.

Litecoin

Like many altcoins, Litecoin is based on the Bitcoin protocol, but is designed to make sure that mining is much cheaper and more democratic than BTC.

Litecoin is a peer-to-peer cryptocurrency and open-source software project. Creation and transfer of coins is based on an open source cryptographic protocol and is not managed by any central authority.

Litecoin is often seen as the “silver” to Bitcoin’s “gold” – a valuable but somewhat lesser alternative. Litecoin offers faster transactions than Bitcoin, and has a higher cap of how many coins can be mined

Ethereum

Ethereum is the second largest cryptocurrency platform by market capitalization, behind Bitcoin.

It is a decentralized open source blockchain featuring “smart contract” functionality.

Ether is the cryptocurrency generated by Ethereum miners as a reward for computations performed to secure the blockchain. Developers who want to create apps, or smart contracts on the Ethereum blockchain need the Ether token to pay nodes to host it, while users of Ethereum-based apps may need Ether to pay for services in those apps.

Companies can also sell services outside the Ethereum network and accept payment in Ether. Ether tokens can also be sold for cash on an exchange, like they can with Bitcoin.

Ripple

Ripple is a real-time gross settlement system, currency exchange and remittance network created by Ripple Labs Inc., a US-based technology company.

Ripple is built upon a distributed open source protocol, and supports tokens representing fiat currency, cryptocurrency, commodities, or other units of value, such as frequent flier miles. The ledger employs the decentralized native cryptocurrency known as XRP, which as of 2020 was the of of the largest “coins” by market capitalization

In 2013, the company reported interest from banks for using its payment system. By 2018, over 100 banks had signed up, but most of them were only using Ripple’s XCurrent messaging technology, and avoided the XRP cryptocurrency due to its volatility.

Recent updates report that XRP can now process 50,000 transactions per second, compared with credit card company VISA’s 24,000 transactions per second.

Resources

The CoinMarketCap website is an excellent resource for those wishing to begin researching the cryptocurrency and altcoin markets.

You can find this data on the CoinMarketCap website

(Please note, we are not responsible for third-party content)