The fundamentals of cryptocurrencies
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understand cryptocurrencies: main stakes and key challenges
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The fundamentals of cryptocurrencies
- 3. ! ! Cryptocurrencies- All#about#cryptocurrencies# September-2014-–-page-3/15- ! - ---www.chappuishalder.com---------------------------------------Chappuis-Halder-&-Cie-------------------------------------pbucquet@chappuishalder.com----- ------ - ! What-are-bitcoin,-litecoin,-peercoin,-etc.?- - - - - Following!the!initial!launch!in!2009!by!pseudonymous!developer!Satoshi!Nakamoto,!bitcoin! has!been!in!the!media!limelight!for!both!good!and!bad!reasons.!Its!meteoric!global!adoption! has!also!inspired!the!introduction!of!other!alternative!coins!including!litecoin,!peercoin,! namecoin!and!the!list!goes!on!with!over!275!cryptocurrencies!trading!online!to!date.!!So! what!are!these!“coins”?!Industry!associates!and!researches!have!endeavoured!to! collectively!agree!on!the!terminology!to! describe!these!“coins”!as!cryptocurrencies.!! As!the!majority!of!the!cryptocurrencies!are! payment!systems!that!work!peer_to_peer! without!a!central!repository!or!single! administrator,!they!are!therefore!also!known!as! decentralised!digital!currencies.!Technically,! cryptocurrencies!are!digital!currencies!but!not! all!digital!currencies!are!actually! cryptocurrencies.!Other!digital!currencies! include!e_gold!and!Rand!and!they!are!not!to!be!confused!with!cryptocurrencies.!! What-is-a-cryptocurrency?- Basic!definition! ! Cryptocurrency!is!named!as!such!because!of!its!relation!to!cryptography!and!currency.! Cryptography!is!the!study!of!the!methods!of!encrypting!information!to!send!out!a!message! securely!and!privately,!and!currency!is!commonly!referred!to!generally!accepted!money! used!as!a!medium!of!exchange!for!goods!and!services.- Cryptocurrency!is!hence!a!form!of!digital!currency!that!relies!on!distributed!networks!and! shared!transaction!ledgers!to!become!secure,!anonymous!or!pseudonymous,!traceable!and! potentially!stable.!Bitcoin!is!the!first!and!most!popular!cryptocurrency!and!other! cryptocurrencies!are!often!termed!as!alternative!currencies!or!altcurrencies.!! ! ! ! ! ! ! ! ! Bitcoin,!Litecoin,!Peercoin,!etc.!are!known!as!cryptocurrencies!and digital!currencies!such!as!e_gold,!they!rely!on!distributed!network transaction!ledgers!through!cryptography!to!become!secure,!anon traceable!and!potentially!stable.!
- 4. ! ! Cryptocurrencies- All#about#cryptocurrencies# September-2014-–-page-4/15- ! - ---www.chappuishalder.com---------------------------------------Chappuis-Halder-&-Cie-------------------------------------pbucquet@chappuishalder.com----- ------ - ! Is!cryptocurrency!a!real!currency?!Or!is!it!a!commodity?! ! Cryptocurrency,!though!in!name!shares!great!resemblance!with!currency,!is!very!dissimilar!to!a!real!currency.! Most!major!cryptocurrencies,!except!for!peercoin,!have!limited!supply!(e.g.,!Bitcoin!has!a!total!of!21!million! bitcoins),!therefore!prices!will!need!to!vary!according!to!the!shifts!in!demand.!For!fiat!currencies,!this!works!the! other!way!round!whereby!supply!can!be!adjusted!to!maintain!stability!of!the!value!of!the!currencies.!! So!with!limited!supply,!is!cryptocurrency!a!commodity!like!gold!which!is!a!good!store!of!value!and!remains!stable! over!time?!To!understand!how!similar!or!different!cryptocurrency!is!from!real!fiat!currency!and!commodity,! table!1!is!drawn!up!to!compare!Bitcoin!with!USD!and!gold!based!on!their!respective!attributes.!! - - - - Attributes- ------- - ------ -------- -- - Limited!supply! Yes,!21!million,! decentralised! No,!supply!is!adjusted!to! maintain!stability!of!the! value,!centralised! Yes,!a!finite!resource! Ease!of!storage! Yes,!private!keys!are!used! Yes,!physical/e_cash!in! savings!account! Yes,!non_radioactive!and! dense!element! Portability! Yes,!very!minimal! transportation!cost! Yes,!minimal!transportation! cost! No,!high!transportation!costs! Stability!and! predictability! No!(at!present),!“reactive”!! based!on!software!used!and! demand!is!not!predictable! Yes,!it!is!known!as!a!hard! currency! Yes,!least!reactive!solid! element!with!predictability! on!demand! Substitutability!! Yes,!it!can!be!substituted!by! other!cryptocurrencies!such! as!!Litecoin!or!Ripple,! although!they!are!not!yet! serious!threats! No,!widely!accepted! globally! No,!silver!and!platinum,!the! closest!elements,!are!unable! to!substitute!the!value!of! gold! Acceptance! Weak,!but!rising!use!in! payments!and!investment! High,!widely!accepted! globally! High,!industrial,!medical!and! technological!uses! Table!1:!Comparison!of!bitcoin,!USD!and!gold! As!illustrated!in!table!1,!Bitcoin!shares!greater!similarities!with!gold!than!USD!but!because!of!its!unstable!value! and!limited!alternative!uses,!its!status!as!a!commodity!still!remains!debatable.! As!Bitcoin!and!altcurrencies!are!generally!still!in!their!early!stages!of!development,!the!status!of!Bitcoin!as!a! currency!or!a!commodity!is!therefore!highly!subject!to!the!regulator’s!definition.!For!example,!Germany!has! defined!them!as!“private!money!and!a!financial!instrument”!and!on!the!other!hand,!the!People's!Bank!of!China! has!stated!that!bitcoin!"is!fundamentally!not!a!currency".!As!the!definition!of!bitcoin!is!not!yet!universal,! cryptocurrencies!are!still!largely!distinguished!from!real!currency!in!the!media.!!
- 7. ! ! Cryptocurrencies- All#about#cryptocurrencies# September-2014-–-page-7/15- ! - ---www.chappuishalder.com---------------------------------------Chappuis-Halder-&-Cie-------------------------------------pbucquet@chappuishalder.com----- ------ - ! Overview!of!the!major!cryptocurrencies!today! Even!with!the!introduction!of!a!plethora!of! cryptocurrencies!of!late,!Bitcoin,!with!its!first!mover! advantage,!remains!bested!by!virtually!no!others! with!the!highest!market!capitalization!of!US$8,099! million,!followed!by!Litecoin,!which!was!launched!in! 2011,!with!US$257!million.!! Table!3!below!illustrates!the!differences!and! similarities!of!the!various!major!cryptocurrencies.! Notably,!Litecoin!and!Peercoin!are!technically!nearly! identical!to!Bitcoin,!but!Litecoin!has!a!higher! maximum!number!of!coins!and!reduced!block! generation!time,!while!Peercoin!does!not!have!an! enforced!limit!on!the!number!of!possible!coins.!! Ripple!functions!not!only!as!a!payment!system!like!the!others,!it!also!performs!as!a!currency!exchange!and! remittance!network!for!other!fiat!currencies!and!cryptocurrencies.!Lastly,!Darkcoin!is!the!only!closed!source! cryptocurrency!that!uses!its!proprietary!DarkSend!to!add!privacy!to!transactions!to!allow!for!100%!anonymity.! Cryptocurrency,- year-launched- Function(s)- Unit-of- currency- Hashing- Algorithm- Coins- released- (mn)- Open/Closed- source,-Type-of- ledger- Transaction-time- Bitcoin,!2009! ! ! Payment! system! ! bitcoin! (BTC)! SHA_256! ~13.20!of!21! ! ! Open,!Public! ! 10!mins/! blockchain! Litecoin,!2011! litecoin! (LTC)! SCRYPT! ! ~31.55!of!84! 2.5!mins/! blockchain! Peercoin,!2012! peercoin! (PPC)! SHA_256! ! ~21.67!of!∞! 10!mins/! blockchain! Ripple,!2013! Payment! system,! currency! exchange!&! remittance! network! ripple! (XRP)! ECDSA! ! 100,000!of! 100,000! Open,!Public! consensus! 2!to!5! secs/consensus! ledger! Darkcoin,!2014! Payment! system! darkcoin! (DRK)! X11! ~4.60!of!22! Closed_DarkSend,! Public! NA! Table!3:!Overview!of!the!major!cryptocurrencies!as!of!29 th !August!2014! ! ! ! ! Figure!2:!Comparison!of!major!cryptocurrencies!based!on!launch! year!and!market!cap!as!of!21 st !July!2014,!Statista!Chart! 8099! 257! 30! 42! 31! 0! 2000! 4000! 6000! 8000! 10000! Bitcoin,! 2009! Litecoin,! 2011! Peercoin,! 2012! Ripple,! 2013! Darkcoin,! 2014! Market!Cap!(US$!mn)! Bitcoin!with!the!uppercase!“B”!is!the!underlying!peer_to_peer!network!supporting!the! unit!of!that!network,!bitcoin,!with!the!lowercase!“b”.!
- 10. ! ! Cryptocurrencies- All#about#cryptocurrencies# September-2014-–-page-10/15- ! - ---www.chappuishalder.com---------------------------------------Chappuis-Halder-&-Cie-------------------------------------pbucquet@chappuishalder.com----- ------ - ! However!there!are!also!disadvantages!of!using!cryptocurrencies!over!the!other!existing!alternatives! Volatility! Unstable-value-makes-it-less-practical-as-money- High!volatility!and!unpredictability!on!price!movements!due!to!external!factors!including! vulnerabilities!in!the!security!platform!render!it!less!useful!as!a!medium!of!exchange.! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! ! Source:!CitiFX,!Blockchain.com,!Bloomberg,!BitMex! ! Acceptance- ! Demand-for-daily-use-is-still-relatively-weak- Limited!acceptance!points!and!awareness!across!the!globe!make!real!currencies!much!better! alternatives!due!to!their!wider!acceptance!of!use!and!demand.! ! Legal-issues- ! Use-of-cryptocurrencies-for-illegal-means! The!pseudonymous!nature!creates!unintended!protection!for!illicit!and!illegal!activities.! - Security- issues! - Users-have-to-face-risks-with-merchants-and-cyberWattacks- As!transactions!are!not!reversible,!buyers!have!to!put!their!complete!trust!with!the!merchant,! who!in!this!case!is!the!protected!party!in!the!transaction.!Given!its!digital!nature,! cryptocurrencies!are!also!subject!to!cyber_attacks!–!several!exchanges!including!Mt!Gox,! TradeHill!Bitcoin!and!Bitcoinica!exchange!have!faced!similar!challenges,!leading!to!their! downfall.!! - Regulations- ! Legal-restrictions-hinder-growth-and-increasing-regulations-may-increase-cost-of-use- Cryptocurrencies!have!restricted!use!in!countries!including!China,!Japan,!India,!Indonesia,!etc.! Increasing!regulations!will!also!likely!increase!cost!of!use!in!the!future.! ! ! ! ! ! ! - - 0%! 20%! 40%! 60%! 80%! 100%! Gold!spot! NASDAQ! Composite! BRL/JPY! Bitcoin! Market!Price! Realised!volallity!over!250!days!from!! Aug!13!to!April!14! However,!the!great!volatility,!limited!acceptance,!and!legal,!security!and!regulatory! issues!might!impede!the!usage!of!cryptocurrencies!in!daily!lives.!
- 12. ! ! Cryptocurrencies- All#about#cryptocurrencies# September-2014-–-page-12/15- ! - ---www.chappuishalder.com---------------------------------------Chappuis-Halder-&-Cie-------------------------------------pbucquet@chappuishalder.com----- ------ - ! Focusing!on!P2P!transfers!in!developing!markets! In!July!2014,!Vaurum,!a!California_based!startup!that!enables!companies!including!banks!and!brokerages!to! trade!and!store!bitcoins!on!behalf!of!customers,!successfully!bid!for!30,000!bitcoins,!which!was!part!of!a!larger! pool!of!virtual!currency!seized!from!the!Silk!Road!website!at!a!U.S.!government!auction.!These!30,000!bitcoins! will!serve!as!a!source!of!liquidity!for!the!startup!in!providing!access!to!bitcoins!in!developing!economies.!! The!idea!of!using!bitcoins!as!mobile!money!in!developing!economies!is!not!entirely!new.!There!have!been! instances!in!several!states!including!the!pioneer!in!mobile!money,!Kenya!and!the!Philippines,!the!second!largest! recipient!for!remittances!in!Asia,!with!a!total!of!US$23!billion!transferred!in!2013.! Bitcoin!wallet!in!Kenya!by!Kipochi! Rebit.ph!in!the!Philippines!by!Satoshi!Citadel! Industries! Kipochi!Ltd!has!launched!a!groundbreaking!solution! in!July!2013!that!allows!people!to!send/receive! Bitcoin!and!convert!it!to!and!from!an!M_Pesa! balance.! ! This!enables!Kenyans!to!receive!money!transfers! from!the!diaspora!in!an!easier,!faster!and!cheaper! way,!compared!to!using!banks!and!money! transferring!services!such!as!Western!Union!and! MoneyGram.! Source:!Kipochi! Rebit.ph!was!launched!in!July!2014!as!an!easier,!faster! and!cheaper!alternative!for!the!12!million!Filipinos! working!abroad!to!remit!their!money!back!home.! ! As!compared!to!the!other!existing!remittance!services! that!charge!10%!or!more!in!fees!and!exchange!rates!if! the!sent!amount!is!less!than!$125!USD,!Rebit.ph! allows!users!to!send!small!amounts!of!money,!even! $50!or!$25,!at!much!more!reasonable!fees.! Source:!Reddit! ! ! ! Table!5:!Comparison!between!bitcoin!and!e_money! Source:!CGAP!&!SwitchYard!Media! - - - - - - ! ! Accessibility- Largely!limited!to!internet!connection! Access!to!electronic!devices!such!as! mobile!phones,!and!an!agent!network! Value- Determined!by!supply!and!demand,!and! credibility!of!the!system! Determined!by!the!amount!of!fiat! currency!exchanged!into!electronic!form! Customer-ID- Anonymous! Financial!Action!Task!Force!standards! apply!for!customer!identifications! Production- Mathematically!generated!(mined)!by! peer!network! Digitally!issued!against!receipt!of!equal! value!of!fiat!currency!of!central!authority! Issuer- Community!of!developers,!called!“miners”! Legally!established!e_money!issuer! Regulator- None,!though!an!increasing!number!of! regulators!have!stepped!in! Regulated!by!central!authority,!typically!a! central!bank! Differences-between-bitcoin-and-eWmoney- The!comparison!chart!below!illustrates!the!fundamental!differences!and!it!is!evident! that!there!are!still!gaps!that!bitcoin!has!to!close!before!becoming!a!true!alternative! to!e_money.!-
- 13. ! ! Cryptocurrencies- All#about#cryptocurrencies# September-2014-–-page-13/15- ! - ---www.chappuishalder.com---------------------------------------Chappuis-Halder-&-Cie-------------------------------------pbucquet@chappuishalder.com----- ------ - ! Focusing!on!P2B!payments! The!rising!popularity!of!bitcoin!as!the!medium!of!exchange!for!goods!and!services!between!end!users!and! merchants!is!illustrated!with!the!tremendous!increase!in!acceptance!of!use!with!Coinbase,!a!US_based!Bitcoin! exchange!established!in!mid_2012!which!has!been!noted!for!its!user_friendly!interface.!As!highlighted!in!figures!3! and!4!below,!the!number!of!Coinbase!wallet!users!tripled!and!the!number!of!merchants!partnered!with! Coinbase!increased!more!than!six!fold!within!5!months.!! ! Figure!3:!Number!of!Coinbase!wallet!users!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!Figure!4:!Number!of!merchants!partnered!with!Coinbase! Source:!Coinbase!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!Source:!Coinbase! On-legality:-Bitcoin-as-a-solution-to-eradicating-web-based-illicit-activities- There!have!been!rising!concerns!on!how!bitcoin!can!provide!unintended!protection!for!illicit!activities!given!that! it!can!be!used!to!make!private!and!irreversible!payments.!However,!these!features!already!exist!with!cash!and! wire!transfer,!which!are!widely!used!and!well_established.!The!use!of!Bitcoin!will!undoubtedly!be!subjected!to! similar!regulations!that!are!already!in!place!inside!existing!financial!systems.!With!the!recent!seizure!and!auction! of!bitcoins!from!Silk!Road,!the!online!illicit!drug!marketplace,!it!has!affirmed!the!fact!that!the!Bitcoin!is!not-likely- to-prevent-criminal-investigations!from!being!conducted.!! Contrary!to!common!belief,!Bitcoin!is!designed!to!make!money!more!secure!and!act!as!a!significant!protection! against!many!forms!of!financial!crime.!The!following!are!some!points!worth!noting:! • Bitcoin!is!impossible!to!counterfeit.! • Users!are!in!full!control!of!their!payments!and!cannot!receive!unapproved!charges!such!as!with!credit! card!fraud.!! • Bitcoin!transactions!are!irreversible!and!immune!to!fraudulent!chargebacks.! • Bitcoin!allows!money!to!be!secured!against!theft!and!loss!through!tried!and!tested!mechanisms!such!as! backups,!encryption,!and!multiple!signatures.! On-security:-Heightened-security-platform-with-insured-bitcoin-storage-service- Protecting!financial!health!with!insurance!has!long!been!a!common!practice.!With!the!increasing!use!of!bitcoin! as!a!digital!currency,!insurance!has!now!come!into!play!with!Elliptic!Vault,!the!world’s!first!insured!bitcoin! storage!service,!launched!in!the!UK!by!Elliptic.!Elliptic!Vault!offers!protection!against!the!loss!or!theft!of!Bitcoin! holdings,!with!insurance!underwritten!by!Lloyd’s!of!London.!Thus,!an!individual!who!stores!bitcoins!with!Elliptic! Vault!will!have!his/her!bitcoins!protected!with!strong!encryption!and!secure!physical!locations!known!as!the! “deep!cold!storage”!and!in!the!event!of!loss,!the!liability!to!the!individual!will!be!the!market!value!of!bitcoins,! capped!by!the!liability!limit!determined!by!the!individual,!with!a!cost!of!2%!bitcoin!of!that!limit!per!annum.!
- 15. ! ! Cryptocurrencies- All#about#cryptocurrencies# September-2014-–-page-15/15- ! - ---www.chappuishalder.com---------------------------------------Chappuis-Halder-&-Cie-------------------------------------pbucquet@chappuishalder.com----- ------ - ! shared!transaction!ledgers!to!become!secure,!anonymous!or!pseudonymous,!traceable! and!potentially!stable.! Bitcoin-and-bitcoin- Bitcoin!with!the!uppercase!“B”!is!the!underlying!peer_to_peer!network!supporting!the! unit!of!that!network,!bitcoin,!with!the!lowercase!“b”.! Altcurrencies- Alternative!currencies;!a!general!term!for!cryptocurrencies!other!than!bitcoin.! Chargeback-fraud- Chargeback!fraud!occurs!when!a!consumer!makes!an!online!shopping!purchase!with! their!own!credit!card,!and!then!intentionally!requests!a!chargeback!from!the!issuing! bank!after!receiving!the!purchased!goods!or!services.! ! About-CH&Cie- - ! ! ! - - ! Chappuis-Halder-&-Co!is!a!consulting!company!dedicated!to!financial!services!offering!local!business! solutions!advisory!for!its!clients.!We!rapidly!expanded!our!client!scope!both!geographically!and! sector!wise.!Our!firm!covers!3!types!of!clients:!Corporate!&!Investment!Banking,!Retail!&!Private! Banking!and!Insurance!and!is!organised!around!3!business!lines:!CH!Management,!CH!Solutions!and! CH!Analytics.! ! Our!consultants!deliver!strategic-and-operational-assignments-for-international-clients-in!North! America!(Montreal!and!New!York),!Europe!(Paris,!London!and!Geneva)!and!Asia!(Hong!Kong,! Singapore!and!Shenzhen).! ! Internationally,!we!work!for!Private!Banking,!Retail!Banking!and!CIB.!Our!assignments!are!mainly! focused!on:! • Business!consulting!(strategy,!benchmark,!revenue!oriented)! • Risk!&!Regulation!(SOX!LIGHT,!Basel!II)! • Operational!efficiency!(FX,!Management!Reporting,!cost!oriented)! !