Cryptocurrency

A cryptocurrency (or crypto currency) is a medium of exchange using cryptography to secure the transactions and to control the creation of new units. Cryptocurrencies are a subset of alternative currencies, or specifically of digital currencies. Bitcoin became the first decentralized cryptocurrency in 2009. Since then, numerous cryptocurrencies have been created. These are frequently called altcoins, as a blend of bitcoin alternative.

Cryptocurrencies use decentralized control as opposed to centralized electronic money/centralized banking systems. The decentralized control is related to the use of bitcoin’s block chain transaction database in the role of a distributed ledger.

Overview

Decentralized cryptocurrency is produced by the entire cryptocurrency system collectively, at a rate which is defined when the system is created and which is publicly known. In centralized banking and economic systems such as the Federal Reserve System, corporate boards or governments control the supply of currency by printing units of fiat money or demanding additions to digital banking ledgers. However, companies or governments cannot produce units of cryptocurrency and as such, have not so far provided backing for other firms, banks or corporate entities which hold asset value measured in a decentralized cryptocurrency. The underlying technical system upon which decentralized cryptocurrencies are based was created by the group or individual known as Satoshi Nakamoto.

As of March 2015, hundreds of cryptocurrency specifications exist; most are similar to and derived from the first fully implemented decentralized cryptocurrency, bitcoin. Within cryptocurrency systems the safety, integrity and balance of ledgers is maintained by a community of mutually distrustful parties referred to as miners: members of the general public using their computers to help validate and timestamp transactions adding them to the ledger in accordance with a particular timestamping scheme.

The security of cryptocurrency ledgers is based on the assumption that the majority of miners are honestly trying to maintain the ledger, having financial incentive to do so.

Most cryptocurrencies are designed to gradually decrease production of currency, placing an ultimate cap on the total amount of currency that will ever be in circulation, mimicking precious metals. Compared with ordinary currencies held by financial institutions or kept as cash on hand, cryptocurrencies are less susceptible to seizure by law enforcement. Existing cryptocurrencies are all pseudo-anonymous, though additions such as Zerocoin and its distributed laundry feature have been suggested, which would allow for true anonymity.

History

In 1998, Wei Dai published a description of «b-money», an anonymous, distributed electronic cash system. Shortly thereafter, Nick Szabo created «Bit Gold».Like bitcoin and other cryptocurrencies that would follow it, Bit Gold was an electronic currency system which required users to complete a proof of work function with solutions being cryptographically put together and published.

The first decentralized cryptocurrency, bitcoin, was created in 2009 by pseudonymous developer Satoshi Nakamoto. It used SHA-256, a cryptographic hash function, as its proof-of-work scheme. In April 2011, Namecoin was created as an attempt at forming a decentralized DNS, which would make internet censorship very difficult. Soon after, in October 2011, Litecoin was released. It was the first successful cryptocurrency to use scrypt as its hash function instead of SHA-256. Another notable cryptocurrency, Peercoin was the first to use a proof-of-work/proof-of-stake hybrid. Many other cryptocurrencies have been created though few have been successful, as they have brought little in the way of technical innovation. On 6 August 2014, the UK announced its Treasury had been commissioned to do a study of cryptocurrencies, and what role, if any, they can play in the UK economy. The study was also to report on whether regulation should be considered.

Starting 2014, a so-called 2nd generation of cryptocurrencies appeared, like Monero, Ethereum and Nxt. They have advanced functionalities like stealth addresses,smart contracts, side chains or assets.

Publicity

Central bank representatives have stated that the adoption of cryptocurrencies such as bitcoin pose a significant challenge to central banks’ ability to influence the price of credit for the whole economy. They have also stated that as trade using cryptocurrencies become more popular, there is bound to be a loss of consumer confidence in fiat currencies. Gareth Murphy, a senior central banking officer has stated «widespread use [of cryptocurrency] would also make it more difficult for statistical agencies to gather data on economic activity, which are used by governments to steer the economy». He cautioned that virtual currencies pose a new challenge to central banks’ control over the important functions of monetary and exchange rate policy.

Jordan Kelley, founder of Robocoin, launched the first bitcoin ATM in the United States on February 20, 2014. The kiosk installed in Austin, Texas is similar to bank ATMs but has scanners to read government-issued identification such as a driver’s license or a passport to confirm users’ identities.

The Dogecoin Foundation, a charitable organization centered around Dogecoin and co-founded by Dogecoin co-creator Jackson Palmer, donated more than $30,000 worth of Dogecoin to help fund the Jamaican bobsled team’s trip to the 2014 Olympic games in Sochi, Russia. The growing community around Dogecoin is looking to cement its charitable credentials by raising funds to sponsor service dogs for children with special needs.

Legality

The legal status of cryptocurrencies varies substantially from country to country and is still undefined or changing in many of them. While some countries have explicitly allowed their use and trade, others have banned or restricted it. Likewise, various government agencies, departments, and courts have classified bitcoins differently. China Central Bank banned the handling of bitcoins by financial institutions in China during an extremely fast adoption period in early 2014. In Russia, though cryptocurrencies are legal, it is illegal to actually purchase goods with any currency other than the Russian ruble.

On March 25, 2014, the United States Internal Revenue Service (IRS) ruled that bitcoin will be treated as property for tax purposes as opposed to currency. This means bitcoin will be subject to capital gains tax. One benefit of this ruling is that it clarifies the legality of bitcoin. No longer do investors need to worry that investments in or profit made from bitcoins are illegal or how to report them to the IRS. In a paper published by researchers from Oxford and Warwick it was shown that bitcoin has some characteristics similar to the precious metals market more than to traditional currencies, hence in agreement to the IRS decision even if based on different reasons.

Legal issues not dealing with governments have also arisen for cryptocurrencies. Coinye, for example, is an altcoin that used rapper Kanye West as its logo without permission. Upon hearing of the release of Coinye, originally called Coinye West, attorneys for Kanye West sent a cease and desist letter to the email operator of Coinye, David P. McEnery Jr. The letter stated that Coinye was willful trademark infringement, unfair competition, cyberpiracy, and dilution and instructed Coinye to stop using the likeness and name of Kanye West.

Concerns of an unregulated global economy

As the popularity of and demand for online currencies increases since the inception of bitcoin in 2009, so do concerns that such an unregulated person to person global economy that cryptocurrency denominations offer may become threats to society as a whole. Concerns abound that altcoins may become tools for anonymous web criminals.

Cryptocurrency networks display a marked lack of regulation that attracts many users who seek decentralized exchange and use of currency, however these very same lack of regulations have been critiqued as potentially enabling criminals who seek to evade taxes and launder money.

Transactions that occur through the use and exchange of these altcoins are independent from formal banking systems, and therefore can make tax evasion simpler for individuals. Since charting taxable income is based only upon what a recipient reports to the IRS, it becomes extremely difficult to account for transactions made using existing cryptocurrencies, a mode of exchange that is complex (and in some cases impossible) to track.

Systems of anonymity that most cryptocurrencies offer can also serve as a simpler means to launder money. Rather than laundering money through an intricate net of financial actors and offshore bank accounts, laundering money through altcoins stands outside institutions and can be achieved through anonymous transactions. Laundering services for cryptocurrency exist to service the bitcoin currency, in which multiple sourced bitcoins are blended to obscure the relationship between input and output addresses.

Arrests

There have been very few arrests in the United States related to cryptocurrency. This is primarily due to the difficulty of tracking cryptocurrency payments. The arrests that have been made are all on charges of using cryptocurrency to launder money. A notable case was the arrest ofCharlie Shrem, the CEO of BitInstant.

In Florida, a localbitcoins.com user was charged with felony violations of Florida’s law against unlicensed money transmitters for transmitting $30k. He was arrested by an undercover cop pretending to be a customer.

Fraud

On August 6, 2013, Magistrate Judge Amos Mazzant of the Eastern District of Texas federal court ruled that because cryptocurrency (expressly bitcoin) can be used as money (it can be used to purchase goods and services, pay for individual living expenses, and exchanged for conventional currencies), it is a currency or form of money. This ruling allowed for the SEC to have jurisdiction over cases of securities fraud involving cryptocurrency.

GBL, a Chinese bitcoin trading platform, suddenly shut down on October 26, 2013. Subscribers, unable to login, lost up to $5 million worth of bitcoin.

In February 2014, cryptocurrency made national headlines due to the world’s largest bitcoin exchange, Mt. Gox, declaring bankruptcy. The company stated that it had lost nearly $473 million of their customer’s bitcoins likely due to theft. This was equivalent to approximately 750,000 bitcoins, or about 7% of all the bitcoins in existence. Due to this crisis, among other news, the price of a bitcoin fell from a high of about $1,160 in December to under $400 in February.

On March 31, 2015, two now-former agents from the Drug Enforcement Administration and the U.S. Secret Service were charged with wire fraud, money laundering and other offenses for allegedly stealing bitcoin during the federal investigation of Silk Road, an underground illicit black market federal prosecutors shut down in 2013.

On December 1, 2015, Homero Joshua Garza stands accused of securities fraud following his development of the cryptocurrency known as Paycoin. Garza was the owner of the now defunct GAW Miners website that sold mining equipment for cryptocurrency. Garza is accused of masterminding an elaborate ponzi scheme under the guise of «cloud mining» with mining equipment hosted in a data center. Garza purported the cloud miners known as «hashlets» to be mining cryptocurrency within the Zenportal «cloud» when in fact there were no miners actively mining cryptocurrency. Zenportal had over 10,000 users that had purchased hashlets to the tune of over 19 million U.S. dollars. GAW Miners was co-founded by Homero Joshua Garza and Stuart Fraser of Cantor Fitzgerald, a well known securities company.

Darknet markets

Cryptocurrency is also used in controversial settings in the form of online black markets, such as Silk Road. The original Silk Road was shut down in October 2013 and there have been two more versions in use since then; the current version being Silk Road 3.0. The successful format of Silk Road has been widely used in online dark markets, which has led to a subsequent decentralization of the online dark market. In the year following the initial shutdown of Silk Road, the number of prominent dark markets increased from four to twelve, while the amount of drug listings doubled from 18,000 to 32,000.

Darknet markets present growing challenges in regard to legality. Bitcoins and other forms of cryptocurrency used in dark markets are not clearly or legally classified in almost all parts of the world. In the U.S., bitcoins are labelled as «virtual assets». This type of ambiguous classification puts mounting pressure on law enforcement agencies around the world to adapt to the shifting drug trade of dark markets.

Since most darknet markets run through TOR, they can be found with relative ease on public domains. This means that their addresses can be found, as well as customer reviews and open forums pertaining to the drugs being sold on the market, all without incriminating any form of user. This kind of anonymity enables users on both sides of dark markets to escape the reaches of law enforcement. The result is that law enforcement adheres to a campaign of singling out individual markets and drug dealers to cut down supply. However, dealers and suppliers are able to stay one step ahead of law enforcement, who cannot keep up with the rapidly expanding and anonymous marketplaces of dark markets.

Timestamping

Cryptocurrencies use various timestamping schemes to avoid the need for a trusted third party to timestamp transactions added to the block chain ledger.

Proof-of-work schemes

The first timestamping scheme invented was the proof-of-work scheme. The most widely used proof-of-work schemes are based on SHA-256, which was introduced by bitcoin, and scrypt, which is used by currencies such as Litecoin. The latter now dominates over the world of cryptocurrencies, with at least 480 confirmed implementations.

Some other hashing algorithms that are used for proof-of-work include CryptoNight, Blake, SHA-3, and X11.

Proof-of-stake and combined schemes

Some cryptocurrencies use a combined proof-of-work/proof-of-stake scheme, The Proof-of-stake is a method of securing a cryptocurrency network and achieving distributed consensus through requesting users to show ownership of a certain amount of currency. It is different from proof-of-work systems that run difficult hashing algorithms to validate electronic transactions. The scheme is largely code dependent on the coin, and there’s currently no standard form of it.

Economics of cryptocurrency

Cryptocurrencies are digital currencies which are used primarily outside existing banking and governmental institutions, exchanged over the internet. While these alternative, decentralized modes of exchange are in the early stages of development, they have the unique potential to challenge existing systems of currency and payments.

Competition in cryptocurrency markets

Today, there are over 200 digital currencies in existence. Entry into the marketplace is undertaken by so many due to the low cost of entry and opportunity for profit making through the creation of coins.

Network Effects/ play an important role in analyzing the development of cryptocurrency markets. Since any given currency gains use value as the number of its users increase, popularity of a certain currency is integral in that currency’s success. Economists postulate that large competitors (such as the most popular mode of cryptocurrency: bitcoin) will attract more new users due to the size of their growing exchange pools and as a result will effectively dominate the market.

A study entitled «Competition in the Cryptocurrency Market» conducted by members of the NET Institute over three periods between 2013 and 2014 charts the analysis of changes in price data over time in regards to budding cryptocurrency markets. It analyzes bitcoin and other similar cryptocurrencies referred to as «altcoins». These include Litecoin, Peercoin, and Namecoin; cryptocurrencies listed in order by which account for the largest percentages of digital market capitalization behind bitcoin (which accounts for 90%).

The NET study found that of these four, all were early entrants into the digital currency marketplace, designed to correct perceived bitcoin’s flaws and amass popularity in an infant market whose popularity was rapidly growing. This study introduced the question of the role of demand in cryptocurrency markets, and what impetus demand has in relation to emerging coins. The study dealt namely with two common forces of demand that shaped the market: reinforcement and substitution effects. The reinforcement effect expects demand to increase based on usership, and that the cryptocurrency that could gain the most buyers and sellers would win out above all others, thus dominating the marketplace. The substitution effect implies that as the price of bitcoins rose with increased usership, people would begin to look for other options in the cryptocurrency market, thus discouraging any one coin from gaining complete dominance.

List of cryptocurrencies

Academic studies

In September 2015, the establishment of the peer-reviewed academic journal Ledger (ISSN 2379-5980) was announced. It will cover studies of cryptocurrencies and related technologies and is published by the University of Pittsburgh. The journal encourages authors to digitally sign a file hash of submitted papers, which will then be timestamped into the bitcoin block chain. Authors are also asked to include a personal bitcoin address in the first page of their papers.