Blog 2

Dr. Neeraj Oak offers a definition of a cryptocurrency and looks at the many types and flavours of cryptocurrencies available today.

The growth of cryptocurrencies has been much too fast for definitions to keep pace with. That said, practically all cryptocurrencies can be said to share one key characteristic: decentralisation. But what is decentralisation, and how has it created such a potentially disruptive business model?

The traditional way of making non-cash payments is through a bank or financial institution (FI). These organisations provide a service as a central, trusted authority that guarantees the transaction in exchange for a fee.

Cryptocurrencies avoid using any central authority to route transactions by sending money directly between ‘wallets’. These wallets contain some quantity of the cryptocurrency, and possess a public and private keys. The public key can be thought of as an account number- a unique identifier that is visible to others and through which currency can be directed to you. The private key is more like a password, and is necessary to gain control over your wallet.

 

Transactions are made peer-to-peer, as wallets may transfer messages to one another over the internet instructing each other about the time and value of transactions. This cuts out the need for a central authority and the associated fees. On the other hand, transactions cannot be reversed in the decentralised model; it’s rather like paying in cash to a complete stranger.

Cryptocurrencies also share many similarities in the way they maintain a ledger of transactions, a vital requirement in keeping transactions secure. I’ll cover this in greater detail in a later post, but it’s important to note at this stage that it is vital for cryptocurrencies to make sure users can’t use the same money twice.

Beyond decentralisation, the number of types and flavours of cryptocurrencies is vast. Each cryptocurrency sets out its benefits in a subtly different way in order to stand out and attract new users.

Looking at the advertising messages of the top 15 cryptocurrencies, I’ve created an index that shows the attributes that each try to emphasise to their prospective customers. This is shown in the column chart ‘Importance of attribute by currency’.

It’s clear that each cryptocurrency sees its appeal differently. Some, such as Peercoin and Blackcoin set out their product as being more environmentally friendly due to the lower computing power costs they require. Others such as Dogecoin appeal to users through a fun, community-focussed message. However, one needs to look at the trends in the advertising messages too.

The diagram ‘Weighted importance of attributes for top 15 cryptocurrencies’ was created by aggregating advertising messages of all of the top 15 cryptocurrencies. Surprisingly, cryptocurrencies seem most keen on appearing to be a convenient method of transferring money. It’s also clear that security is seen as a primary concern of prospective customers.

The ability to transfer money cheaply across long distances is also emphasised by most cryptocurrencies. This is an especially useful attribute for users who need to move money across borders, where government fees would otherwise apply.

Of late, cryptocurrencies have acquired a reputation for providing an anonymous service that circumvents financial and legal barriers. Few of the largest cryptocurrencies seem willing to emphasise this point further, as they perceive it as a barrier to their ambitions of moving into the mainstream of online payments. That said, some cryptocurrencies such as XC and Darkcoin heavily emphasise these attributes; it’s possible that this strategy will win over ‘ideological’ adopters of cryptocurrencies, who value a more libertarian way to pay.

Join me for my next post “Bitcoin: The coin that launched a thousand coins”, in which I look at the history of the world’s first and largest cryptocurrency.

Blog 1

In this series of blogs, I will examine the global cryptocurrency economy, looking at its history and technical design, the many types of business models that have sprung up to make use of it and what the future might hold for this new and potentially disruptive concept. I will examine cryptocurrencies from several perspectives, including that of investors and banks, merchants, consumers and governments. Finally, I will consider the fundamental stability of cryptocurrencies, drawing on my background as a mathematician and complexity scientist.

Since 2009, there has been a radical new way of making payments. The creation of the first decentralised peer-to-peer payment system, Bitcoin, has led to the creation of a novel and booming set of payment services- known collectively as ‘cryptocurrencies’. These digital currencies are not created or backed by any government, nor does any one user have complete control over them. Could this become the chief way people pay for goods and services in the 21^st century?

 

It’s clear that cryptocurrencies are an important and rising element in today’s digital economy. At the time of writing, the market capitalisation of the top 10 cryptocurrencies in the world was around $8.69 Billion and growing. But why have so many people invested their belief (and perhaps more importantly, their money) in digital currencies that have little-to-no intrinsic value and no state to back them up?

In the wake of the 2008 financial crisis, the trust in banks, financial institutions and governments has melted away amongst the populations of Europe and the USA; this is especially true amongst the younger, more tech-savvy demographic. It is from amongst this group of people that Bitcoin emerged. A central tenet of cryptocurrencies is to avoid using banks or established financial institutions to route money or accept payments. This cuts out the need for banks as third-party guarantors of transactions, and limits the ability of governments to interfere or regulate payments.

A side effect of removing third-party guarantors from payments is that the new payment method must be decentralised and trust-free. In such an environment, it is considerably easier to conceal one’s identity; indeed, declining to reveal personal information becomes the norm.

Inevitably, by providing a means of making payments secretly and without government interference cryptocurrencies have become popular with providers of illicit products and those who would rather operate under a cloak of anonymity.

However, there is a significant following of cryptocurrencies who appreciate secrecy as a response to a distrust of governments as a result of the spying allegations made by WikiLeaks and Edward Snowden. Many also feel that the internet should remain free of state regulation, and supporting cryptocurrencies might be a means of expressing this libertarian view.

Finally, the growth of cryptocurrencies has been fuelled significantly by the activities of speculators, who can harness the volatile prices that cryptocurrencies often exhibit to make large profits.

While these groups of people have brought the cryptocurrency industry to its current state, they are unlikely to be able to create a viable and sustainable business model over the coming years without participation from the more mainstream economy. If cryptocurrencies are to become more than just a passing phase, the coming years must see a huge change in the types of users of these services.

Join me over the next few weeks as we look at the history of cryptocurrencies, their business models and technical structures and what the future might hold for this innovative but fragile industry.