Bitcoins, Blockchains and the Future of Cryptocurrencies

On August 1st 2017, Bitcoin reached a fork in the road, and split in two. The digital currency market is populated with thousands of copycats (“Altcoins”), but only Ethereum competes, and in some ways, beats Bitcoin.

Eight years ago, an enigmatic figure called Satoshi Nakamoto published a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System”. This paper described a payment system that removed banks and other financial intermediaries from the equation by creating a chain of verified transactions. In order to validate and protect these transactions, cryptography was used. The aim of the paper was not to create a new digital currency, but one of the outcomes was the birth of a new digital currency called Bitcoin in 2009. This was not the first digital currency, nor the first attempt to use cryptography to manage the currency, but Bitcoin is still around, unlike Mr Nakamoto. The avatar, or pseudonym, has disappeared, but the real person (or persons) who assumed the name is probably still around and actively participating in the market.

Why Does Anyone Need Digital Currency?

Consider any financial transaction you undertake; it involves a horde of intermediaries, all of whom control the terms under which you operate and expect to get paid for it. This ranges from governments and treasuries who have the license to print money and decide upon the prevailing interest rates, to your local bank, who charges you for the privilege of holding an account with them and charges you again when you use it. Digital currencies do not require any of these bodies to operate, buyers and sellers interact directly, using a secure and tamperproof transaction chain, the “Blockchain”, which is managed by a network of users, known as miners, who are incentivised by earning a small fee for adding a record to the blockchain. The fee you are charged for the transaction is a fraction of what you would pay any of your current banking service providers. In order to make these digital currencies democratic, there are a few principles that define them.

Some Defining Characteristics of a Cryptocurrency

  • The currency is decentralised; it is not issued by a central bank and is owned by the community that transact with it.
  • The currency is finite; based on the principles that hark back to the gold standard, only a specified amount of the currency is available, now in the future (although the events of August 1 2017 contradict this). Bitcoin was originally pegged at a finite 21 million bitcoins in the Bitcoin Protocol. Because of their digital nature, Bitcoins can be divided into infinitesimal chunks, like the Satoshi (named after Mr Nakamoto), which is 1/100,000,000 of a Bitcoin. Contrast this with the propensity of central banks to print more money as and when they need it.
  • It is secure and tamperproof: transactions cannot be deleted or changed, and all transactions are available for inspection for as long as the blockchain remains in existence. (Yes, I will talk about Ethereum later).
  • Transactions are fast, efficient and cheap, because of the elimination of intermediaries
  • They are supported by a blockchain, an immutable and permanent record of every transaction that has happened.
  • The people who add transaction blocks to the chain are known as “miners”. They use very powerful computer arrays to calculate the algorithms and solve the mathematical formulae that drive and validate the blockchain. The miner who solves the equation first receives a fractional Bitcoin reimbursement. The calculations have become incredibly complex, which sparked the August 2017 fork, which we will discuss later.

The Altcoins and Where to Find Them

Imitation is the sincerest form of flattery, and as Bitcoin gained in popularity it attracted many copycats, commonly known as “Altcoins”. There are thousands of them out there, mainly minnows, although there are some, like Ripple and Litecoin that have a good following. Not only are there many altcoins, there is a growing number of exchanges where you can trade in them, as well as Bitcoin. We are not going to discuss the pros and cons of trading here, there is plenty of information out there about wallets (to keep your cryptocurrency in) and it is probably best to stick to the more heavily traded exchanges and currencies.

However, there is one (or two, because of a dramatic hard “fork”) cryptocurrency out there that requires our attention, because it focuses on the potential of the blockchain beyond money; Bitcoin does have limited non-financial uses, which they are trying to develop further, but Ethereum is your bet if you want to disrupt and improve your current supply chain.

Ethereum and the Non-Financial Blockchain

The only real competitor to Bitcoin is Ethereum, brainchild of Canadian Vitalik Buterin. Ethereum is a lot more than a cryptocurrency platform, its strength is in its ability to process non-financial transactions via blockchain, using “smart contracts”. A smart contract is not so much a contract as code that controls the progression of the contract from start to finish, and is developed using Ethereum’s own “Turing-complete” computer language. Ethereum runs on the EVM (Ethereum Virtual Machine), which is a huge network of computer nodes.

Ethereum also has a different approach to currency – the basic currency is ether, and it is stored in tokens, which are programmable. The processing of transactions also differs from Bitcoin, Ethereum processes an account, rather than a coin or part of a coin. This means that the total ether in circulation, both now and in the future, is not pegged, unlike Bitcoin’s 21 million coins.

There are two versions of Ethereum, ETC (classic) and ETH (or Ethereum hard fork), because of a dramatic raid that happened in 2016 on an entity called the DAO (decentralized autonomous organization), where a hacker managed to siphon off $50 million of $150 million raised via a crowdfunding initiative. This hijacking was foiled by a “hard fork”, which is an action where the blockchain is split in two. This action restored the funds to all participants, but caused a lot of commotion in the market. The “old” blockchain is known as “Ethereum Classic”, and not all participants did migrate to the new ETH for a variety of reasons. While a hard fork has to be agreed before it can take place, it usually results in a new entity that has a different ethos from its previous incarnation, and not all investors agree with the new rules.

Ethereum’s strength is in its suitability for non-financial blockchains, which is probably where the future opportunities lie.

The Future of Cryptocurrencies

This is a young and turbulent market, and opinions range from seeing digital currencies as Ponzi schemes to hailing them as the future of money. The main players in this market are good at disrupting their own business, which creates confusion and doubt among investors. Bitcoin’s action on 1st August is typical; Bitcoin was split into two by a hard fork. Everyone who had a stake in Bitcoin got an equal stake in the new entity, Bitcoin Cash. First of all, this means that the cap has changed to 42 million, even if the new entity has different business rules, thus flouting the rule of a finite currency. Secondly, not all investors and exchanges support the fork. The reason behind the fork was that the transaction for a bitcoin was becoming so complex that a breakaway group of miners motivated for the fork in order to have a newer and simpler currency and processing algorithms. While the jury is still out on Bitcoin Cash, the share price on Bitcoin dipped initially, but has now recovered and is scaling new heights. Maybe digital currencies are a passing fad, but blockchain has a far more predictable future. A blockchain can offer secure and efficient support of transactions ranging from shipping and baggage handling to passport control and issue of identification documents. While many banks and exchanges are putting their toes into the murky waters of digital currency, all organizations are seeing the possibilities in blockchain. Companies such as IBM have invested heavily in the future of blockchain, and companies with complex supply chains are planning to move to smart contracts and blockchain.