Cryptocurrencies 101
THEY’VE TAKEN THE TECH WORLD BY STORM BUT WHAT ARE CRYPTOCURRENCIES AND HOW DO THEY WORK? TECHLIFE DIVES THROUGH THE HYPE AND LOOKS AT THE BASICS OF NEW DIGITAL CURRENCIES.
UNLESS YOU’VE BEEN living a self-imposed digital detox for the last year, it’s been tough to miss the skyrocketing hype surrounding cryptocurrencies and Bitcoin in particular. News of speculators making millions from investing in digital currencies are often offset by stories of imminent carnage as bubbles burst and investments slide. Still, what actually is a cryptocurrency, how does it work and what can you do with it?
WHAT IS A CRYPTOCURRENCY?
A cryptocurrency is its own virtual, digital currency — you can’t physically hold it, but you can spend it like normal currency where it’s accepted. However, it’s more accurate to describe it as a series of transactions stored in a global database — and in that regard, there’s arguably less distance between digital and physical currencies than ever before.
Over the last few years, there’s been growing chat about Australia becoming a ‘cashless society’, possibly even as soon as 2020. With internet banking, EFTPOS and credit cards, Apple Pay and Android Pay, you could argue we’re nearly there already. These digital mechanisms are links to the Australian dollars we have in our bank accounts, but think about this — how often do you see those dollars? The practical reality is our money exists as entries in a database and when we buy that DVD series on eBay, we’re digitally transferring amounts of currency from one account to another in return. In Australia, those transactions are confirmed by your bank and the bank of the service or product provider, financial institutions regulated by Australia’s central bank, the Reserve Bank.
HOW CRYPTOCURRENCIES WORK
But here’s where cryptocurrencies differ — cryptocurrencies typically have no regulated, centralised control. Instead, they use a distributed database or ledger that works a bit like peer-to-peer file-sharing. The database doesn’t exist in any one location on a main system or organisation's server — it exists over a network of equal-ranked computers or ‘nodes’, where each node on the network has access to the entire database. When you make a transaction using a digital coin, it first must be checked that you have that coin to spend. The transaction then has to be written to the ledger, a task performed by ‘miners’, computers set up for this purpose. As you’d expect, this isn’t simply written down on the next blank line of a ledger book. The ‘crypto’ in 'cryptocurrency’, you might have guessed, refers to the fact that all of these transactions are recorded in encrypted form. To ensure the accuracy and permanency of the ledger, your transaction must first be added to others to form a group or ‘block’. The next step is adding this block to the previously-recorded blocks in the ledger and this is where the concept of the ‘blockchain’ comes from — it’s literally a chain of blocks, each containing many transactions.
But here’s the clever bit — before a new block can be added to the blockchain, the block’s transaction data is combined with a number that produces a special code or ‘hash’ that starts with a particular number of zeros. How do they find the number? Literally, by guess work.
Miners are in a race to discover these unknown numbers or ‘nonces’ (number used once). Once a miner has discovered a valid hash, it gets to write a block of transactions, becoming the next block in the blockchain.
Cryptocoin-mining is this process of discovering block nonces, creating new blocks and writing them to the ledger, but because of the computational complexity involved and to incentivise them to continue the word, cryptocoin miners are rewarded with coin of their own. Early on, the reward for writing a valid block to the Bitcoin blockchain was 50 bitcoins — but back when one bitcoin was worth only a few US dollars, so bitcoin-mining was for the die-hards mostly. Meanwhile, that block reward number reduces over time, halving every four years or so. Today, it’s only 12.5 bitcoins — but at US$8,000 per bitcoin, that’s US$100,000 and as you can imagine, bitcoin-mining is fast becoming a popular business.
CAN’T BUY A PC GRAPHICS CARD?
So there are two ways you can theoretically get into a cryptocurrency like Bitcoin — you can either buy it or mine it. For a while in the early days, a reasonably powerful home computer was enough to mine coins at a sustainable rate and make a bit of money on the side. However, as electricity prices rose, and combined with Bitcoin’s relatively-static value and falling block reward rate, costs began to overtake and only the enthusiasts continued. More recently, Bitcoin’s booming price has seen coin miners come out of the woodwork, building high-end systems to crank up mining operations.
At the same time, PC gamers began noticing a rise in PC video card prices due to an increasing card shortage. According to reports, prices for cards such as Nvidia’s GeForce GTX 1080 or AMD’s Radeon RX 580 have doubled as the frenzy deepened. A look at local suppliers showed mid-range cards such as the GTX 1070 were often unavailable.
But why graphics cards? You can mine cryptocurrency with almost any computer — even a small Raspberry Pi. However, PC graphics cards feature many small-scale but very fast processing ‘cores’ that are not only ideal for generating vivid 3D gaming graphics, they’re also suited for processing the calculations associated with mining crypto-coins.
The problem is, with so many now competing in the race to mine coins, including commercial miners using much faster FPGA (field-programmable gate array) and ASIC (application-specific integrated circuit)-based systems, plus the ever-growing complexity in finding a valid nonce, its questionable whether home miners can even make back the electricity bill these days, let alone turn a profit.
HOW MANY DIGITAL CURRENCIES?
If you have only a passing interest in digital currencies, you’ve probably heard of Bitcoin, you may have heard of Ethereum, or even Litecoin. As of February 2nd this year, cryptocurrency market tracking website Coinmarketcap ( coinmarketcap.com) followed around 1,500 digital currencies, worth collectively a little over US$400 billion. About a third of that belonged to Bitcoin at US$142 billion, each Bitcoin then worth just under US$8,500, followed by Ethereum with a market capitalisation of US$85billion. Even number 25 on the list — Zcash — made the billionaire’s club at US$1.129 billion total. More surprisingly, there were 743 digital currencies with a valuation of at least US$1 million as of February 2nd. But as you’ll quickly discover, cryptocurrency valuations can be a very volatile business.
THE BITCOIN BOOM
The hype behind digital currencies has been fuelled in no small portion by the meteoric rise in the value of Bitcoin. From a practical value of less than one cent per Bitcoin back in May 2010, it had risen to $13 by the end of 2012. By April the following year, it peaked at $266. When we covered blockchain technology in this column back in October 2016, it had spent the last two years trading in a range between $500 and $800. It broke new ground in March 2017, topping $1,300 and then went for a run, catching the mainstream media as it reached US$2,000 by May, $5,000 by September (and this is where things get white-knuckle) before hitting the summit of US$17,900 in December. Bitcoin’s incredible run even prompted a father-of-three in the Netherlands into selling everything he owned — including a house worth 300,000 Euros — in part at least to buy Bitcoins.
Still, nothing defies gravity forever and the inevitable correction followed. By the end of January 2018, the price had plummeted nearly 50% from its December 2017 peak to be US$9,850. It then fell another US$1,000 on February 1st alone, as more than US$100 billion was slashed from the cryptocurrency market in just 24 hours.
MAKE YOUR OWN CRYPTOCURRENCY?
The Bitcoin Boom also brought along for the ride many of its competitors, alternative coins or so-called ‘altcoin’, such as Ethereum and Litecoin. The digital currency hype became so infectious, just announcing a cryptocurrency was in the works seemed enough to light a rocket under a company’s share price. Kodak was best known for making film cameras, yet in the days immediately following its 9th January 2018 announcement of plans to launch its own cryptocurrency, KodakCoin, the company’s share price tripled as investors piled onto the bus. By early February, the share price had slid back to under US$7, but still well above its pre-announcement levels.
That got us thinking — if a camera company can set up its own cryptocurrency, is it possible to make your own? As it turns out, there are several ‘altcoin’ service providers that offer, for a fee, to take care of the blockchain tech management for you. But if you have C++ coding skills, you can do it yourself — the source code for Bitcoin and Litecoin is available on the GitHub source-code repository. However, you just can’t create a new coin and expect everyone to jump on-board — consensus seems to be you generally need a user community to get things moving. That’s where businesses, with their customer base and loyalty programs, would seem to have ready-made communities for the job.
WHAT SETS A CRYPTOCURRENCY’S WORTH?
The value of a cryptocurrency is determined by many different factors, such as scarcity of the currency, fear of government regulation and good-old fashioned hype, but ultimately, its value is set by basic supply and demand. Yet, while most cryptocurrencies aim to be alternatives to traditional centrally-controlled currencies, you’re likely to see a significant change come over the cryptocurrency landscape in the next few years, thanks largely to loyalty programs.
Businesses have used loyalty programs to keep customers coming back for years — just look in your wallet. However, many loyalty schemes will likely suffer from two major limitations — you’ll be limited in how you can spend your points and, after a period of time, those points will often expire. Cryptocurrencies are starting to be seen by big retailers as a way out of the problem. Here’s an example that’s literally ‘food for thought’ — Burger King in Russia launched ‘Whoppercoin’, its own cryptocurrency, as a loyalty program in 2017. Buy a burger and you get coins in your digital wallet. The value of the coins comes by being able to redeem the coins for burgers (one burger will cost you 1,700 Whoppercoins), but also by trading them with other coin holders.
A recent trial of a cryptocurrency loyalty scheme involving students and faculty at the University of New South Wales, backed with New South Wales Government support, has been an early example here. We reckon it won’t be the last, so expect cryptocurrency loyalty reward programs to take off over the next few years.
THEFTS AND RISKS
The blockchain technology behind cryptocurrencies might well ensure the legitimate owner of coins enjoys the spending power of those coins, but it can’t necessarily prevent them from being stolen. Earlier this year, Japan’s Coincheck digital currency exchange alerted investors in the ‘NEM’ cryptocurrency that its network had been broken into on January 25th and around US$530 million worth stolen. It was later reported the funds were stolen from an online wallet rather than a more secure off-line option, raising questions of why that much currency wasn’t more securely stored. Cryptocurrency thefts are not unheard of — the Mt. Gox exchange reportedly suffered losses from Bitcoin theft of approximately US$460 million before it halted trading in 2014.
Meanwhile, financial institutions are growing increasingly wary of digital currencies and Bitcoin in particular. The head of England’s Financial Conduct Authority, Andrew Bailey, hasn’t minced his words when it comes to Bitcoin. “If you want to invest in Bitcoin, be prepared to lose your money — that would be my serious warning,” Bailey told the BBC in December 2017. In February 2018, Facebook even banned all ads promoting cryptocurrencies, including Bitcoin.
BLOCKCHAIN’S HEALTHY FUTURE
While cryptocurrencies appear set to continue their rocky ride, blockchain technology continues to be researched for a range of alternate applications. One of those areas is electronic health records (EHR), where researchers are investigating techniques for applying blockchain tech to manage access to patient medical data.
Much in the way cryptocurrencies use blockchain tech to store transactions, researchers are devising systems to implement blockchain as a permanent record of all accesses to personal data. In 2017, DeepMind — the artificial intelligence unit launched by Google’s parent company, Alphabet — announced plans to develop such a system and is working with hospitals in the UK.
Increasingly, the value of medical data is being seen through machine-learning and other artificial intelligence methods searching for treatments for a range of medical conditions and diseases, from mental health to cancer. Concurrently, research is looking into ways of anonymising the data so that it still provides health researchers with the raw materials they need, without identifying the person the data describes.
BLOCKCHAIN’S THE KEY
As eye-catching as cryptocurrencies are, the real story here is the rise of blockchain and the cryptography technologies combining with it. With talk of it being used in everything from political elections to electrical power generation, a distributed ledger acting as a permanent record that’s difficult to hack is tech that’s quickly gaining the interest of governments, industry and university research around the world.