08/30/2018 |

The Rise And Fall Of The Crypto Boom

From the earliest days of mankind, the need to find, store, and transfer value has been a challenging exercise. Even to this day, this continues to task the brightest minds in society. From violent takeovers to formalized barter systems, humans have come a long way in our methods of exchange in value. The more modern approach has been the usage of objects with intrinsic value such as fiat or paper money, but even that is starting to become a thing of the past. Today, we arrive at the doorstep of cryptocurrencies and blockchain technology and how they became one of the hottest topics since the “Dotcom Bubble”.

Origin Of Cryptocurrencies

Simply put, cryptocurrency is traditionally a tech jargon for the fusion of currency and cryptography. A currency is a medium of exchange of value while cryptography is a technique for deploying a set of protocols to exchange secure information in the presence of third parties. Therefore, in layman terms, a cryptocurrency is a type of digital currency which is based on cryptography.

Figure 1: The process of how cryptography works. This image is from researchgate.net. 

At the height of the dotcom bubble of the early 90s, many tech geeks attempted to create some type of online digital cash system. However, every one of these early forms of digital money failed due to issues surrounding centralization. By the turn of the new millennium, most people were convinced that a successful invention of digital currency is not likely as centralized control cannot be bypassed.

In late 2008, a previously unknown character, Satoshi Nakamoto (still mysterious to this day and believed to be a pseudonym for a person or group of individuals), announced that he had successfully built a digital cash system without central control which ended up being named the infamous “Bitcoin”. What Mr. Nakamoto didn’t realize at the time was that he had just invented a whole new medium of exchange, cryptocurrency. By January 2009, Satoshi Nakamoto launched the first block of Bitcoin. He basically ran a hashing algorithm referred to as SHA 256 on his computer for a while and stored the result in a ledger which was rendered available to the public. This is the first blockchain, the Genesis Block, which at that point became the first cryptocurrency to be mined. The information recorded in the ledger was copied and distributed to all computers across the Bitcoin ecosystem, making it decentralized. This data was therefore now impossible to alter, reverse, or duplicate by any one party including the originator.

Figure 2: The Bitcoin Genesis Block (Raw Hex Version).

Shortly after Satoshi Nakamoto released the Genesis Block to the public, the crypto world began to take note. Many cryptographers began mining Bitcoin. Successful miners would (and still do) get rewarded with Bitcoin and as the cryptocurrency has no centralized control, virtually anyone with access to the internet and suitable hardware could mine Bitcoin or cryptocurrency. As long as you have the computing capacity to compile recent transactions into blocks and solve the computationally difficult puzzle presented by the built-in algorithm, you will be successful. The first step to solving the puzzle is to “place” the next block on the blockchain and thereby claim the reward which serves to incentivize the whole Bitcoin mining business. The reward is made up of the transaction fees associated with the compiled transactions in the block as well as freshly released Bitcoin.

At this stage, Bitcoin had no real value. Bitcoin holders only agreed on exchange rates after bargaining. Besides mining, the only other means of obtaining Bitcoins was to privately purchase from an existing holder. Bitcoin was not widely known and thus could not be used as means of payment in the real world. However, a couple of events took place in the United States and East Asia which launched Bitcoin into an upward trajectory.

On October 5, 2009, New Liberty Standard Exchange, a US-based trader, listed Bitcoins (BTC) with an initial exchange rate of 1,309.03 BTC to one US Dollar. This rate was derived from the cost of electricity required by a computer to mine one Bitcoin. For once, early adopters of Bitcoin now had a universal value for their holding. Then on May 22, 2010, a certain Laszlo Hanyecz placed an order for two large pizzas in an online forum for which he paid 10,000 BTC. This legendary transaction, now celebrated as the Bitcoin Pizza Day, confirmed the possibility of using Bitcoins as a medium of payment for physical items. The news spread quickly and by July of that year, Mt. Gox, a Tokyo based company, launched their own Bitcoin exchange for Bitcoin trading. Within a short period, other cryptocurrency trading exchanges began to spring up around the world which accepted various fiat currencies for Bitcoin trading. By June 2011, Bitcoin climbed to $31 (a staggering 4,000,000% rise from the original offer)

Figure 3: A photo of Steve Kalcanides, whose company was paid 10,000 Bitcoin by Laszlo Hanyecz to deliver a pizza. (Image credits to staradvertiser.com).

In October 2011, the world’s second cryptocurrency, Litecoin, was introduced to the market after which other popular crypto coins like Ethereum (ETH) and Ripple (XRP) also came into existence. Cryptocurrency prices steadily gained, albeit with intermittent periods of exponential growth followed by sudden crashes.

Figure 4: This image shows how Bitcoin pulled back after every big move before making the next leg up. Notice when euphoria kicked in and the spike lasted much longer than the previous ones but the crash was massive. Notice this still occurs even in today’s trading cycles over the last few months. 

By 2016, China and Japan were the major centers for cryptocurrency trading. Buoyed by access to cheap electricity and computer hardware, these two countries became catalysts fueling the rise in cryptocurrency prices. China, in particular, became the epicenter of the cryptocurrency mining world and up to 70% of all Bitcoin trading was Yuan based. Soon, the People’s Bank of China observed that unscrupulous folks were taking advantage of cryptocurrency trading to bypass the government’s strict control of the Yuan. It was announced that the Chinese government was researching on launching its own cryptocurrency.  At the beginning of 2017, the Chinese government began a large-scale crackdown on China-based cryptocurrency miners and exchanges leading to a huge drop in prices. All China-based cryptocurrency exchanges shut down and transactions went from market leadership to zero immediately. The neighborhood’s next big cryptocurrency market, Japan, quickly filled the void created by the Chinese stagnation. Japanese Yen based Bitcoin trading, for example, went from 1% to 6% of global trading volume immediately. In April 2017, Japan lifted the consumption tax on Bitcoin trading and officially declared Bitcoin and other crypto coins as legal tender and recognized medium of exchange. It also eliminated the possibility of double taxation on Bitcoin trading. These measures fueled institutional acceptance of cryptocurrencies leading to growth in prices. Japan’s biggest banks all backed the country’s leading cryptocurrency exchange, bitFlyer. Also, Well-known companies like BIC Camera and Recruit Lifestyle commenced acceptance of Bitcoins at their various outlets and affiliate centers all over Japan leading to some degree of cryptocurrency usage for real-world transactions.

What Pushed Cryptocurrencies To Become Mainstream In 2017?

The year 2017 witnessed a phenomenal rise in the price of cryptocurrencies. It was the year in which cryptocurrency trading and its supporting technology went from the fringes to being talked about at the hair salon. Many popular crypto coins gained massive percentages on their opening price. Between January 2017 to mid-December 2017, the price of Bitcoin rose from $750 to $20,089. Also, in Ethereum Trading, the price of Ether went from about $11 to $650!! We are talking thousands of percentages growth on assets that have been stagnant for years. What is the cause of such a boom?  Is this the making of a giant global economic leap or are we back to the days of Irrational Exuberance as it was with the “Dotcom” bubble of the 1990s?

Figure 5: This image shows the time frame in which Bitcoin and many other cryptocurrencies experienced a meteoric rise in price. 

In the beginning, the cryptocurrency world was limited to tech geeks, software developers, and the likes. However, the official Japanese acceptance of cryptocurrencies as a medium of exchange in 2017 coupled with Chinese moneybags using Japanese exchanges as a route to move their money out of government-controlled Yuan led to the first wave of the price spike. A few other governments also announced varying liberal policies towards cryptocurrencies which attracted the attention of the public and institutional players. At the end of the year, CME Group, a Chicago based futures market player announced that they will be listing Bitcoin futures.

Another Major Influence on the rise of cryptocurrencies was the plethora of successful Initial Coin Offerings (ICO). An ICO, is the cryptocurrency trading version of the real world stock exchange’s Initial Public Offerings (IPO) where investors are given the opportunity to be the first to fund a project. Due to the significant doubts surrounding the legal status of ICOs, Promoters accept payment in other cryptocurrencies rather than fiat money. When Ethereum conducted its ICO in July 2014, the only acceptable mode of payment was in Bitcoins. It was a very successful ICO from which the company was able to fund the eventual Mining of its “ether” token for release in the following year. Other developers took note and by 2017 alone, up to 235 ICOs took place with the bulk of these based on Ethereum’s platform. Every successful ICO pushed the price of BTC and ETH. The resultant increase in the value of the popular crypto coins attracted more people to the cryptocurrency world which further powered the next ICO! One fed into the other and led to the phenomenal price gains fueled by seeming irrational exuberance.

Figure 6: This image shows an example of a coin that had an ICO (Iota) and then moved up over 4,000% from it’s very low. 

New cryptocurrency exchanges also sprang up all over the world most of which were not licensed by the governments and therefore not subject to regulatory standards. Many ICOs turned out to be a pure scam as an unregulated market filled with unqualified investors attracted financial cowboys seeking opportunities to make a killing. Many of the shady techniques such as round tripping, painting the tape, etc which are criminal in real-world security exchanges, yielded billions of dollars in the crypto world.

The phenomenal rise in the value of cryptocurrencies and resultant participation in the market by the general public and institutional investors brought blockchain technology into the mainstream. Many top banks started deploying blockchain for more secured record keeping. Ripple, whose system supports seamless cross-border transfers, is now partnered by a growing list of financial institutions.

Top 5 Cryptocurrencies

Bitcoin (BTC)

Figure 7: Bitcoin logo. Image from Steemit.com.

Market Cap. – $114.6B

Price – $6,651.01

Supply – 17.23m coins

Bitcoin was invented by the anonymous Satoshi Nakamoto and released to the public in 2009. It is the original cryptocurrency and remains by far the most popular crypto coin and the largest by market capitalization and price per coin.

Bitcoin is useful as an alternate medium of exchange from fiat currency and is highly regarded for its security, confidentiality and decentralized systems. Bitcoin’s volatility is a major concern as its value skyrocketed to about $20,000 in December 2017 before tumbling rapidly only to rebound to just under $7,000.

Ethereum (ETH)

Figure 8: Ethereum Logo. Image from Ethereum.org

Market Cap. – $27.74B

Price – $273.19

Supply – 101.56m coins

Ethereum was birthed in 2015 following a successful ICO resulting from the Work of co-founders; Vitalik Buterin, Gavin Wood, and Joseph Lubin.

Ethereum was designed as an alternate platform for all types of decentralized applications for developers to build on. Unlike Bitcoin, it serves beyond mere financial use and is available for development of smart contracts. Ethereum has the largest developer community among all blockchains and it allows users to create their own tokens.

Ripple (XRP)

Figure 9: Ripple logo. Image from Ripple.com

Market Cap. – $12.73B

Price – $0.3219

Supply – 39.52B coins

The XRP was initially released in 2012 by the developer, Ripple, based on the works of Arthur Britto, David Schwartz, and Ryan Fugger. By 2018, it had become the third largest cryptocurrency by market capitalization. XRP is different from Bitcoin and Ethereum in that it is designed for use by financial institutions and payment providers as settlement infrastructure technology with its goal being to improve efficiency in cross-border transactions. Also unlike the top two cryptocurrencies, the price of the XRP is very small while the total supply is very high.

XRP deploys its own patented centralized transaction network called RPCA (Ripple Protocol Consensus Algorithm) which is available to banks just like SWIFT. Companies like UBS, UniCredit, Santander have all adopted XRP and the list is growing with more payment providers coming on board. There is no mining of the XRP as all available XRP tokens, 100 billion in all, were produced at once. Ripple retains about 60 billion tokens for itself while the rest were distributed to its clients.

Bitcoin Cash (BCH)

Figure 10: Bitcoin cash logo. Image from blog.zebpay.com.

Market Cap. – $8.99B

Price – $519.50

Supply – 17.31m coins

Bitcoin Cash arrived in the market in August 2017 as a direct result of a split between Bitcoin adopters over BTC’s technical limitations. Bitcoin Cash was created by “hard forking” the blockchain to create a new blockchain with new rules and a new token. While the BHC is building scalability into its network, advocates of BTC retain the confidence that scalability will be provided by second layer solutions like Lightning Network.

BHC’s main proponents, Jihan Wu of Bitmain and Roger Ver of Bitcoin.com, have continued to defend BHC’s split from the Bitcoin community. And while the BHC has cemented itself amongst the top five cryptocurrencies, it has never matched Bitcoin in usage, price and market capitalization.

EOS (EOS)

Figure 11: EOS logo. Image from currencymarket24.com 

Market Cap. – $4.43B

Price – $4.88

Supply – 906.25m coins

The EOS is a blockchain platform introduced in 2017 as a direct competition for Ethereum as the go-to platform For decentralized applications.

EOS is owned by Block.one whose CTO, Dan Larimer, was the lead developer who intended the platform to surpass Ethereum’s low number of transactions per second. He believed that Ethereum’s numbers were not high enough to support the ‘internet of things’ in the future.

Top Risks For Cryptocurrency Moving Forward

All over the world, there has been a mixed reaction from governments towards cryptocurrency risks with most countries still reviewing their position. An unfavorable disposition by major governments and regulators in the future may spell the end for cryptocurrencies.

Cryptocurrencies are, by their design, very secure. However, the same cannot be said of the storage medium of most owners. Hackers can gain access to your computer or even the exchange. About $500 million worth of coins were estimated to have been stolen by hackers in 2017 alone.

Figure 12: Mt. Gox logo, one of the main exchanges in 2014 that incurred massive losses from hacks. 

The cryptocurrency market is largely unregulated and therefore susceptible to manipulations. A few countries have started laying the regulatory groundwork to mitigate cryptocurrency risks. A future where the market remains unregulated is likely to bring about vicious cycles of boom & bust which could turn investors off in droves or warrant government crackdown.

Many well-respected experts like the investor, Warren Buffet and Bank of America CEO, Bryan Moynihan have warned that the cryptocurrency market is a bubble driven by hype. Stefan Ingves, Chairman of the Basel Committee on Banking Supervision, declared last year that investing in Bitcoins is a prospect as dangerous as the famous Dutch tulip mania of the 17th century.

Virtually all cryptocurrencies lack any intrinsic value. There is a concern that the current market prices are premised on hype and that should this fade, the coins could crash to zero dollars!

Nobody can say for certain what the future holds for cryptocurrencies. We are either experiencing a bubble, the beginning of a new world or both. As a pointer, the dotcom bubble which resulted in many failures also gave the world the likes of Microsoft, Amazon, Yahoo, and Google.

 

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