Cryptocurrency and blockchain: history and market prospects

Crypto Markets in Numbers

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Crypto Market

History of Crypto Boom

Top 10 largest cryptocurrencies according to capitalization (by Aug 5, 2017)

Billion dollars

Source: coinmarketcap.com

Both Bitcoin and Ethereum “clones” remain in the list of top 10 cryptocurrencies according to capitalization level

In the spring of 2010, the software specialist Laszlo Hanesh ordered two pizzas jokingly paying for them 10,000 Bitcoins – a little-known cryptocurrency at that time. If Laszlo had kept this money then, he would own about $30 million now.

Bitcoin appeared in the autumn of 2008, when another software developer Satoshi Nakamoto (his identity is so far unrevealed, so, it could be his or some group of people’s pseudo) published a short document on the Internet, describing the quasi-money tool algorithm operation. After nine incomplete years have passed, the Bitcoin ecosystem’s capitalization has reached almost $53 billion, and up to 40 million people carry out payments using this cryptocurrency. There are also other cryptocurrencies: more than 200 of them exist in the Web nowadays.

The Bitcoin ecosystem includes two kinds of participants: ordinary users and miners. The former perform transactions, and the latter process them using dedicated software. Many expected the blockchain technology, on which this system is based, to change the world. However, it has not led to any revolution so far, and its powers are still waiting for the area to be implemented in.

Startups, which previously had to compete to win investors’ attention, raise millions of dollars now emitting and selling cryptocurrencies (ICO, Initial Coin Offering, similarly with a traditional IPO, Initial Public Offering). According to Smith + Crown, a blockchain technology research company, blockchain startups attracted more than a billion dollars via ICO campaigns in the first half of 2017, which is ten times more than in 2016.

New digital profit-making processes have attracted thousands of miners – retail cryptocurrency “earners” who have replaced the word “boom” with the newly-coined “hype” in their language.

 

Algorithm instead of intermediaries

The Byzantine army laid siege upon a city. Generals have to work up a unified action strategy leading to victory even in case there are traitors among them, who deliberately falsify data on their detachments size and their offensive campaign time.

What you have just read is not an excerpt from the annals. This way, one of the classic statements in cryptology – the “Byzantine generals’ objective” – is phrased. It is about principles able to coordinate all actions of system participants united by a single goal but lacking trust in each other.

When no mathematics used, creating a single supervisory and audit body able to guarantee system participants the reliability of the data received seems the obvious solution. In the case of Byzantine generals, it may be some commission body loyal to the emperor, which rides all over the armies and coordinates their actions.

For hundreds of years, humanity has been following the path. Banks and payment systems guarantee money transfers. In all public relations, notaries perform this function, and election commissions verify the political elections results.

Blockchain technologies change the usual logic, and intermediaries have run their course. This is achieved using a special form of storing data on transactions on all computers of the system simultaneously – in distributed ledgers or databases.

In 2008, Satoshi Nakamoto invented a new way of reaching a social consensus which allows confirming all transactions validity involving no third parties. The easiest way of showing how it works is to briefly explain the essence of blockchain technologies using Bitcoin transactions as an example.

Every single transaction is carried out online and looks like a message about one user’s Bitcoin transfer to another network user. Once the transaction is done, it becomes visible to miners.

No transaction is considered to be complete until it is recorded in the so-called block – this is exactly what miners do. Each block contains data on thousands of transactions processed. To consider the block generated, a miner has to compute a hash function – a digit-letter string, into which the incoming data array is converted.

The hash function contains data on the previous block, hence – on all transactions which have taken place since Bitcoin appeared on the web as a currency. Change at least a bit of data in the previous chain link, and the hash function will also change beyond recognition. Therefore, the distributed database of a blockchain is a chain of blocks, each of which refers to the previous one.

Keeping the Bitcoin transactions history prevents users from transferring unavailable amounts to someone else. Blockchain technology also allows avoiding double spending – an action when a person tries to spend the same amount of money twice. A large number of users, as well as miners’ economic motivation, are the key factors here.

Spending time and money on computing the hash function, the miners’ motivation is quite simple. As soon as a block takes its place in the chain, a miner who created it receives a certain amount of Bitcoins – this is the way Bitcoin emission occurs. Miners also receive a commission fee for each transaction. According to the rules, established by Nakamoto, the compensation amount is reduced by half every 210,000 blocks.

In 2008, a newly generated block resulted in 50 new Bitcoins, and in 2017 more than 477 thousand blocks were created. So, the reward for each new block reduced to 12.5 Bitcoins. The next reduction, to 6.25 Bitcoins, is expected in 2020. It is believed that by 2140, the reward will have become so small that the emission will actually stop, and the number of Bitcoins will not exceed 21 million (currently 16 million in circulation).

In the ecosystems of some other cryptocurrencies, for example, Ethereum, the second most popular cryptocurrency after Bitcoin (its capitalization is more than $24 billion at the beginning of August 2017), miners receive fixed rewards, and the emission is unlimited.

Mining has long become a fully-fledged business. According to the study conducted at the University of Cambridge, since Bitcoin came into existence, miners have earned more than $2 billion for carrying out calculations and $14 billion as commissions fees taken from transactions.

Mining equipment manufacturers have experienced a strong increase in demand as well. Some time ago, home computers were good for Bitcoin mining, and in 2017, this process is carried out at dedicated “farms”: huge hangars filled with processors. Actually, each block creation is an extremely complicated process, and miners have to consider a certain set of rules while calculating.

For example, in 2017, each hash function has to begin with 18 zeros. To receive a value like this, either great luck or searching about a trillion values is necessary. That is why mining requires an impressive investment in computing equipment. By 2017, the total Bitcoin ecosystem’s computational power 800 times exceeded the fastest supercomputer capabilities.

ASIC chips are the most popular devices for Bitcoin mining. They are mass-produced in China and the United States nowadays. These chips were created exclusively for hash function calculation and replaced video cards with their powerful processors which earlier used to cope with computations most efficiently. The computational power of NVIDIA GeForce GTX 1080 Ti, the fastest video card in 2017, is about 332 gigaflops. An ACIS chip of the same price range ($1,000 -$1,200) provides 163 petaflops – 500,000 times more.

High equipment requirements have led to Bitcoin market division among the largest pools, combining their computing powers. About 70% of cryptocurrency farms are based in China.

The main mining business model is simple: invest in equipment and, as new bits of virtual currency are mined, exchange them for fiat (traditional credit) money. One can do so resorting to numerous cryptocurrency exchange services and using Internet currency exchangers.

 

Civil wars

In 2013, the young Canadian coder of Russian origin Vitalik Buterin seriously promoted the blockchain technology development. He realized then that blocks in a chain are suitable for recording data on absolutely any events along with currency transactions. The system can also contain software which allows creating applications working on the principles of “smart contracts” – standalone software which is run if certain conditions are met.

This way Ethereum, a new blockchain platform which Buterin created with a group of like-minded people, appeared. Like Nakamoto’s development, Buterin’s service had its own cryptocurrency of the same name as the platform itself. At the end of 2015, Ethereum emitted $18.5 million.

The German developers from the project Slock.it were among the first to test the “smart contracts”. Their idea was to create smart locks. They offered to install such locks on any rented property: starting from a bicycle to a car or an apartment. The lock owner quoted the rent, the renter paid for it in Ethereum, and then the lock was released and closed again when the rental period was over.

The Slock.it creators did not restrict themselves to a blockchain and the Internet of things combination but initiated the creation of the world’s first decentralized autonomous company The DAO based on Ethereum. They presented it as a new generation venture fund, a sheltered institution managed by investors – DAO tokens owners. They started to sell the tokens on April 30, 2016, and in four weeks, more than 11,000 people invested Ethereums, equivalent to $150 million, in The DAO. And then, a certain unpleasant event occurred.

The DAO’s rules stipulated the possibility of a subsidiary company creation (“split”), with a promise to grant a reward for it in Ethereum. That is exactly what one of the users did on June 17, 2016. However, he did not restrict himself to one split but launched the recursive creation of subsidiaries. Within a few hours, he withdrew about 3.6 million cryptocurrency units, equivalent to $43.9 million, from the DAO ecosystem.

Ironically, the community warned the developers about the possibility of such actions not long before the incident, but the Slock.it team failed to impose a transactions moratorium, taking a decision to deal with the threat in the current mode setting.

 

Bitcoin exchange rate: US$ to BTC

Source: Blockchain.info

The lack of “fair” Bitcoin cost guidelines determines its rate high volatility and periodic phases of the speculative growth

 

The Ethereum exchange rate dropped from $22 to $12 within a few days. Another rule saved the system from the total collapse: the final funds’ withdrawal could be performed no sooner than after 27 days – time allowed for The DAO’s subsidiary company formation. Then the Ethereum developers, led by Vitalik Buterin, had to intervene.

To return money to investors, they took a decision to carry out a “hard fork” – to roll back the entire system to the very block preceding the recursive split, return the invested cryptocurrency to users, and start afresh. The DAO project had to be forgotten. The Ethereum platform forked into two chains: in one the withdrawal was conducted, in the other, it was not. The first chain was expected to eventually vanish because working simultaneously with both was not cost-efficient for miners.

Nevertheless, it became an ethical issue: a group of enthusiasts who were convinced that the platform irreversibility was more important than the loss compensation for The DAO took a decision to keep up the other chain. Therefore, two parallel universes started to exist: Ethereum Classic, where the money was withdrawn, and Ethereum, which survived the hard fork. The cryptocurrency also circulates under two different guises. As a result, Ethereum Classic (ETC) sells for about $17, and the forked one (ETH) for $200. In the spring of 2017, the Ethereum Classic participants decided to overhaul the system’s financial policy and draw nearer to Bitcoin (also for the sake of the currency exchange rate improvement). The platform managers introduced the emission limit (not more than $230 million in Ethereum) and miners’ reward reduction rule (20% less after every five million blocks).

As for the Ethereum platform, over time, hard forks have become a usual practice for it, used to improve the code or eliminate DDoS attacks consequences. In late July, Ethereum suffered another hacker attack, and again due to the “smart contracts” immaturity. Attackers withdrew $32 million worth in Ethereum from the purse Parity used by some Ethereum partners. Another group of hackers who gained control of the wallet saved the system from more large-scale losses, transferring funds from the remaining accounts to some safe place. This time, the Buterin’s team did not take chances with another hard fork.

 

Bitcoin cloning

The computing powers race has reached the level when mining is no longer economically sound. The 1MB maximum block size allows miners to process no more than seven transactions per second. Visa and MasterCard payment systems show figures of two thousand transactions per second at many times smaller capacity cost than it is necessary for cryptocurrency miners. Of course, miners can raise the commission fee, but it can ruin the Bitcoin economic paradigm. Consequently, the solution sought should be purely technical – increasing the transaction quantity in one block.

Nowadays, this issue has two opposing opinions. The Bitcoin Core group represents one of them. The participants offer to sequentially activate a number of upgrades (primarily the Segregated Witness protocol or SegWit). Its implementation should reduce the amount of “secondary” data processed by network members and free up more space for transactions themselves.

The other group, Bitcoin Unlimited, suggests increasing the block size to 2 MB or higher all at once. This opinion is primarily supported by Chinese miners who control up to 70% of all Bitcoin computing capacities.

The parity of the two groups did not last long. On August 1, 2017, Bitcoin received the Bitcoin Cash clone, where the block size increased to 8 MB. The previous transactions and the chain remained common for both Bitcoin versions, and the new ones will be different for each of the systems. The Chinese exchange service ViaBTC was one of the first to trade Bitcoin Cash.

Leading cryptocurrencies’ exchange rates are extremely volatile because the fundamental principles of their emission are quite vague. In mid-June 2017, the tremendous drop of almost all quotations occurred and lasted for about a month. In mid-July, the fall switched to stabilization, and in early August, the new growth started.

 

The issues Ethereum has faced this year have created a certain general crisis of confidence in cryptocurrencies. Though the correlation among them is not direct, it still exists: the Ethereum sagging dragged along other cryptocurrencies quotes.

Roman Tkachuk

senior analyst of the Alpari Forex Company

 

One of the reasons for the Ethereum exchange rate sagging, as Tkachuk claims, was Vitalik Buterin obituary notice which appeared at the end of June 2017 (the blockchain platform creator denied it by publishing his photo with the last generated block number).

There were other reasons as well. In June, the increased demand for Status tokens (assets of the Singapore developer creating the interface for accessing the Ethereum platform via iOS and Android) resulted in a large number of Ethereum transactions. The system was unable to withstand the load, and the transactions seized being processed. A number of exchange platforms forcedly suspended trading on Ethereum.

Having given in to the rush, the investors actually committed an ideal DDoS attack. Bitcoin and Ethereum functional issues show the crudity of the ​​“smart contracts” idea and highlight fundamental flaws in the Bitcoin algorithms. The transactions anonymity makes cryptocurrency an ideal means of drugs and weapons trade, as well as money withdrawal and laundering. Exactly Bitcoin was used as means of payment at the largest hidden web trading platforms, two of which an international law enforcement team has recently managed to close down.

 

New world

When blockchain technology appeared, it was considered to be the future basis of all social and economic processes. Most of the ideas, like smart contracts application, still are the matter of future developments. The appearance of dozens of blockchain projects allows assessing the overall market condition and find promising areas.

One group of blockchain applications includes projects initiated by “traditional” companies. New technologies allow conducting significant optimization of business processes. Operating time and staff costs reduction are the main economic effect of such projects.

The Russian National Settlement Depository utilizes the blockchain technology for the securities holders’ electronic voting procedure. The “33 Elephants” Company carries out document circulation among real estate purchase and sale participants within their data platform based on the blockchain technology. The Prosto.Insure insurance companies’ aggregator records data on the sold insurance into their blockchain-based database. Alfa-Bank and S7 Airlines sell air tickets, using the Ethereum platform, which allows reducing the transaction time from 14 days to 23 seconds. Since the beginning of 2017, “Sberbank” and “M. Video” use blockchain technologies to conduct factoring transactions: when earlier, the data exchange processes within each transaction were carried out using letters and phone calls and took up to three days, now, this time has been reduced to several hours.

From mid-June until mid-July 2017, the Ethereum exchange rate gradually reduced by 60%, but then it started reasserting its positions.

The other group of blockchain applications is more diverse. First of all, startups building a distributed economy using this technology belong here. These are primarily blockchain platforms like Ethereum, Tezos, Stratis or the Russian platform Waves. They create their own ecosystem and blockchain technology modification which other startup projects can also use.

 

Multiple projects are built into an already existing ecosystem, so, they do not have to create their own cryptocurrency and mine it or increase computing powers.

Alexander Ivanov

founder and general director of the Waves blockchain platform

 

The distributed economy can be applied to whatever strikes the startup founders’ fancy. For instance, the Israeli-based company La’Zooz positions itself as an alternative to taxi services online ordering. Customers pay for drivers’ services using the company’s virtual tokens. They are also accrued to drivers: traveling with a speed of at least 20 kilometers per hour on roads is a kind of mining for La’Zooz.

The Australian project Chronobank tries to provide users with the opportunity to directly trade their labor power. Tokens are pegged to the average hourly earnings in different regions. The startup plans to cooperate with recruiting companies, which have to acquire a certain amount of Chronobank tokens when signing a contract.

Yet, they acquire them not for money, but for the obligation to provide working hours of their employees compensating for these tokens. The repayment occurs when the token owner, who bought it on the secondary market, asks Chronobank to find them an employee for a task to be fulfilled. A business model like this has already been implemented in multiple Internet projects (e.g., in YouDo).

Active developments at the convergence of smart contracts and the Internet of things are also carried out: the abovementioned Slock.it project is a good example. This technology has already penetrated into “smart homes” where it operates in a self-contained system. The Russian project Machinomy tries to create a maximally open platform, to which devices from all over the world could connect. The blockchain platform allows system participants (people or devices) to interact directly, exchanging data, as well as provides more flexible pricing. Within the Slock.it project environment, money was accrued for the rental period, and Machinomy developers plan to apply this principle for the electric utility industry allowing consumers to pay the light bulb, rather than the generating company, for the light according to an average electricity rate.

Messengers and games also operate using blockchain technologies. Etheroll – a game of dice, released in February 2017 – is one of them.

Another game project, called Beyond the Void, has recently launched. It is a massively multiplayer online role-playing game in which blockchain technologies are utilized to secure players’ rights for particular game assets (e.g., weapons and armor). It is interesting that Vitalik Buterin entered the world of cryptocurrency due to the online game World of Warcraft, in which gamers can purchase weapons for Bitcoins.

 

Crypto market regulation

Cryptocurrency speculations as such do not yet carry any systemic risk to the global financial system – the market size is not comparable so far.

 

The crypto market has a small sales turnover for the time being: it is $110 billion for 950 tradable tokens and cryptocurrencies within the last month – an equivalent to the shares turnover of some large technological corporation (Apple has $90 billion and Facebook – $60 billion).

It is not so noticeable for the global financial market. No negative incidents at the global economic level are anyhow possible, but for some investors, located around the world, incidents do take place since all traded digital currencies are not in any way backed up, so their quoted price can change swiftly.

Anton Agranovsky

president of the Agranovsky IT Investments & Consulting Venture Company

 

Nevertheless, when exchanging cryptocurrency for fiat money, users may quite possibly experience some problems. This is how you can buy Bitcoins using the popular Internet exchanger Localbitcoins. A user selects a Bitcoins seller, sends an appropriate request indicating the necessary amount, and makes a respective deposit on their account. Then the user transfers money to the seller (e.g., via a bank or a payment system).

Only after the seller confirms the transaction was successful, Bitcoins are shown in the buyer’s personal account. Certainly, the website itself also functions as an arbitrator in the disputable cases, but this example shows that the fiat money and cryptocurrency flows are still poorly synchronized.

Bitcoin Price

There are cryptocurrency exchange services which operate under the local regulators’ supervision. They account for the great majority of cryptocurrencies sales. In May 2017, at the height of the tokens issue, the daily trading volume ranged up to $4.3 billion.

The establishments like these are too young, and their existence often becomes a problem for the market. In 2014, a sensational bankruptcy of the Japanese website MtGox four years after its launch and rumors of a possible Bitcoin prohibition in China led to the first major sagging of this cryptocurrency. On November 30, 2013, its exchange rate reached a historic peak of that time – $1,120 and dropped sharply to $430 till April 2014.

At the end of July 2017, in Greece, a Russian citizen Alexander Vinnik was detained on suspicion of laundering more than $4 billion using cryptocurrencies. He is considered to be one of the administrators at the BTC-e exchange platform popular among Russians. The currency exchange website became inaccessible then.

The most alarming news for blockchain communities came this year from China. At the beginning of the year, the People’s Bank of China forbade the local BTCC, Huobi, and OKCoin exchange platforms to withdraw cryptocurrencies, citing the money laundering law violation.

 

Crypto-anarchism is a movement which involves cryptography utilization to create virtual societies where each participant is anonymous and protected from being tracked. Trading drugs and weapons using cryptocurrencies are the most obvious manifestations of crypto-anarchism. In a more developed meaning, this movement involves blockchain applications implementation into social relations, as well as state institutions elimination.

 

Coins and Bank Regulations

Now the Chinese central bank develops its own rules to regulate the crypto market, the rules which are expected to require all exchange platforms to disclose users’ personal identification. This Chinese example reveals a third group of risks – the political one. Many states will eventually try to control the cryptocurrency turnover.

On April 1, 2017, Japan granted Bitcoin and Ethereum the status of means of payment. The market reacted accordingly to this: until the end of May, the Bitcoin exchange rate rose from $1,000 to $ 2,300, while during 2016, it had risen from $450 to $960. Another Japanese innovation exempted transactions carried out in cryptocurrencies from 8% consumption tax. However, cryptocurrencies did not become fully convertible money, they just became equated with digital assets and can be used to make reciprocal payments or pay for commodities and services.

At the same time, the Japanese authorities tighten regulations for cryptocurrency exchange platforms. In his letter to the Bank of Russia, Russian business ombudsman Boris Titov appeal for the Japanese experience adoption, highlighting one of its components – exchange operators state registration and the requirement to verify all transactions and user data.

Similar news arrives from the USA. In late July 2017, the US Securities and Exchange Commission announces it would not make any differences between the ICO and the IPO. Companies which raise money using blockchain platforms will have to register their transactions. An equivalent rule applies to cryptocurrency exchange services, otherwise, according to the law, they will face punishment.

The chosen interaction format, implemented in the US and China, seems to be a potential trouble spot. It may decimate the tokens issuing popularity: the startupers’ enthusiasm will run against complex bureaucratic procedures; on the other hand, projects originally aimed at fraudulent fundraising, taking advantage of the hype in this area, may leave the market.

A more unfavorable scenario may find its development as well. The anonymity of cryptocurrency owners and transactions is one of the key advantages. It is very unlikely that cryptocurrency traders will positively accept the governments’ desire to control their activities. The world of blockchain may quite possibly find itself on the brink of war of any state against crypto-anarchists. As a result, a “grey” exchange market handling virtual currencies and fiat money may develop.