Cryptocurrency is the buzzword of 2021.
If you’re an investor, not a single day goes by without a headline about bitcoin popping up in the newspaper, a tweet about cryptocurrency going viral, or your investor friends singing the praises of blockchain technology. It is hard not to get involved, and it is never too late to learn. Know about basic ideas and concepts behind cryptocurrency here.
If you are an accountant or tax preparer, understanding Blockchain Technology and the mechanics of cryptocurrencies become even more important.
Blockchain Technology and Cryptocurrency
What is Blockchain Technology?
A blockchain is a database of transactions that acts as a digital ledger, and duplicates and exists across the entire network.
The idea behind a blockchain is enhanced security. Blockchain technology has wider application, way beyond cryptocurrencies.
Blockchain technology allows us to trade cryptocurrencies securely. A cryptocurrency is a currency that does not exist in tangible form things like coins and bills. It exists in the form of transaction records of those who are buying and selling it. Cryptocurrency is one of the major applications of blockchain technology.
Essentially, a blockchain is a decentralized ledger that can be used for recording transaction information. It has multiple applications like digital payment in fiat money like dollars, monitoring the supply chain for a product, tracking prescription drugs, and more.
However, cryptocurrency is one of the applications of blockchain technology. Without blockchain, cryptocurrencies wouldn’t exist.
How is Cryptocurrency Different From Fiat Currency?
Although nowadays, cryptocurrency and fiat currency are both mediums of exchange, there are critical differences between the two.
- While fiat currency is circulated in notes and coins, cryptocurrency does not have a tangible form. It exists only in the form of records of transactions. It’s entirely digital.
- Fiat currency is a legal tender of any country but cryptocurrencies are not.
- The government issues fiat currency, and the government also controls its supply limit. But that’s not the case with cryptocurrencies. No authority issues a cryptocurrency. The transactions occur without the interference of a government. New coins enter circulation through mechanisms like proof of work and proof of stake.
- The value of fiat currency is tied to the country’s macroeconomic factors such as imports and exports, employment, foreign exchange reserves, and so on. However, the value of cryptocurrency is purely based on supply and demand.
- Fiat currencies are traded through banks and stored in a bank account, whereas cryptocurrencies are directly traded between buyers and sellers. They are stored in a crypto wallet the way we store notes and coins in a physical wallet.
- Fiat currencies are accepted in all countries, as in you can always convert them into another country’s currency when you want to spend there. To note though, cryptocurrencies are not legal in some countries yet.
Key Terms & Concepts
Here is a list of terms and concepts necessary for understanding blockchain technology.
A blockchain is a decentralized ledger where cryptocurrency transactions are recorded.
Cryptocurrency is stored in a crypto wallet. A wallet comes with a public address where you receive coins from others and a private key to send coins to others. The public address is different for every new transaction. The private key is known only to you and should not be disclosed to anyone for security purposes.
Cryptocurrency mining is the process of solving complex computational math puzzles.
The miner who solves the puzzle first has to verify the transactions on a block to maintain their validity. The winner also gets rewarded with cryptocurrency, which then freshly enters circulation. Thus, mining serves two purposes- verifying blockchain transactions and pumping new coins into circulation.
A cryptocurrency exchange is a platform where you can buy cryptocurrency by paying in fiat money. You can also trade one cryptocurrency for another. Generally, a market to convert cryptocurrencies into fiat money and vice versa.
A cryptocurrency address is a virtual address where you receive cryptocurrency from others. As mentioned earlier, it’s different for every new transaction.
Bitcoin is the first cryptocurrency that was ever launched. It was invented by an anonymous entity named Satoshi Nakamoto in 2009. Soon after that, several other cryptocurrencies were launched as modifications or variations of bitcoin called altcoins, as alternatives to bitcoin. Ethereum and Litecoin are examples of altcoins.
A block contains a record of cryptocurrency transactions in a particular period. For example, Bitcoin updates its blockchain every 10 minutes, which means that every block contains transactions over 10 minutes. You can think of blocks as pages of a record book.
Coins and tokens
Cryptocurrency can be in the form of coins or tokens. Coins have their own independent blockchain and have inherent value. Tokens live on another blockchain and don’t have inherent value, e.g., there can be a token that entitles you to 10 bitcoins or an hour of gaming on a video gaming blockchain.
A blockchain explorer is a search engine that gives you access to transaction data on any wallet address. The data may include the amount transacted, the status of transactions, and their sources and destinations. It is to be noted that all user transaction data is public, but the identity of users is not.
Smart contracts are programs stored in a blockchain. The basic idea is that the terms of an agreement can be written into pieces of code. When certain conditions are met, they are executed automatically without anyone having to enforce them. It saves time and effort.
Decentralized Finance (DeFi)
DeFi is an umbrella term for systems that differ from centralized finance systems with a central point of control.
DeFi is used in many contexts like banking, insurance, and money management.
Digital currency is not the same as cryptocurrency. Digital currency is a term used for any exchange of currency without involving tangible objects like notes and coins, not just cryptocurrency. For example, online fund transfer in dollars also involves digital currency. Still, it is tied to fiat money. Cryptocurrency, on the other hand, is not tied to fiat currency.
Decentralized apps (dApps)
dApps are applications that run on a blockchain consisting of a network of computers instead of a single device. Traditionally, apps like Twitter and Facebook are owned and operated by one organization. The organization feeds to content, and the users consume it. This does not have to be the case with dApps. All users collectively do the action of both feeding and consuming content.
The whale is the term used for users who own massive amounts of cryptocurrency. For example, there are 2000 whale addresses on the Bitcoin blockchain, and three of them own more than 100,000 bitcoins.
Gas price is the fee that you have to pay for a blockchain transaction. Some blockchains accept higher fees for faster speed of transactions.
When several developers are at work modifying the features of a blockchain, they sometimes have disagreements. So they go their separate ways, and after a certain block, the blockchain forks or splits into two chains, dividing the users into one or the other side.
What Exactly is Blockchain?
Blockchain is an extension or type of Distributed Ledger System (a.k.a DLT).
Simply put, a blockchain is an online ledger or record book that is accessible to all its users. Every block is like a page of this record book. When someone makes a transaction, it gets recorded on a block. Each block is verified by crypto miners, who get rewarded for this in the form of cryptocurrency. The added security of blockchain comes from its verification by all the participants in the chain.
How does Cryptocurrency Work and How to get them?
Cryptocurrencies are an application of Blockchain technology. The principle objective behind this is decentralization, no middle man, and enhanced security.
You can buy cryptocurrency from an exchange by paying in fiat money or some other cryptocurrency that you already own. You can also buy it directly from people who own cryptocurrency through a decentralized exchange instead of a centralized one.
A centralized exchange acts as a middleman between buyers and sellers and charges fees for that. A decentralized exchange, on the other hand, directly connects buyers and sellers.
You can sell the cryptocurrency for money or directly use it to buy products from companies that accept this form of payment. For example, Microsoft accepts payment in cryptocurrency for games and applications.
You can also exchange one cryptocurrency for its equivalent amount in another cryptocurrency, e.g., one Bitcoin is worth 14 Ether.
Decentralized and Distributed: What Does it Mean?
A blockchain is decentralized and distributed.
It is decentralized in the sense that there is no central authority that controls transactions. It is distributed as all the users on the blockchain collectively process the transactions.
History of Blockchain
The seeds of blockchain technology were sown in 1991 by Stuart Haber and W Scott Stornetta. These research scientists were trying to compute a system by which they could time-stamp digital documents to avoid tampering and backdating. They built this system on a chain of cryptographically secure blocks to store the documents.
Soon after that, several small developments took place, e.g., they added the Merkle trees feature to make the system more efficient, and in 2004, Hal Finley introduced the Reusable Proof of Work System. A monumental event was when the theory of distributed blockchains was introduced in 2008. It was the brainchild of an anonymous entity named ‘Satoshi Nakamoto.’
This theory added a few things to the existing blockchain model. It facilitated the addition of new blocks to the chain without needing verification or approval from trusted parties. Instead, a peer-to-peer network was appointed for verifying and time stamping transactions. The model explained in their white paper was first implemented in 2009 in the form of a public ledger for bitcoin transactions.
In 2014, people started using blockchain technology for purposes other than cryptocurrency transactions. In the same year, Ethereum introduced smart contracts. Interestingly, the exact term ‘blockchain’ became popular only in 2016. In the 2008 white paper, it was simply referred to as ‘blockchain.’
In 2012, Estonia became the first nation-state in the world to use blockchain technology in digital ID systems. In 2015, Nasdaq, a major stock exchange in the US, announced its first security transaction using blockchain.
In 2018, blockchain was featured in the five-year development plan of the Chinese government. A couple of years later, South Korea, too, invested millions in blockchain development initiatives. In 2018, the European Union set aside $300 million for developing blockchain projects.
In 2019, the US government held hearings regarding regulatory frameworks for digital currency and blockchain. Today, we have a lot of reasons to be optimistic about the future of blockchain technology. Blockchains are evolving into a cloud-based that helps people develop their own digital products by working with a blockchain.
Some developers are attempting to resolve privacy and security issues on social media platforms using blockchain technology. Efforts are being directed toward interlinking blockchains so that users can access data and transact across different blockchains.
Moreover, video streaming platforms like Netflix could use blockchain technology to store user data in a more secure and accessible manner. Lastly, in an age where we are worried about our digital footprint, the most important application of blockchain technology is that it secures digital identity. Because data is stored in a decentralized and incorruptible manner, it is protected from identity theft and fraud.
Evolution of Bitcoin
Bitcoin was originally invented as an alternative medium of exchange so that we won’t always have to rely on traditional financial institutions involving middlemen and commission. But today, a lot of people treat it not just as a currency but also as a store of value, speculation and a hedge against inflation.
When Bitcoin was launched in 2009, it did not have a lot of value. The first bitcoin transaction happened in 2010 when a man from Florida paid a pizza bill of $25 in 10,000 bitcoins. If we were to do this transaction today, those coins would be worth $40 million!
Bitcoin has always been notorious for its volatility, leading to frequent price bubbles. The first bubble appeared in 2011. The price shot up from $1 in April to $32 in June and slumped down to $2 in November.
In 2013, it underwent not one but two price bubbles. The price fell from $220 in April to $70 in the same month in the first one. Later that year, it shot up to $1156 in December and, only three days later, fell to $760.
After 2013, the price of Bitcoin seemed to be at an all-time low for a long time. In 2014, Mt.Gox, a leading cryptocurrency exchange, lost 850,000 bitcoins in a hack. Following that, the price of Bitcoin showed a 32% decline.
And in 2015, it had fallen to $315. Yet another roller coaster ride was lined up for 2017. At the beginning of the year, the price was $1000, then it fell to $975 in the next two months and again shot up to $20,089 in March.
It was after 2017 that a lot of people began to take notice. Governments and investment experts began to debate and discuss the future of Bitcoin. However, the price did not shoot up again until 2019, when it rose to $10,000 but fell down the same year in December.
When the pandemic hit the world in 2020, investors were fretting over the collapse of the global economy. Interest rates on traditional investments crashed, so a lot of investors started exploring the cryptocurrency market. At the beginning of the year, the price was $7200 and rose to $18,353 in November.
In January 2021, it soared up to $40,000 (and dropped to around $30,000 three days later). Recently, individual investors and institutions like commercial banks, government agencies, and private companies have shown interest in Bitcoin.
Previously it was thought that the price of Bitcoin would depend on how frequently people are using it as a medium of exchange. But many people are buying bitcoin and holding on to it for a profitable sale in the future instead of using it to buy goods and services. This means that a lot of investors are treating it as a store of value.
Evolution of Altcoins
Apart from Bitcoin, we have more than 10000 cryptocurrencies on the market today. New coins and tokens are listed on cryptocurrency exchanges every week. A lot of these die very quickly soon after their launch due to the tough competition, but we also have some very innovative projects that show tremendous potential.
After the invention of Bitcoin in 2009, it only took two years for the first few altcoins to appear on the market. In 2011, Namecoin, Swiftcoin, and Litecoin were launched one after the other. Namecoin brought to the table a decentralized alternative to the traditional domain name system. To access this service, you have to use a separate plug-in on a browser like Google or Firefox. Namecoin also introduced, for the first time, merged mining, a protocol where two blockchains can be mined together.
Litecoin, launched in the same year, is considered the next best thing after bitcoin in terms of popularity and user base. It was the first coin to have a memory-hard mining puzzle instead of Bitcoin’s computation hard one. Another stark difference is that Bitcoin mining was mainly GPU (a type of hardware used for crypto mining) based in 2011, while Litecoin is GPU resistant.
A completely different form of mining, the proof of state model, was first introduced by PeerCoin in 2012. PeerCoin uses a proof of work model for creating new coins and a proof of state model for mining them. Cardano later implemented a more secure, complete proof of stake model in 2015.
A rather amusing cryptocurrency trend is observed today- meme coins. This trend perhaps started in 2013 with Dogecoin, which was visibly created as a joke. Keeping in line with this ‘have fun’ philosophy, they gave random rewards to miners based on neither their efforts nor coin holdings, but just luck.
In the same year, an important player, Ethereum, appeared on the market. It was the first platform to introduce smart contracts. The next area of innovation that altcoins targeted was anonymity. Monero, a privacy-focused cryptocurrency launched in 2014, allows transactions to be tracked to a group of users, but not one particular user who actually made it.
As new coins and tokens mushroom on the cryptocurrency market, there are concerns that the asset class is becoming overcrowded, raising questions of cybersecurity and the effects of mining on the environment. It is speculated that with time, the smaller tokens will die out. Cryptocurrency investors must be mindful of this before investing in any upcoming crypto asset.
The dark side of Cryptocurrencies: Illegal activities
When Bitcoin was launched in 2009, many people were skeptical of it and suspected it to be a scam. But today, most investors have a fair idea of how cryptocurrency works and understand the extent of its risks.
Although no one calls it a Ponzi scheme anymore, there are still concerns about its potential or ongoing involvement with illegal activities.
For example, the Secretary of the US Treasury, Janet Yallen, expressed concern that cryptocurrency could be used for criminal activity and terrorist financing. Some regulations need to be put in place to prevent this. And, yes, this is an evolving situation and we can expect to see regulations coming up sooner than anticipated.
Proponents of cryptocurrency make a fair argument that all cryptocurrency is not used for illegal activities. Chainalysis, a blockchain analysis company, said in their 2021 report that in the year 2019, criminal activity represented only 2.1% of all cryptocurrency transactions. Well, the answer to this is, yes, 2.1% for criminal activity is a big deal.
Some of the popular cryptocurrencies of today are:
Bitcoin is the most popular cryptocurrency. The supply of Bitcoin has a cap of 21 million coins, of which 18.9 are currently in circulation (maybe more when you read). Satoshi Nakamoto invented Bitcoin in 2009. Bitcoin has the highest market capitalization.
Being the pioneer of cryptocurrency and the blockchain, Bitcoin is so popular that sometimes it is used synonymously with the word ‘cryptocurrency.’ People have gone to the extent of calling it digital gold.
The market cap value of Litecoin is about 13 billion dollars, and it sells at a price of about 200 dollars per coin. The supply of Litecoin is limited to 84 billion coins, of which 66 billion coins are currently in circulation. It is often referred to as ‘digital silver,’ meaning that it is the next best thing after Bitcoin.
Ethereum has a market cap of 460 billion dollars, and it sells for 4000 dollars per coin. The supply of Ether is limitless, and currently, there are 115 million coins in circulation.
While Ethereum was meant to complement Bitcoin, today, they compete as rivals. Ethereum is superior to bitcoin in several ways.
- The bitcoin blockchain updates itself after every 10 minutes, while Ethereum does it every 14 seconds. So, while Bitcoin can make four transactions per second, Ethereum can make 20.
- While Bitcoin makes every computer in the network process all data in the blockchain, Ethereum uses a process called sharding wherein each computer processes only a tiny bit. Hence the total amount of data that the blockchain can process together is much more than Bitcoin.
Ethereum was the pioneer of smart contracts. Also, their website says that they are soon going to shift to a proof of stake model.
Polkadot entered the market in 2020. The vision of Polkadot is to create a worldwide network of computers for users to create and run their own blockchains. One main blockchain or relay chain holds together different chains, which are referred to as parachains. We are talking not just about small players but even giants like Bitcoin and Ethereum.
Polkadot currently has a market cap of 19 billion dollars, and it sells for around $1.75 per coin. The supply of Polkadot is unlimited, and currently, there are about 900 million coins in circulation. The only thing to beware of is Polkadot’s history of being attacked by hackers.
Cardano blockchain was started in 2017. The coin they supply is called ADA. It has a market cap of 55 billion dollars and sells at the price of 1.75 dollars per coin. The supply of ADA has a limit of 45 billion coins, out of which 31.9 billion are currently circulating.
A feature of Cardano that appeals to and amazes most people is the proof of stake system as opposed to the evidence of work system used by Bitcoin for mining coins. Proof of work involves miners competing to solve computational puzzles for rewards in bitcoins.
In a proof of stake system, however, the reward goes to a person picked by chance, and the more ADA you have, the greater chance you stand of winning. This is more effective for incentivizing users to stay on the blockchain, keeps them happy with small rewards, and saves electricity.
Another interesting feature of Cardano is its ambition to become the internet of blockchains. Their vision is to connect different blockchains on a common platform where people can trade cryptocurrencies across blockchains.
Ripple is a blockchain-based digital payment network. Their token is called XRP, and it is a bit different from other cryptocurrencies. Since the main service provided by Ripple is the transfer of money between different cryptocurrencies, XRP tokens are used to facilitate this exchange.
Normally, this settlement is done using US dollars, which takes more time and fees. Using Ripple, you first convert the cryptocurrency into its equivalent value in XRP, and then you exchange those XRP tokens for the cryptocurrency you want to buy.
Unlike Bitcoin and Ethereum, which crypto miners mine, XRP is pre-mined, which means all the coins were already mined when Ripple was launched. The supply limit of XRP is 50 million tokens, of which around 45,000 billion are currently in circulation. The market cap is around 51 billion, and one token costs $1.12.
Initial Coin Offering
An initial coin offering (ICO) is similar to an initial public offering (IPO), except that it refers to start-ups in the cryptocurrency and blockchain space. An upcoming company launches an ICO as a way of raising funds.
Those who buy into the offering are issued tokens representing some stake in the company. You can also exchange these tokens for a product or service of that company. Here are some examples of recent ICOs.
PointPay is a fintech company that has recently created a cryptocurrency ecosystem of 10 fully functional products. It provides services that can be called crypto equivalents of those offered by a bank, like current and savings accounts and loans under the collateral of crypto assets. Their ICO opened last year in June and will end by July 2021.
Their token, PXP, has an initial value of $0.1, and it is an ERC20 token (a term used for tokens that are improvements over Ethereum). The soft cap (minimum amount required to launch the project) is $1 million, and the hard cap (the maximum amount they are willing to collect) is $30 million. Their white paper says that they have raised around $160 through crowdfunding and $4.3 by self-financing.
Merchant Token offers a DeFi protocol emphasizing protecting consumers from the hassles of traditional card payment systems like fraud resulting from stolen credit cards and a failure to verify the owner’s identity. The ICO opened in April 2021 and will end by June 2021. This one, too, is an ERC20 token. The token soft cap is around $5 million, and the hard cap is around $37 million. As of now, they have raised around $464 355.
Mina Protocol has launched the token MINA on the Ethereum platform and describes itself as “the world’s lightest blockchain, powered by participants.” They claim, with their design, to have overcome the problem of slowing down transactions because of network congestion. Among other exciting features, they also accept payments in user-generated programmable tokens.
The ICO opened in March 2021 and will end by the 17th of April. The initial price of MINA is $0.2. The sales soft cap is $4 million, and the hard cap is $10 million. They raised $18.7 million in their first community-facing token sale (more than the maximum amount offered) in just four hours.
Paradise is an exclusive content subscription platform for non-fungible tokens (NFTs). NFTs are tokens that you cannot exchange for other assets. For example, you can exchange bitcoins for money; hence they are fungible. In the cryptocurrency space, a lot of NFTs are traded exclusively for digital art.
Paradise aims to decentralize content ownership and give internet creators a new way of connecting with artists by giving them opportunities to get early glimpses or inside scoops into art and merchandise, facilitated by the artists themselves who would get paid for doing this.
The ICO opened on the 19th of April 2021 and ended on the 30th of April 2021. Their token, $fana was at an initial price of $0.05. Its soft cap was $2 million, and the hard cap was $15 million. By the end of their ICO, they had raised $500,000.
World Mobile Token
World Mobile Token is a digital token on the World Mobile Chain, based on the Cardano platform. Interestingly, they aim to solve digital exclusion, i.e., people not having access to technology.
The ICO opened in May 2021 and will end in August 2021. Their token, WMT, is initially priced at $0.2. The soft cap is $10 million, and the hard cap is $40 million.
Mining of Cryptocurrencies
Crypto mining is the process by which new coins are mined. They are mined not the way people mine gold but by solving complex computational math problems. Those who do this task are called crypto-miners.
Transaction verification process
Apart from pumping new coins into circulation, crypto mining serves another vital function of verifying transactions on the blockchain. For each block of transactions, crypto miners engage in a process called proof of work. Simply put, each block on the chain has strict cryptographic standards. When miners process the block, they verify whether the block meets these standards or not.
Mining does not work like this for all blockchains. On blockchains that use a proof of stake model instead of proof of work, transactions are verified by users who stake the highest amount of cryptocurrency rather than solve a puzzle. Some blockchains like Dogecoin verify transactions and give rewards randomly like a lucky draw.
How do miners earn?
When miners verify blocks of transactions, they are rewarded for it in cryptocurrency. But there are two criteria for getting rewarded. The first one is that they need to process 1 MB worth of transactions. The second one is that they need to solve a computational puzzle or come close to solving it before everyone else.
It is a way of reinforcing miners to process data with both speed and accuracy. While mining as a source of income looks lucrative, it is important to know the costs involved, like electricity usage and special hardware and software required for processing.
A cryptocurrency exchange is a platform where you exchange one cryptocurrency for another. You can also buy cryptocurrency by paying in fiat money.
There are two kinds of exchanges. The first one is a centralized exchange. These require you to complete a KYC process while creating an account. After you link a payment option and create a wallet for your cryptocurrency, they take custody of your funds, connect you with buyers or sellers in their database and execute the transaction for you. You have to pay commission and transaction fees.
Decentralized exchanges, which have developed recently and are fewer in number, directly connect buyers and sellers and don’t charge commission. However, decentralized exchanges don’t allow cryptocurrency exchange for fiat money; they only facilitate trading between different cryptocurrencies.
Cryptography is the science of transforming information into a code that unintended recipients cannot understand. This process is called encryption. The text before encryption is called plaintext, which is changed using an algorithm. The text after encryption is called ciphertext. An uninformed observer would not be able to comprehend a ciphertext.
In a blockchain, encryption is involved in the public key and the private key. The public key is used to encrypt messages so that no one except the intended user can understand them. This user, identified by their wallet address, has a private key.
They use their private key to decrypt the message, which cannot be decrypted with any other private key. So the public key is the encryption key, and the private key is the decryption key.
A cryptocurrency wallet is used to store the cryptocurrency you own. It does not store your coins in the traditional sense; it only carries a record of your transactions. Wallets have a public key and a private key for security.
Wallets are classified as hot wallets connected to the internet and cold wallets, which are not. Hot wallets are used for day-to-day transactions, while cold wallets are a safer storage place for the bulk of your funds, like a bank vault.
Wallets are also classified as custodial and non-custodial. It is based on whether they are controlled by the user or a third party, like a centralized exchange.
Hot or cold, custodial or non-custodial, wallets fall under four major categories. There are web wallets that you operate from a server. There are mobile and desktop wallets that you operate through apps. Hardware wallets are special devices resembling a pen drive.
Lastly, paper wallets are printouts of passwords and keys or QR codes. Paper wallets are the safest of all, and web wallets are the riskiest in terms of cybersecurity issues.
Applications of Blockchain Technology other than Cryptocurrencies
Blockchain is a revolutionary technology having applications in diverse settings other than cryptocurrency. People all over the world highly endorse decentralization and transparency, which are the core values of blockchain. Here are some emerging and ongoing uses of blockchain.
The covid pandemic has thrown light on the importance of an efficient healthcare system. We can use blockchain technology to manage electronic medical records, share medical history among multiple healthcare providers, trace medical supplies, verify health insurance claims, track epidemics, and store genome (DNA-related) data for research purposes.
For example, Medicalchain, a decentralized database of health records, launched a telemedicine platform where patients consult with doctors online and pay in Medtokens.
A decentralized database with transparent access to information and privacy protection can significantly boost people’s trust in the public sector.
Such a system would place the government in a better position to secure data for identity verification like birthdates, social security numbers, driver’s license numbers, residential addresses.
Moreover, it can make information processing more efficient by reducing the time lag in transferring documents and funds.
Entertainment and media
Introducing blockchain in the entertainment industry can enable pay-per-use subscriptions, where consumers pay for only a specific part of the content, like a single chapter or episode, rather than unwillingly buying the whole thing or not buying it at all.
It can drastically increase revenue. It can also better resolve royalty disputes through smart contracts and reduce illegal sharing of content by tracking who is sharing and making sure they pay for it. Moreover, a blockchain can do what it does best- connect content creators to consumers without an intermediary.
Blockchain technology would allow reliable verification of certificates and degrees without a trusted third party in the education sector. It can create a better mechanism for detecting fake degrees, plagiarized papers, and false information on resumes.
It can alleviate problems like inadequate academic guidance and inconsistent course materials across schools and universities by allowing real-time data sharing between students. Moreover, it can incentivize teaching and learning through the exchange of tokens.
The most important and perhaps obvious application of blockchain in agriculture is eliminating intermediaries between producers and buyers. It can also give buyers access to data about a product’s value chain, i.e., all the processes and activities that raw material goes through before reaching the consumer as a product.
We can use smart contracts to make agricultural insurance practices more efficient and fair. Lastly, a decentralized database can store information about environmental changes, climate, agricultural produce, and food supply without falling prey to the vested interests of government agencies and with better protection against distortion and misuse.
Apart from these, blockchain can transform major industries like real estate, gaming, travel, retail, advertising, and more. It also has applications in niche areas like digital payment processing, supply chain management, digital identity verification, digital voting, tax regulation, copyright, and royalty. Since all the sectors in the world use these systems, blockchain is relevant in all of them.
Blockchain technology may soon become common for payment systems such as Paypal, Transferwise, or any other cross-border payment services. One such startup based out of London, United Kingdom is aiming to revolutionize the industry through its outstanding app called Blyncc.
(Disclosure: Maroof HS CPA Professional Corporation has provided a limited finance consultancy to Blyncc).
Benefits of Blockchain
The sheer number of industries and settings that are interested in the development of blockchain technology speaks for the benefits that it provides. Here is a list of reasons why blockchain technology is so appealing and relevant today.
Permanent and Unalterable
You cannot reverse transaction records on a blockchain.
For example, if you send bitcoins to your friend and want them back, you cannot undo the transfer. You will have to ask your friend to send them back to you.
The blockchain will record them as separate transactions. Every transaction that ever happened on the blockchain is traceable (without revealing the user’s identity). Hence the database is comprehensive and reliable.
Each transaction on the blockchain is time-stamped and recorded on a block. Each block is cryptographically secured. The mathematical function used for securing it, i.e., the hash, is unique for each block and cannot be reverse-engineered. As a result, the transaction data on the blockchain cannot be tampered with.
Transaction Speed and Costs
Because of the elimination of third parties, the absence of human error, and integration of all information on a single decentralized database, blockchain transactions are faster and more efficient than traditional payment and information sharing systems.
Since third parties are mediating the transactions, users don’t have to pay a commission. So when it comes to cost-effectiveness, blockchain earns a point over traditional systems.
No central control and dependency
The blockchain records its transactions on each device in the system. The records are not owned or managed by any central authority. Users don’t depend on a third party to validate the transactions. Crypto miners verify each block of transactions and get rewards for their work in cryptocurrency.
No government control
As mentioned earlier, blockchains are not owned, controlled, or monitored by a central authority. Hence, in contrast to financial institutions like banks monitored by national governments, any government agency does not monitor transactions on a blockchain.
However, there are ongoing discussions on whether governments will place some regulation or restraint or demand access to data on blockchains in the future.
Transparency and verification
Transactions on a blockchain are stored on a single database. They are present in an identical form on all devices in the system. Every user has access to the same information at the same time. The transactions are also time-stamped and date-stamped, making the chronology of transactions clear beyond doubt.
This transparency reduces the possibility of fraud and tampering, which is common in organizational databases, both online and offline. Moreover, every transaction on the blockchain is verified by the users themselves, leaving little scope for unintentional errors and intentional manipulation.
As mentioned earlier, blockchain transactions have no middlemen and hence charge no commission. However, blockchains consume many resources like the electricity and equipment required for mining. The miners cover these costs from their own pockets.
Also, while blockchains don’t charge a commission, they do charge a transaction fee, which in some cases determines the speed of transactions. So it is essential to weigh these considerations against each other while deciding the cost-effectiveness of blockchain.
A Wide Range of Applications
We can put blockchain technology to use in almost all major industries, from health care to entertainment. It has a variety of applications in each of these sectors.
Risks involved: Blockchain Technology & Cryptocurrencies
While blockchain is popular as a cutting-edge technology that defies the boundaries of traditional databases and transaction procedures, critics have raised reasonable concerns about it.
Here is a list of the most common risks associated with blockchain.
Volatility and risk of financial losses
The volatility of cryptocurrency is more like a negative connotation associated with blockchain rather than a risk. Cryptocurrencies, which are based on blockchains and are most commonly associated with blockchain than anything else, are notorious for their very high volatility. The recent crash of Bitcoin has shown that cryptocurrencies are a high-risk asset class.
Investors are wary of adding it to their portfolio, and critics have many valid arguments about the dangers of investing in cryptocurrency. These conversations have given blockchain technology a lot of negative labels in the eyes of ordinary people and organizations.
Lack of regulations and compliance
While government agencies have shown interest in using blockchain technology, there are no government regulations on blockchains in general. If your wallet got hacked and someone stole your coins, there is no government body where you can file a grievance.
Blockchain technology is still a relatively newer technology. While it ensures user anonymity and reliable verification, it is not immune to hacking, stealing, double spending, and compromising user information like public and private keys. It is also vulnerable to viruses and technical glitches that can wipe out records and jeopardize your investments.
Permanency and transparency of records in the blockchain are double-edged swords. Because the records are public, they are accessible to criminals attempting to identify vulnerabilities and hack into user accounts.
Because they are permanent, users cannot delete or take them down temporarily to protect themselves from hackers.
The responsibility of securing one’s cryptocurrency lies entirely on the user. Even if users take precautions to prevent cyber attacks, glitches and forks in the blockchain too can compromise data.
Because government laws do not regulate blockchains, it is not difficult for criminals to launder money by putting the funds into cryptocurrency, or use it as a workaround for filing taxes. People could also use cryptocurrency blockchains for making payments involving drugs, human trafficking, child pornography, and illegal goods.
Taxation of Transactions in Cryptocurrencies
One of the hottest topics this tax season!
The governments are scrambling around bringing some sort of regulations and beef up their tax intelligence resources to identify the non-compliance. IRS and CRA have pooled their resources to identify such noncompliance. IRS has already added a question about virtual currency transactions on form 1040. IRS treats cryptocurrencies as income from the property.
Canada Revenue Agency treats cryptocurrencies as commodities. Rules related to business income, capital gains, and barter transactions are discussed in the above-mentioned link.
The Future of Cryptocurrency
Investors and experts disagree on the question of whether cryptocurrency has a future or not. Proponents of cryptocurrency think that it will revolutionize finance, while critics say that it is a risk not worth taking.
On the one hand, investors are worried about how traditional financial institutions and investment firms will take the pandemic blows. As a result, more people are exploring investment options related to cryptocurrency. Some experts believe that people from countries having weak economies should prefer cryptocurrency over local investment options.
Developers are coming up with price prediction tools to automate cryptocurrency market analysis. Moreover, cryptocurrency is getting attention from national governments and private organizations. These developments paint quite an optimistic picture.
At the same time, there is speculation that if traditional financial institutions like banks improve their digital payment systems and overall functioning, they will defeat cryptocurrency in its battle for preference. Cryptocurrency is still a side investment. Competition from traditional institutions and government regulation on the use of cryptocurrency might knock it off from its precarious position.
It’s difficult to predict what will happen to cryptocurrency. But it’s possible to tell which cryptocurrencies will survive the competition. It is likely that out of all the altcoins added to the list every week, very few are here to stay.
Liquidity, i.e., the ease with which you can buy and sell a cryptocurrency and adjust your position in the market, is a crucial factor to look at while investing. Cryptocurrencies with low liquidity can put you in a tough spot.
Some experts think that only about 17 of these cryptocurrencies have a market worth more than $10 million, and those, according to them, are the ones worth giving a shot.
This post is an attempt to explain cryptocurrencies to different users such as accountants, income tax preparers, or the general public. The governments on both sides of the border in the U.S. and Canada are working actively to bring this under regulations. Since this is an evolving topic, at the time of reading, some information may have become obsolete. Users should exercise caution while using any statistics or information presented in this post.