What is going on with cryptocurrencies?

what-is-going-on-with-cryptocurrencies

Every day dozens of people come to me with a wide range of questions. How to make money? How to create their own cryptocurrency? What is going on? Where should they invest their money? etc. The euphoria in the market will inevitably lead to the fact that many people will lose all their savings. Therefore, I will try to give some sober answers to the most common questions.

About Bitcoin

1. What is Bitcoin?

In reality, this is a currency and an algorithm guarantees its supply and processing. The rules of ‘how it works’ (like DNA or the constitution) were initially designed, and are not changing. There is no company or a person behind Bitcoin who can “steal all the money.” The best analogy that explains Bitcoin is that it is digital gold. Bitcoin is a decentralised, completely transparent system where each participant controls that others ‘play by the rules’. It does not overlap with any banking system.

2. Is Bitcoin a pyramid scheme if it is growing so fast?

No. This asset has a fixed supply, so the price is very sensitive to growth or decline in demand (even more so than, for example, oil).

3. How can you make money with Bitcoin?

If you believe that it will grow, then buy it and wait. It is still possible to mine it.

4. Will Bitcoin grow?

This depends on many factors. Right now the demand for Bitcoin is mostly speculative. People believe that price will grow and are investing some percentage of their savings. However, Bitcoin is used in a real (but ‘gray’) economy – for example, in the field of international money transfers, which have large fees. We could say that sending money from Ukraine to China is the easiest way to effectively use Bitcoin. Also part of the money from offshore jurisdictions flows into Bitcoin, as it is anonymous and easier to utilise. Permits and restrictions of countries, and the regulation of exchange will definitely influence the potential of the Bitcoin price.

5. What is mining and is it worth investing in it?

Mining is the process of confirming transactions that anyone can do. The purpose of mining is to ensure the reliability of the system. Bitcoin is designed so that those who participate in mining earn Bitcoins. Mining requires a large number of computations and, accordingly, special equipment. Earnings are directly proportional to the power of the equipment. Mining is very profitable if you:
– have cheap electricity;
– you perceive it as work.

6. What risks are exposed to those who hold Bitcoins?

First of all, risk of loss due to the theft of keys. Owning Bitcoin is equivalent to knowing the key from the digital signature that is required to initiate transactions. The keys can be stolen by a virus, or you can lose your phone with a Bitcoin wallet, or simply your computer may break down. If you store Bitcoins on the exchange, the data can be hacked or the owner of the exchange can simply disappear. Due to the fact that accounts in Bitcoin are anonymous, there is no way to recover stolen Bitcoins.

About Blockchain

1. What is Blockchain?

This is a technology created to reconcile a database between parties that do not trust each other. The features of the database built on Blockchain are the following:

  1. it is append only,
  2. it stores the entire history of the changes,
  3. uses cryptography to ensure integrity,
  4. is stored with each participant.

To agree on changes (transactions) a consensus algorithm is used. There are available a lot of such algorithms.

2. How does Bitcoin and Blockchain correlate?

Blockchain is the database of all Bitcoin transactions between accounts. Looking at the Blockchain, you can understand how many Bitcoins belong to each account. Bitcoin uses the consensus algorithm called Proof of Work.

About Ethereum

1. What is Ethereum?

This is, in fact, a decentralised computer with its own execution environment and programming language. In it, by analogy with bitcoin, there is also a currency (Ether) used to pay for operations (CPU cycles). You can issue your own assets overlaying it and create contracts for their behavior.

2. Why is Ether growing so wildly now?

There are several reasons:

  1. banks claim that they are experimenting with it,
  2. people believe that all assets (money, stocks, etc.) will be issued on it and, accordingly, the demand for Ether will grow strongly,
  3. many startups conduct ICO on the Ethereum, which sharply reduces the supply of Ether on the market and increases the demand for it.

About ICO

1. What is an ICO?

The term ICO (initial coin offering) has gone from an analogy to an IPO and means the pre-sale of someone’s own tokens by some startup. Such tokens can have different definitions, but more often they are used to pay for user actions on a platform that the startup is promising to build.

2. How do startups collect tens of millions of dollars by conducting an ICO?

There are several reasons:

  1. an ICO is a relatively simple way to invest in a startup,
  2. people believe that a startup can become another Bitcoin or Ethereum and want to invest early,
  3. historically, currencies sold through ICO have only grown.

3. Is the current state of the ICO only a bubble?

Definitely. The ICO principle itself will lead to positive changes in venture capital investment, but right now people are buying everything indiscriminately (even a complete scam). Inevitably, people are always looking for faster ways to earn. Those who have earned in Bitcoin, invested in the Ethereum, and who earned on the Ethereum, now invest in ICOs, hoping for the same rapid growth. The pyramid will collapse when:

  1. start-ups massively start selling the funds collected in Ether – now they keep them, because rates are only growing,
  2. people will understand that those startups cannot afford their promises and create the announced products,
  3. government involvement (now most ICOs are outside, or on the edge of, the law).

4. What else are cryptocurrencies?

There are a lot of them, but basically they are divided into:

  1. completely decentralised,
  2. digital assets provided by someone or something,
  3. dubious currencies that are emitted and controlled by one company and are not supported by anything.

5. Is it worth creating your own cryptocurrency?

Only in case if you realise what are you doing and what for.

Further posts will answer to questions about what public/private blockchains are, what role the domestic currency can play, and when it is needed at all, what other consensus algorithms there are, etc.

Illustration by Katerina Krashtapuk

Pavel KravchenkoCryptographer, founder of Distributed Lab