Monday, October 2, 2017

Cryptocurrency: the Origin and Growth of Coinopoly

Mired in the aftermath of the U.S. financial crisis, the year 2009 may have started one of the largest financial revolutions since the birth of paper currency in 1690. Much like its predecessors, cryptocurrency faces an uphill battle of understanding, trust, and proper regulation. Eight years since its inception, cryptocurrency has maintained its allure with startups and financial intermediaries, but is still a misunderstood concept to many. We hope to clarify this misunderstanding in a series of posts, beginning here with the basics of cryptocurrency and later discussing blockchain, initial coin offerings, and the current laws and regulations applicable to this industry.

Cryptocurrency is, by any other name, a currency—a medium of exchange used to purchase goods and services. Or, as some have suggested, cryptocurrency is a “peer-to-peer version of electronic cash.” However, this currency has two qualities that distinguish it from traditional bills and coins. First, cryptocurrency is a virtual currency that is created through cryptography (i.e. coding) and developed by mathematical formulas through a process called mining. Secondly, unlike traditional bills and coins that are printed and minted by governments around the world, cryptocurrency is not tied to any one government, and thus is not secured by any one government. This is often referred to as being decentralized.

Cryptocurrency is based on a cryptographic code that can be created (as described by Ethereum here) or based on existing open source software available through platforms like GitHub. Open source software is freely accessible code intended to be shared and improved. We discussed it in more detail in one of our previous blogs. The readily available open source software is what makes cryptocurrency decentralized—no one person or entity has the ability to control how many types of cryptocurrency are out there. According to, currently, there are close to 900 different cryptocurrencies. In comparison, there are about 180 currencies in the world that are recognized legal tender, and virtual currency is not among them.

As a decentralized currency, cryptocurrency is not subject to the inflationary pressures of legally recognized tender. For example, the cryptocurrency Bitcoin has a finite number in circulation, meaning the 21 million outstanding Bitcoins are all there will ever be. Because it cannot be reprinted or minted, like government backed bills and coins, its value is determined by basic economic principles, including supply and demand and allocation of scarce resources. A finite number of Bitcoins means that when the demand for Bitcoins increases and the supply stays the same, then the price of Bitcoin would increase, and vice versa.

Being a decentralized currency comes with flaws, especially as it relates to value. Giving someone a $20 bill has immediate and apparent value because it is backed by the full faith and credit of the U.S. Treasury. A cryptographic code on the other hand has initially little value. This is where the term “mining” comes in. The owner of the original code of the cryptocurrency works with miners to build the currency’s value. In other words, the original coin holder—the developer of the code—needs to exchange the coin for something. The original coin holder will provide coins to miners and, in exchange, the miners will process transactions by confirming and writing them into the distributed ledger. These transactions are recorded as blocks in a long list on the ledger, which creates the blockchain (which will be discussed in detail in the next post). Whether it is an ordinary bank account to withdraw cash from or it is cryptocurrency’s distributed ledger, both function as a historical record of value based on entries (i.e. transactions) from the third-party servicers—banks when dealing with cash or miners when dealing with cryptocurrency.

Of course, the virtual coin only has value if it can be exchanged for traditional goods and services, like the $20 bill. This heavily relies on marketing the cryptocurrency as a valid form of payment; not unlike paper money back in 1690. As described by Chris Ellis, developer of Feathercoin, “Money is a ledger, it is a tool that people will use as a way of achieving their goals and satisfying their needs.”

Various cryptocurrencies have developed into household names, such as Bitcoin, Ethereum, Feathercoin, and many others because of the potential use now available to cryptocurrencies. Cryptocurrencies can be stored and carried around in different types of wallets, including physical wallets that look like paper money, flash drives, and online wallets, and can be exchanged for goods and services at restaurants, online retailers, television providers, and even donated to charitable organizations. Our law firm, for example, accepts Bitcoin payments. As opposed to concerns from critics that this is just Tulipmania and we are ascribing value to an otherwise valueless item, the potential for cryptocurrencies as a medium of exchange is enormous.

The growth in cryptocurrencies begs the questions regarding security, rules and regulations, and ultimately how to utilize the blockchain and cryptocurrencies in other sectors or the financial industry. The following posts in this series will cover these issues and more in depth.

This article is not legal advice, and was written for general information purposes only. If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its authors, Andrew Silvia and Arina Shulga of Ross & Shulga PLLC.  We are a New York-based law firm specializing in advising individual and corporate clients on various aspects of corporate and securities law, including initial coin offerings.

No comments:

Post a Comment