What is cryptocurrency? A short history
In 1993 David Schaum invented DigiCash, the world’s first form of digital money in the Netherlands.
DigiCash transactions were unique in that they were anonymous due to several cryptographic protocols. In 1998 Nick Szabo and Wei Dei published their ideas about a purely digital currency — “bit gold” and “B-money”. While both were never officially launched, they were central to the inspiration behind Bitcoin.
Satoshi Nakamoto creates Bitcoin
In October 2008, in the aftermath of the global financial crisis, a person (or a group of people) under the pseudonym “Satoshi Nakamoto” published a paper titled Bitcoin: A Peer-to-Peer Electronic Cash System. In November, the Bitcoin project was registered at the open-source-projects community SourceForge. The first-ever Bitcoin, created with cryptography, known as the “genesis block” was mined on January 3rd, 2009. In essence, Satoshi Nakamoto performed the first transaction of 50 BTC to the now hallowed address: 1A1zP1eP5QGefi2DMPT fTL5SLmv7DivfNa.
Nine days later, on 12th January 2009, Hal Finney, another pioneering cryptographer started running the Bitcoin software. Since the inception of Bitcoin, analysts estimate that Satoshi Nakamoto mined about one million Bitcoins before disappearing in 2011. However, since Nakamoto’s disappearance, the estimated $19 billion worth of Bitcoins belonging to Nakamoto ( at the 2017 all-time-high), have never been touched . In fact, to this day, Satoshi Nakamoto’s identity remains a mystery.
Fun fact: The first known commercial transaction using Bitcoin took place when a programmer bought two pizzas for 10,000 BTC.
In 2011, Silk Road, an online marketplace operating on the Dark Web, launched, using Bitcoin as its main currency of transaction until it was shut down by the FBI. In the same year more and more Bitcoin exchanges launched, with Bitcoin reaching parity with the US dollar (1 USD = 1 BTC).
In 2012, the Bitcoin Foundation was announced with the aim to accelerate the growth and reach of Bitcoin. The first Halving Day took place on November 28th, 2012, and the reward per block mined on Bitcoin’s blockchain was reduced to 25 BTC. Total market capitalization of Bitcoin exceeded one billion USD a year later.
Figure 1 – The halving is based on the Bitcoin algorithm to “split” the reward to decrease supply
Additionally, due to the open-source code of Bitcoin, other cryptocurrency developers were able to create alternative coins based on its network. The first altcoin was called “Name Coin” and it launched on April 18, 2011. Between 2011 and 2014, the number of altcoin launches started to grow exponentially.
One of the greatest success stories to arise from Bitcoin’s open-source nature came in the form of Vitalik Buterin, a Russian-Canadian programmer. In 2013, Buterin invented Ethereum, a platform that runs on its own blockchain and allows the user to create smart contracts. Ethereum was another milestone for the cryptocurrency market and currently holds the second highest market cap.
Figure 2 – Smart Contracts Main Features and Added Value
Mt. Gox and Mainstream Adoption
In February 2014, Mt. Gox (handling over 70% of all Bitcoin transactions at the time) was hacked. Its exchange ceased operation and the company filed for bankruptcy. While the Mt. Gox debacle led to the rise of negative perceptions towards Bitcoin, the first sign of mainstream adoption occurred.
The ICO Hype and Bitcoin’s Bull run
More coins and tokens started to appear in 2017 as the year of the ICO (Initial Coin Offering) hype took place. ICOs enabled developers to create liquidity overnight and for individuals to speculate on hundreds of projects, even before knowing if there was a real usage for a coin or token. The creation of ICOs led to the rise of fraudulent coin offerings and thousands of investors lost their funds.
In January 2017, the price of Bitcoin broke the $1,000 mark for the first time since 2014. As the number of businesses accepting Bitcoin continued to increase, lawmakers and financial companies became even more interested in cryptocurrencies. Japan passed a law to accept Bitcoin and Russia announced the legal use of cryptocurrencies. Trading volumes continued to increase and banks, including Barclays, Citi Bank, Deutsche Bank and BNP Paribas, said they were exploring ways on how they might be able to work with Bitcoin. The CME Group announced the launch of Bitcoin futures in late October 2017.
Bitcoin hit an all-time-high price on December 18, 2017, reaching $19,891. Three years later, in 2021, that record was broken again with an all time high of $64,000.
Figure 3 – Bitcoin topping $64,000
How do cryptocurrencies work?
The majority of cryptocurrencies are not backed by central banks or governments, instead they rely on decentralized technology called blockchain to act as a guarantor. Crypto is 100% blockchain-based and its value is determined entirely by the price action on the market. Cryptocurrencies can have a finite or unlimited supply set in their protocol. While there are numerous consensus mechanisms the two most popular are proof-of-work (PoW) and proof-of-stake (PoS).
Why are cryptocurrencies so volatile?
Since the cryptocurrency industry is fairly new, there are a lot of price swings and investors can benefit from them to generate quick profit. However, they have to figure out how crypto prices may move and what drives them. There are a couple of basic factors which play a huge role in the price of a cryptocurrency – number of people utilizing the coin, purpose of the coin, amount of holders, scarcity (maximum amount set in the protocol) and hype.
Why has crypto become so popular?
To sum it up with one word: Growth. Investors like to see large green percentage increases as well as contribute to the development of an alternative to the traditional financial system. The crypto and blockchain ecosystem has evolved further by incorporating the DeFi (decentralized finance) movement, smart contracts and non-fungible tokens (NFTs). Was the Pandora tech box opened?
Types of cryptocurrency
The types of cryptocurrencies can be classified as Cryptocurrencies and Tokens. Cryptocurrencies are the native asset to a blockchain such as the Bitcoin network and Tokens are programmable assets which live on a blockchain platform. These tokens can be sent and received and can be used to represent a variety of units of value such as money, electricity, digital assets and coins.
Another type of cryptocurrencies are stablecoins, which can be pegged to an asset such as gold or a fiat currency, carrying the same value. Non-fungible tokens, or NFTs, are the artistic side of cryptocurrencies used as collectibles. They started out as one-of-a-kind digital assets used as a store of value but in 2022 they have much more utility that spreads to gaming, entertainment and more.
Advantages and disadvantages of cryptocurrencies
Cryptocurrencies have pushed society to new limits and as such have inspired passionate investors on both sides of the debate.
● Looking at the past years, buying cryptocurrencies such as Bitcoin have been steadily rising and their supporters have been racing to own them, as they have a scarce supply and are supposed to be more valuable in the future.
● Some supporters argue that cryptocurrencies remove the overextended function of central banks and money supply management, which in essence would stabilize inflation.
● Cryptocurrencies are not racist and as such provide opportunity for all people who want to invest in them.
● Since blockchain technology is used to create cryptocurrencies, supporters argue that this decentralized system is far more secure than traditional banking.
● Despite being banned in many countries, cryptocurrency investments still hold value and can be used as a long-term investment.
● Some cryptocurrencies offer a stable passive income through a process called staking, by which one can grow their crypto holdings without buying more. Crypto staking locks a certain amount of your crypto and uses that to help verify transactions on the blockchain.
● This technology is new and popular and if it doesn’t reach its potential, long-term investors may back off from it.
● Short-term investors and newcomers to the space are especially vulnerable as huge price swings could easily make them bankrupt.
● The large shifts in value make crypto unfit for a safe payment system, as one cannot be sure what they will be worth the next day.
● Crypto mining uses a lot of energy, which is bad for the environment.
● Governments around the world with regulatory changes and crackdowns have the potential to affect the market in unpredictable ways.
What is cryptocurrency mining and how does it work?
Crypto mining is associated with the proof-of-work consensus mechanism which involves solving complex calculations – in return miners are rewarded cryptocurrencies. In the early days of Bitcoin, users’ computers solved these equations with just a CPU. As the difficulty of the algorithm increased, mining now requires powerful GPUs that are quite costly. Even if you have a single one, you can still mine by joining a a mining pool, where users share rewards after getting a successful block.
Cryptocurrency legal and tax issues
Cryptocurrencies are a recent thing. Many have heard of Bitcoin and Ethereum, but little is known about how they work and their potential. It’s hard to create efficient regulation on a phenomenon that is still developing. Most countries lack any kind of crypto regulation. The current regime is pretty vague and ambiguous, especially since principles applied to other types of investment tools (stocks, bonds and others). As the crypto market matures, there’s little doubt that regulators will begin to enforce new crypto specific policies.
People who know little about crypto claim that trading Bitcoin should be avoided, since it can be used to purchase illegal products and launder money. Yes, some may abuse Bitcoin’s anonymity to take part in such transactions, but it doesn’t mean that all enthusiasts want to outfox the system. It’s a troubling trend, because central authorities are encouraged to create policies that limit Bitcoin and its potential. Hopefully, sooner or later everyone learns about blockchain and crypto-assets more in depth. This way scrutiny and excessive regulations can be avoided. It all depends on the responsibility of the users.
Almost every country has taken a slightly different stance in regards to cryptocurrencies. For example, China has banned them all together, while the U.S. have legalized them to an extent. Some countries have gone a step beyond and accepted them as legal tender. Such is the case with El Salvador – in 2021 it became the first country to adopt Bitcoin. These differences also affect the way crypto is taxed, and as such have many unsolved questions and gray areas. However, as a general guideline, cryptos are primarily taxed as property rather than currencies. Feel free to read our comprehensive blog posts about crypto tax guidelines here.
What is a blockchain in cryptocurrency?
The Financial Crisis in ’09 was devastating. The unemployment rate rose from 5% to 10% in two years. Hundreds of thousands lost their jobs and millions lost their homes. Markets crashed, dumping the Dow Jones Industrial Average below 10,000 points for the first time. Everyone lost hope in the financial system.
Satoshi Nakamoto came up with a solution that revolutionized the industry and possibly the way in which society is structured. A new technology rose from a whitepaper that transcribed the complex protocol behind Bitcoin and the crypto universe: blockchain technology.
How does a Blockchain Work?
Figure 4 – How a block is generated when a transaction is requested
A blockchain is a distributed ledger that keeps track of user balances. For newcomers, a blockchain is a chain of blocks that store data. Mainly, the blocks store transactional data between users. The content of each block varies between blockchains. For simplicity, Bitcoin’s blockchain will be used as a reference.
Figure 5 – Adjacent blocks linked by the “blockchain” to have traceability of previous transactions
Bitcoin’s Blockchain Components
Figure 6 – Key components of a block and the information compiled on each of them
Each block contains its hash, data, and the hash of the previous block. The transactions between users is the data comprising the block: the amount sent or received, and the keys of each party. Simple right?
Hash has a unique connotation in the blockchain context. Think of it like a fingerprint. The hash of each block is what identifies each block, and its content. It’s the way to individualize each block. The previous block’s hash is vital because it’s the connector between the chain of old blocks and the new verified block. With today’s computer power, it takes around 10 minutes for miners to decrypt the “golden” hash.
This chain characteristic is what makes blockchain secure. It’s impossible to manipulate the blocks because every subsequent block would be invalidated as the fingerprint of the block’s hash would scramble to avoid further blocks from being manipulated. Furthermore, miners play an exceptional part in securing and maintaining the proper functioning of the blockchain and are rewarded for it (miners receive 6.25 Bitcoin per new block).
Figure 7 – There are two main consensus mechanisms: PoW and PoS
Proof-of-Work vs. Proof-of-Stake
A decentralized network needs a way to keep running. Without an incentive to validate new transactions the blockchain would freeze and new blocks wouldn’t be generated. To keep the protocol running, miners compete against each other to create and verify the hash of the upcoming blocks. Rewarded for solving complex mathematical puzzles, miners receive newly minted Bitcoin. The best part is that all Bitcoin holders have access to a node, or a full copy of the blockchain, to verify that everything is in order. As a result, there is constant node supervision.
Mining is getting too expensive and less competitive. Big players have thousands of mines running, making it extremely difficult to compete against them. As a result, a different type of consensus mechanism came to light. One that doesn’t involve as much energy and is more competitive.
Instead of having to work, or mine, for the reward, crypto holders “lock-up” their crypto investment in nodes that verify new blocks. These validator nodes play the same role as the miners, but it’s much more energy efficient.
Stakers are incentivized to play by the rules and accumulate more of the crypto assets. Interest rates work as a reward in PoS. As more rewards are collected, the staker’s position will continue to increase. The best part is that depending on the amount staked, users also receive voting rights in proportion.
Figure 8 – Key benefits of the blockchain compared to other technological infrastructure solutions
For the first time ever, interacting on a decentralized peer-to-peer network is possible. A new democratized community has been created, ruled and limited by the will of the people.
A network, in which users are free to transact with one another through a transparent and secure system is now made possible with blockchain technology. Expensive fees, delays in payment, and pricey conversions have become obsolete. With blockchain technology, one can send and receive money in minutes without paying high fees. For the first time ever, banks are removed from the equation as there’s no need for a middleman. Institutional freedom at last. Blockchain technology aims to guarantee financial availability and security for all participants.
Cons of Using Blockchain
The anonymity of the system, if abused, can lead to unethical and illegal applications. Satoshi himself asked users not to abuse the liberties granted by his creation. Still, Bitcoin was and is used for illicit transactions.
The original Bitcoin network couldn’t process transactions as fast as a credit or debit card and many doubted that it can be used as an efficient payment method. Imagine trading one Bitcoin for a motorcycle when the price is at $12,000. Patiently, waiting for the transaction to be verified, Bitcoin’s price skyrockets and now one Bitcoin is worth $13,000. Bitcoin’s high volatility poses a threat to buyers and sellers if transactions are not fast enough. Other cryptocurrencies have much shorter finality times, giving them an advantage.
Blockchain exists because market participants demand institutional freedom. The need for third party institutions for the functionality of the system has become a thing of the past. Blockchain began as a peer-to-peer marketplace where users can send and receive money freely in a secure and transparent environment and it is evolving to even broader uses.
From storing information to voting implementations, blockchain technology continues to serve its primary purpose: securely storing information. No one is capable of stealing or misusing the data stored. It’s a common misconception to limit blockchain’s use to transactional details. One example of the use cases is a digital vault in which personal belongings, identities, relationships, etc., are stored in a secure database. Under certain conditions they can be accessed and kept secure at the hand of the owner.
It’s hard to imagine the potential of blockchain technology because it is still so early in its development. The only certainty is the elimination of a middleman dictating the rules. Finally, users can decide upon the outcome of their goods. Society is demanding democratized solutions in which the best product, according to its users, will thrive. With blockchain technology, there is always room for more innovation. The sky’s the limit.
How do you buy and sell cryptocurrency?
Comments like “Bitcoin UP 100%!” are popular in bull runs. It’s hard to miss out on the benefits of a price spike, but buying Bitcoin can seem confusing because it’s not common knowledge. This sentiment is what you call FOMO: Fear of Missing Out. We will explain how buying and selling crypto works if you don’t want to miss out.
Unless one is a miner, the easiest way to purchase Bitcoin or other cryptocurrencies is through an exchange both for beginners and experts. An exchange is essentially a crypto marketplace. Through an exchange, crypto investors are connected with one another and transactions are made possible. In an exchange, users can buy or sell different cryptocurrencies at prices dictated by supply and demand.
Figure 9 – Exchanges allow fiat to crypto transactions and vice-versa, as well as crypto to crypto trades
Think of an exchange as an old-school marketplace, where the stall owners each sell their unique goods. The reason that the goods sold are unique, is because each stall owner grows or produces their own particular product – similar to the way in which miners earn their own Bitcoin. The best thing about this marketplace is that the stall owners can resell their unique goods to other market participants.
Exchanges shouldn’t be considered as peer-to-peer exchanges per se because even though one might be buying someone’s crypto, the transaction is executed through the aid of a middleman: exchanges.
Figure 10 – Exchanges offer a variety of cryptocurrencies and generate a marketplace for users
Binance, Kraken, Coinbase, and FTX are some of the major players in the crypto community. Each of these exchanges offers various solutions to different crypto enthusiasts. One may be a better fit than another, but it all depends on one’s objectives. In the simplest terms, exchanges are portals used to buy and sell crypto assets and currencies.
It may be hard to decide which is the best exchange for some specific objectives because most of them offer similar features:
● Exchange Rates
● Geographical Constraints
● Payment Methods
● Management Team and Angel Investors
What To Look For When Deciding Which Exchange To Use
Keep some of these in mind.
Simplicity is key. Crypto is complicated enough, so it’s best to look for the easiest and most appealing exchanges. If the exchange layout is confusing, how can one transact freely? The experience on the platform should be seamless and intuitive.
The best exchange is usually the one that feels the comfortable to use for you. The process of buying and selling crypto shouldn’t be a hassle. It should be thrilling and exciting. Having nice and clean visuals also helps.
Bitcoin may cost a lot of money to most people. Thankfully, exchanges allow users to purchase fractions of Bitcoin because Bitcoin is divisible by 100,000,000! Meaning that it’s possible to purchase 0.00000001 bitcoin. Exchanges may establish a minimum of bitcoin to be bought because one satoshi could be inefficient and unprofitable for the exchange. Coinbase, for example, has a minimum purchase order of $2 worth of bitcoin. Due to Bitcoin’s divisibility anyone can have access to Bitcoin, as compared to major equity brokers that do not allow fractional purchases.
Most exchanges accept a variety of payment options. You can fund your account by transferring Bitcoin or other pre-owned cryptocurrencies. Linking the exchange account to a bank account may be the best for large deposits and withdrawals – this way, the account is funded via a bank transfer. For first-timers, it might be best to buy crypto with a credit or debit card.
Funding the account via credit/debit card is faster than a bank transfer. This premium quality might have a higher cost. It’s always worth reconsidering the different payment methods offered by each exchange.
Figure 11 – Exchanges offer different payment methods such as bank transfers, crypto or fiat
Exchanges may offer different fees depending on the features and services provided. Some may charge deposit or withdrawal fees. Others charge for premium features. Similar to comparing fees when deciding on the payment method, comparing different exchanges and fees is crucial. It’s important to know which exchange to choose because if your balance isn’t that high to begin with, the fees might be bigger than your profits.
The most user-friendly exchanges offer a limited amount of crypto assets to select from – usually including the most popular cryptocurrencies. It’s a great place to start but there’s more under the surface.
For those who crave risk, the best exchange is the one with the largest portfolio of cryptocurrencies and assets. Currently, more than 6,000 cryptocurrencies are circulating on the market. The more the merrier, however, fees may increase as more opportunities are offered by the exchange.
Figure 12 – All current exchanges and digital wallets to choose from
There is no standard Bitcoin price on the market. Depending on the exchange in use, Bitcoin may be cheaper or more expensive (based on the exchange’s business model). Comparing the options’ price to the “average” Bitcoin price is the best way to ensure one gets a fair rate.
Millions of dollars have been lost due to exchange hacks. Binance, one of the biggest exchanges in the market, lost 40 million dollars because of a hack in 2019. If used properly, blockchain technology is immune to hacks or manipulation, but exchanges are not because they’re centralized. An exchange is a platform that runs on the top layer of blockchain technology. If the platform is hacked, it doesn’t necessarily mean that Bitcoin was hacked. It means that a large depositary custodian, or the exchange, has lost a lot of money that belonged to its users.
When choosing between exchanges, it’s fundamental to look for related news. Has the exchange been hacked? If yes, were crypto investors reimbursed? Were security measures increased to prevent future hacks? The popularity of the exchange is a great way to determine if it’s safe. The more active traders the exchange has, the more secure it is. Be wary of fake or fraudulent exchanges which want to steal your cryptocurrencies. They won’t hesitate to take crypto scams. For example, CoinFlux, a Romanian exchange, admitted to participating in laundering 1.8 million dollars online.
Management Team and Angel Investors
Getting an idea of the team running the exchange is the best way to get a hint of where the project is going. If the team behind the exchange is experienced and they have received funding to create and secure the exchange, it’s a great sign of future progress. Most of the time, management will follow the desires of their angel investors. Successful investors are always looking to mitigate risk. It’s a good sign that the exchange is compliant with new guidelines and regulations.
Most exchanges are not limited geographically. They are intended for users all around the world. One can be geographically limited if Bitcoin is not pre-owned. Creating the account in the exchange is not the problem, funding the account is, because specific credentials are required (KYC). For instance, the exchange may not accept a credit card because it doesn’t support payments from a specific country.
A study investigated the 100 most popular crypto exchanges and found out how their traffic is distributed by countries.
Figure 13- Top crypto exchanges
If an exchange offers popular cryptocurrencies, in a secure and relatively cheap market, but is incapable of receiving funds by cash, bank transfer, or credit/debit card form; it’s best to transfer some Bitcoin from pre-existing wallets and avoid the geographical speed bump. It’s always a good idea to store crypto assets in different digital wallets to diversify and reduce risk.
The Best Exchange
The best exchange may vary between users. The best fit depends on individual objectives, risk tolerance, and feature preferences. Be sure to try out the exchange before funding your account. User-friendliness, diverse payment methods, low fees, fair exchange rates, and a prestigious reputation are a must when choosing the right exchange.
Managing cryptocurrency risk
Blockchain and cryptocurrencies are young when compared to other products on the market. Vitalik Buterin, the genius behind Ethereum, claims that his creation and blockchain itself are undergoing their development phase – a period marked by minor flaws and bugs that need fixing before the maximum potential can be reached. Time and experience are needed to perfect blockchain technology and the industry it created.
Figure 14 – Stages of industry maturity over time: Introduction, Growth, Maturity and Decline
Cryptocurrencies are notorious for their high volatility, meaning that the value of crypto assets can change drastically in short periods of time. Drastic changes in price make it hard to value everyday items in something like Bitcoin or Ethereum. Imagine wanting to buy a car with Bitcoin. In the morning, 1 Bitcoin was enough to buy it, in the afternoon with the same amount of Bitcoin, one could have bought two motorcycles.
Average Annualized Volatility
Figure 15 – Volatility on different commodity index markets
The cause of Bitcoin’s unstable price is speculation. Speculation is not a thing of this century. Its roots go back to the Roman Republic, where merchants would buy and sell goods in hope that the price would rise or drop in the future. The stock market went through periods of uncertainty and instability at its premature phase – led by speculation once again. It’s a matter of time before Bitcoin and other crypto-assets reach the maturity phase in which speculation becomes background noise.
Volatility isn’t all bad news for crypto investors. It’s the main catalyst that sends Bitcoin higher and higher, especially when FOMO, or fear of missing out, kicks in (when Bitcoin is in a bull market).
Cryptocurrencies, in their current stage, are moved by theoretical beliefs, because there isn’t a physical object backing the price. Thus, the price is based on faith in the technology. If crypto enthusiasts suddenly start to doubt the potential of a project, the price will plummet. In a way, the system is designed to follow the laws of natural selection: only the fittest crypto and trader survive.
Figure 16 – Graph of a survey in which people were asked which institution they found more trustworthy
Lost keys, time and irreversible transactions
Private keys are the codes required to open the safe storing Bitcoin and other crypto. Without the private key the ” linked” crypto is lost forever. Losing access to Bitcoin stored in a wallet because of misplaced keys is a common phenomenon. It’s estimated that approximately 20% of the circulating Bitcoin is unaccessible because users have lost their private keys.
Sending and receiving Bitcoin can be a hassle. Not only are private keys long alphanumeric codes, but the process leading to the disposition of Bitcoin is confusing and sometimes time consuming. Yes, crypto is meant to be transferred in short time periods, but it all depends on the protocol backing the cryptocurrency in question. Bitcoin is considered a bit too slow for transactions (between 10 – 15 minutes), but other blockchains solved this problem.
Figure 17 – Average transaction times on popular cryptocurrencies
However, slower transactions are not a flaw of the system per se. As popularity increases , the network may become congested as more miners, and more computational power is required to confirm transactions. Even though coins are not lost, they patiently await in line to be confirmed, and put into a block.
Once the transaction is confirmed it becomes irrevocable, meaning that, if a mistake is made when transacting, it’s impossible to “undo” the transaction. For example, if Bitcoin is sent to an erroneous address, the lucky holder of the recipient wallet can keep the Bitcoin. The only way to recover the funds is by an act of goodwill.
Hacks and scams
2019 was a big year for hackers but it was only the beginning. Billions of dollars were stolen by hacks and fraudulent scams. Bear in mind that scams and hacks do not occur on the blockchain itself, since manipulating block information is merely impossible because the pre-existing chain would be rendered invalid.
Hacks occur on the top layer of blockchain. Hackers target applications or softwares that run on the blockchain, like exchanges. For example, just because an app that is offered in the app store gets hacked, it doesn’t mean that the app store itself was hacked. The same logic applies to Bitcoin – hackers target exchanges that have custody of a lot of capital, since hacking the blockchain is borderline impossible. Therefore, it’s highly recommended to store crypto in cold wallets (wallets that are not connected to the internet).
Figure 18 – Layers in a blockchain ecosystem (simplified)
Fraudulent scams, on the other hand, target naive crypto holders. The most recent Twitter attempt asked users to send Bitcoin to a specific wallet to receive double of what was sent. Other types of scams involve ICOs. Initial Coin Offerings are similar to Initial Public Offerings (IPO) in the way that developers seek funding by offering, for the first time, the opportunity to buy the token (crypto asset) at an early stage before price surges. A research study revealed that 80% of the ICOs conducted in 2017 were fraudulent. In the past few years, things got a lot better as the crypto community became wiser and learned to do thorough research before buying a new cryptocurrency.
Hard and soft forks
One of the best attributes of blockchain is its open source characteristics, meaning that anyone can interact with the code behind blockchain. It can be accessed, modified or cloned. Some may argue that this feature can enable manipulation that can lead to misappropriation of Bitcoin. A task that is deemed impossible, because the whole community needs to agree on the update consisting of the manipulation.
When a blockchain is updated, it is called a fork. After a fork, the blockchain’s way of validating transactions changes. Now, for the blockchain to be forked, or updated, consensus is required by nodes. If consensus is not reached, the blockchain is split into two different protocols with the same backstory.
Blockchain technology is a chain of blocks that store information. When a hard fork occurs the old blocks are not able to interact with the new modified blocks. This leads to a new blockchain, dividing the old and the new. The good news is that coins held before the fork are incorporated into both blockchains.
Ethereum underwent a hard fork after its Decentralised Autonomous Organization (DAO) was hacked. Investors lost around 3.6 million Ether ( Ethereum’s native cryptocurrency) and it was decided that a hard fork was to be done to give investors access to the capital lost because of the hack. The hard fork resulted in two separate systems: Ethereum (ETH) and Ethereum Classic (ETC).
Figure 19 – The DAO hack caused the ETH blockchain to fork into Ethereum (ETH) & Ethereum Classic (ETC)
A soft fork is different from a hard fork because the new “rule” is not incompatible with the older rules. Soft forks are common for decreasing the size of blocks. For example, Bitcoin’s protocol establishes a limit on how big a block can be, but the lowest size of a block is up to the community. Let’s say a soft fork is implemented to decrease the size of blocks. The new rule would reject big blocks by filtering out some information. The new smaller blocks do not clash with older big blocks.
Forks can be a risk because a change in the protocol affects the way users interact with one another, so it can have a direct impact on the value of the crypto in question. Be sure to look for new or past updates and the reason behind each fork.
Liked our crypto 101 guide and want to read more? Visit our Blog for much more exciting content.