Intro To Digital Assets

PROLOGUE

An updated and summarized slide show version of the information contained in this article may be found on my company sub-domain here: (http://disruptive.resonova.com) A photo album version can also be viewed here: (DISRUPTIVE – Google Photos Album)

This report, which contains a collection of research and industry data, is intended to serve as a high level overview and introduction to the emerging realms of digital assets, bitcoin, and blockchain technology. Extensive references to supporting reliable external data have been included in the form of direct “Source” references and as live text hyperlinks.

Primary Topics:

  1. The Beginning of Digital Assets
  2. What is Bitcoin
  3. Important Observations
  4. Distinguished Attributes of Bitcoin
  5. Major Divisions of the Industry
  6. Greatest Industry Challenges

THE BEGINNING OF DIGITAL ASSETS

The birth of digital assets occurred on the 31st of October, 2008 (a time period of great economic distress worldwide) when a pseudonymous creator using the name Satoshi Nakamoto published his Bitcoin Whitepaper and shared it on an obscure cryptography mailing list. This seemingly small event set into motion a worldwide financial revolution which spreads and grows exponentially stronger to this day.

Satoshi speaks about the need for bitcoin

All digital assets are defined and governed by a protocol which acts as a peer-to-peer distributed ledger system called the blockchain. Bitcoin is considered the father of the digital asset class because bitcoin was the world’s first functioning application of the blockchain protocol. Not long after the birth of bitcoin several other new digital assets began being introduced. Today there are over 3,600 various digital assets which are actively traded on live cryptocurrency exchange platforms around the world.

To understand the fundamental elements of the blockchain protocol and how it operates in conjunction with Bitcoin, observe the illustration below (provided by Goldman Sachs Global Investment Research):

Blockchain functions diagram
Source: Goldman Sachs Global Investment Research

WHAT IS BITCOIN?

The following information is from CoinDesk:

“Bitcoin is a form of digital currency, created and held electronically. No one controls it. Bitcoins aren’t printed, like dollars or euros – they’re produced by people, and increasingly businesses, running computers all around the world, using software that solves mathematical problems. It’s the first example of a growing category of money known as cryptocurrency.

Bitcoin can be used to buy things electronically. In that sense, it’s like conventional dollars, euros, or yen, which are also traded digitally. However, bitcoin’s most important characteristic, and the thing that makes it different to conventional money, is that it is decentralized. No single institution controls the bitcoin network. This puts some people at ease, because it means that a large bank can’t control their money.

This currency isn’t physically printed in the shadows by a central bank, unaccountable to the population, and making its own rules. Those banks can simply produce more money to cover the national debt, thus devaluing their currency. Instead, bitcoin is created digitally, by a community of people that anyone can join. Bitcoins are ‘mined’, using computing power in a distributed network. This network also processes transactions made with the virtual currency, effectively making bitcoin its own payment network.”


IMPORTANT OBSERVATIONS

As it pertains to investing and wealth generation in the cryptocurrency ecosystem, there are three important observations of bitcoin which must be considered.

Bitcoin VS Traditional Currencies

“Bitcoin, that nebulous digital currency that trades in cyberspace and is “mined” by code-cracking computers, emerged as a better bet this year than every major foreign-exchange trade, stock index and commodity contract. The electronic coin that trades and is regulated like oil and gold surged 79 percent since the start of 2016 to $778, its highest level since early 2014, data compiled by Bloomberg show. That’s four times the gains posted by Russia’s ruble and Brazil’s real, the world’s top two hard currencies.”

~ Bloomberg (December 16, 2016, 5:00 AM EST)

Bloomberg Data chart
Source: Bloomberg data

Growing Global User Base

In 2016, the daily number of unique bitcoin addresses used more than doubled from previous years which suggests a growing user base. A growing user base means an increased demand.

Number of Unique Bitcoin Addresses Used
Source: Blockchain.info

Historical Price Data and Overall Trend

Over the past six years, the effects of high demand, international capital controls (such as the shift toward a “cashless society”), and the increasing bitcoin scarcity (due to the rising amounts of bitcoin holdings worldwide and the reduction in mining rewards) have driven the price of one bitcoin up by over 827,000 %. Below is a chart showing some of the historical trading data of bitcoin:

Historical Bitcoin Prices - Then and Now
Source: The Wall Street Journal

Having explored a brief summary of the fundamental components of bitcoin and digital assets along with a few of their primary market trends, examine now the key facts behind bitcoin which cause it to be so desired by so many people around the world:


DISTINGUISHED ATTRIBUTES OF BITCOIN

Peer-To-Peer Decentralized Structure

The entire bitcoin network runs on a fully peer-to-peer distributed ledger system called a “blockchain”. The transactions which take place between the users are verified by “miners” who, by contributing their computing power, earn transaction fees and generate new bitcoins. The distributed nature of the blockchain ledger adds a level of resiliency and redundancy that is unmatched in the current payment processing space.

To put the value of this concept into perspective, consider the following facts: The Federal Reserve calculates all their payment processing at 100 Orchard Street, East Rutherford, New Jersey. They also have back-up systems that can be brought online within 60-90 minutes at the Federal Reserve Banks of Richmond and Dallas. If those three centers were compromised or destroyed then the entire monetary system of the United States would be completely nonfunctional. However, the Bitcoin network cannot be so easily compromised in this way as it has a current total of 5920 nodes (or “processing centers”) with more being added every day from various countries around the world. In order for the Bitcoin network to be taken out by a physical attack, all of the thousands of Bitcoin nodes scattered around the world would have to be destroyed.

In addition to the advantages of distributed redundancy, the Bitcoin system equally distributes authority to all users. The Bitcoin system is not owned, issued, or governed by any central authority such as a bank or a government or company. The entire system is governed by the protocol which clearly lays out the never-changing rules of the system. It will never favor the system over the users of the system because the users ARE the system. No human status or title will ever cause the system to treat one user more favorably than another.

CNBC talks about bitcoin
Source: CNBC News

In a centralized financial system corruption is, and always has been, a major flaw which consistently undermines the benefit of that financial system to the end users.

Privacy and the Protection of Authorization Credentials

No personal identity is required for a person to use, store, or transact with bitcoin. Upon bringing up the topic of bitcoin’s provision of a degree of privacy, many people initially begin thinking about the potential enabling of illegal purchasing, however there is a major benefit to the anonymity of bitcoin which is often overlooked: Consumer protection.

The increased level of consumer protection used by the bitcoin network would save billions of dollars if implemented in place of the American dollar. Most credit card and debit card users are unaware of the amount of information stored on the magnetic strip on their credit card. Every single time they swipe their card to make a purchase, they share every last bit of their private payment authorization information with the merchant and the 5-7 various intermediary entities which stand between their bank account and the bank account of the merchant. During CNP (“card not present”) transactions over the phone and the internet all information required to authorize the spending of funds is also relayed in a similar (and often less secure) manner.

Credit Card Network Transaction Flow
Credit Card Network Transaction Flow Source: WalletHub.com

Hackers have come to learn about this high level of sensitive information exchange and, for quite a while now, have been cracking payment databases of countless thousands of merchant websites. Once inside, cyber criminals make off with customer data belonging to thousands of unsuspecting victims. After acquiring all of the necessary data to initiate transactions from the accounts of all the hacked merchant’s previous customers, the hackers use the data to carry out CNP fraud (“Card not present”: Transactions over the internet or by phone). Even worse, statistics show a dramatic 113% increase in an even more dangerous type of fraud called “new account fraud” in which hackers will open entirely new accounts in the name of the victims and then leverage that person’s credit score to borrow as much money as possible before making off with all of the money from that new ghost account.

The recent implementation of EMV chips on credit cards has done little to reduce the level of fraud as this new shift only protects users from fraud during “card present” transactions using terminals equipped to handle an EMV transaction. All non-EMV terminal swipes and all online based purchasing remains just as vulnerable as before. See the conclusions of the report by Javelin below:

CNP fraud will more than double by 2018
Source: Javelin strategy and research

The gradual global shift to a “cashless society” will only further the increase of fraud in the traditional centralized monetary system. The final conclusion is sobering: By simply using a debit or credit card, users put the funds of their financial accounts into the hands of every single merchant they make a purchase from which, as we have seen, presents a critical vulnerability in the traditional centralized digital payment system.

The following graph from the Insurance Information Institute shows an overview of how large of a scale this kind of theft has become:

data breaches historical data
Source: Insurance Information Institute

A simplified breakdown of the total amount of money lost due to fraud:

how serious is the identity fraud issue
Source: Javelin strategy and research

Rampant financial fraud is enabled by the required transmission of private authorization information. The bitcoin network requires no such transmissions to be made for users to spend and send funds and is therefore impervious to any such credential interceptions and fraud.

Value By Design and Monetary Supply

The blockchain protocol dictates that the supply of bitcoin is limited to 21,000,000 bitcoins. In addition to this limitation of the supply, the reward given to the miners who verify the transactions of the network is designed to decrease by one-half roughly every four years. As a result the supply of newly created coins will dwindle over time until all 21,000,000 have been mined. Once new bitcoins are no longer being awarded to miners, the miners will be compensated by transaction fees instead of newly created bitcoins.  While the supply grows less and (as shown above) the demand is growing larger, the value of bitcoin can only increase. Satoshi Nakamoto engineered this feature deliberately, and as we have seen, his purpose of continued valuation has worked flawlessly.

Below is a graph which shows the chronological progression of the  monetary base and inflation rate of bitcoin.

Bitcoin inflation vs time graph
Source: Official Bitcoin Talk Forum

MAJOR DIVISIONS OF THE INDUSTRY

It is important to note that often, many of the ventures in these sectors have a significant level of overlap into other sections. The sections represented below are not all inclusive of the industry, but rather they serve as a general brief overview of the main business types often found in the cryptocurrency financial technology space.

  • Peer-to-Peer Markets
  • Exchanges
  • Brokerages
  • Soft Wallets
  • Hard Wallets
  • Bitcoin ATM’s (or “BTM’s”)
  • Payroll
  • Money Services
  • Investments
  • Compliance
  • Insurance
  • Remittance

Additional resources related to the sectors of the cryptocurrency space can be found below:

http://www.ofnumbers.com/wp-content/uploads/2015/04/bitcoinland-april-2015.png

http://mergertech.com/wp-content/uploads/2014/07/The-Cryptocurrency-Ecosystem.pdf

https://www.mindmeister.com/694609910/bitcoin-blockchain

The Cryptocurrency Ecosystem
The Cryptocurrency Ecosystem – by MergerTech

This graphic (provided by MergerTech) breaks the corporate/website zones of the cryptocurrency ecosystem down into the following general categories:

  • Mining Pools
  • Cryptocurrencies
  • Charts/Information
  • Hardware
  • Ancillary
  • Peer-to-Peer (Spending)
  • Payment Processing (Spending)
  • Merchants (Spending)
  • Mobile Applications (Saving) – [Wallets]
  • Web/Local Client (Saving) – [Wallets]
  • Real Time Trading (Trading)
  • Fixed-Rate (Trading)

GREATEST INDUSTRY CHALLENGES

Compliance and Regulation

Maintaining compliance in all areas of business at all times and in all jurisdictions. Regulations concerning bitcoin, cryptocurrencies, and blockchain-based digital assets varies widely from state to state (in the U.S.) and from country to country (internationally). The core basics of regulatory matters are fairly straight-forward in most cases when new ventures are still in their initial phases. After the ventures begin to grow in size and international reach, it quickly becomes necessary to employ the guidance of an attorney or a team of attorneys.

Fraud and ‘Know Your Customer’

Due to the nature of of digital assets, (namely, the inability of users to initiate payment reversals or “chargebacks”) the number of cyber criminals actively attempting to exploit businesses dealing with digital assets is staggering in number. Because of this high level of fraud, it is imperative that all digital asset businesses institute strong KYC procedures when any trust is placed in an external entity attempting to transact business. (“KYC” is a banking term which means, “Know Your Customer” which is used to help prevent money laundering and fraud)

Learn more about KYC Compliance and regulation on Investopedia.

Monetary Gain Despite Volatility

Insuring stable returns despite cryptocurrency volatility. The U.S. dollar value of digital assets is known to fluctuate widely on a regular basis. While this volatility is the very cornerstone of profit generation for traders (who buy assets when they are falling in value so that they can sell them again when the assets rebound upward to a higher level and thereby make a profit), but this very same volatility can cause substantial difficulty in accounting efforts. Additionally, users of the digital assets could theoretically suddenly suffer large losses in portfolio value in a matter of minutes.

Several methods exist which can reduce a user’s exposure to the risks of cryptocurrency and digital asset volatility. Often these strategies involve using special digital wallets which allow the storage of both bitcoin and traditional U.S. dollars (and/or other government currencies and/or other currencies or assets) in such a way that the user of the wallet may decide what currency their assets are to be stored in.

Insured or Guaranteed Investment Options

Provision of investments that are covered by a type of insurance program so that the average person can safely engage in investment activities without being potentially taken advantage of or suffering losses from any number of cyber security attacks against the platform providing such investing opportunities.

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