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How to Explain Cryptocurrency to Your Grandparents - Blockchain, Security and ICOs

Bitcoin began as a reaction to the 2008 financial crisis. As people grew suspicious of government authorities and banks, a decentralized virtual currency system came to life. Since its inception new cryptocurrencies such as Ether and Litecoin have appeared on the market.

Just like in the physical world, cryptocurrencies really only have value as long as people think they have a value but with one key difference. No central bank is backing this currency.

One key factor that determines cryptocurrency price is its utility. The more places the cryptocurrency is accepted as a form of payment the higher the utility. For bitcoin the utility is high and therefore the price is high. Supply and demand also affect price and this is determined by the scarcity of the cryptocurrency. To create a sense of scarcity that incentives people, there is only a limited number of coins that will ever be produced. In bitcoin’s case that number is 21 million coins. Anyone can download and use the bitcoin software, and you can buy coins for dollars on Coinbase.

In contrast to centralized financial institutions, peer-to-peer cryptocurrency exchanges do not use a trusted third party to process transactions. Rather, the exchange is operated and maintained solely by software. Instead of matching a buyer order with a seller order as a regular exchange would, the software connects the buyer to the seller, so they can conduct the deal without intermediaries. By cutting out the middleman, peer-to peer exchanges cut out fees. Coins can be exchanged on bitcoin exchanges and all the transactions are recorded through a system called blockchain.

Blockchain technology 101

Blockchain is a new form of information tracking. Blockchain serves as the record of all the cryptocurrency transactions. It is not kept by a central institution but by a bunch of people who have a shared record of their assets. In simple terms, it is a ledger that is shared but has a few characteristics that differentiate it from a regular shared Excel spreadsheet. First, records can only be added but none can be replaced.

Second, the records are distributed among any interested party that has access to those records.The parties in the transaction can remain anonymous while the transaction history is preserved for the public.The transaction is attached to all the other prior blocks.

Blockchain technology has begun to be commercially adopted outside the world of cryptocurrency. For example, the Nasdaq already uses blockchain technology to process and validate some financial transactions.[if !supportFootnotes][1][endif]

What makes cryptocurrency secure?

Rather than having financial institutions such as banks back the currency, cryptocurrency is backed by the power of the network.The more computers you have in the network, the more secure it is from attack. Each transaction adds a “block” to the chain of records. To make the blockchain almost invulnerable, each one of the thousands computers worldwide connected to the network holds a copy of the blockchain.

The transaction data stored across this vast networks of computers is constantly checked and verified to abide by the blockchain rules, so that any attempt at a transaction which does not follow them will be rejected. As a result, the database remains secure in cases where there is an attempt at fraud along the chain. For added security some peer-to-peer exchanges introduce obligatory deposits in which both parties deposit a certain amount of cryptocurrency before the trade. Once the trade is completed uncontested, deposits are returned back to users.

Mining - adding new blocks to the chain

People called block miners authenticate and legitimize the cryptocurrency transactions. The miners compete amongst themselves to be first to solve a complex mathematical problem whose solution is necessary to add a block for the new transaction on the shared ledger. The winner adds the block and also receives a prize in the form of coins. In the case of bitcoin, the monetary reward for mining is cut in half every four years.

Initial Coin Offerings or ICOs

According to the New York times, 2017, some some 270 crypto-cash startups have sought funds via ICOs in 2017. That is a 3,000 percent increase since last year.[if !supportFootnotes][2][endif]

Initial Coin Offerings (ICOs) have sprung up as a new way in which startups raise money through crowdfunding. In contrast to public offerings, coin offerings are designed in such a way that the startup does not usually give stock ownership to the investor. In doing so, the startup avoids having to comply with the SEC. Many invest in the coins to use the services on the platform where the coin is its currency. For example, BET is a new coin which is set to serve as chips in an online casino platform.[if !supportFootnotes][3][endif]

Another reason for the increased interest in ICOs is the liquidity of cryptocurrencies. Investors can see gains faster and can cash in on profits more easily. To do so, the investors convert the cryptocurrency profits into Bitcoin or Ether on any of the cryptocurrency exchanges, and then convert it once again to a fiat currency through an online service such as Coinsbank or Coinbase.[if !supportFootnotes][4][endif]

It’s hard to tell where cryptocurrency will be even one year from now. The process of blockchain technological adoption seems to be gradual and steady. In stark contrast, cryptocurrency is experiencing a great deal of volatility. The early 2000’s brought with them a wave of innovation, but also brought with them the Dot-com bubble. so when thinking of investing in cryptocurrencies, do your own due diligence. This is especially true as many of the players in the cryptocurrency space are too young to have experienced or learned from lessons of the past.

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[if !supportFootnotes][1][endif] Blockchain Forges Ahead/Johan Toll

[if !supportFootnotes][2][endif] S.E.C. Warns Celebrities Endorsing Virtual Money/The New York Times

[if !supportFootnotes][3][endif] An Explanation of Initial Coin Offerings//The New York Times

[if !supportFootnotes][4][endif] What Initial Coin Offerings Are, and Why VC Firms Care/ Harvard Business Review