In the past several years, cryptocurrencies have become more mainstream and increasing numbers of people have begun to consider them a valuable part of a diversified portfolio. Whether you are an entrepreneur seeking to get in on the action or simply interested in learning more, here’s a brief overview of some of the fundamentals.
Goals of Cryptocurrencies
The first cryptocurrency to achieve mainstream notoriety was Bitcoin, after its mysterious creator(s), using the pseudonym Satoshi Nakamoto, posted the Bitcoin Whitepaper online. This occurred in November of 2008, in the middle of the financial crisis when trust in government was at historic lows.
The stated goal was to create “an electronic payment system based on cryptographic proof instead of trust, [thereby] allowing any two willing parties to transact directly with each other without the need for a trusted third party.” While this goal may initially seem inconsequential (other than to computer nerds), upon a better understanding of what Nakamoto was trying to achieve, it becomes clear that, if successful, bitcoin would likely revolutionize our relationship with currency.
Bitcoin has the potential to drastically change how we make online payments, government control over currency, legal constraints regarding certain purchases, economic sanctions against hostile states and organizations and the banking industry in general. Clearly, these changes would not only revolutionize the lives of the computer nerds, but also have the potential to revolutionize the lives of everyday people. By removing third party control over transactions, Bitcoin was the first viable and widely acknowledged cryptocurrency to present a method for eliminating the necessity of central banks to print money and third-party intermediaries from serving as middlemen in transactions.
This would create a currency with never-before-seen anonymity, one also unencumbered by government fiscal and monetary policies. Bitcoin was “free to float” in price so that its price was determined by the market as opposed to policy considerations and “expert” opinions. The implications of a successful bitcoin or similar cryptocurrency, free to operate as was initially intended, would be astronomical.
Top 3 Cryptocurrencies Other than Bitcoin
Currently Ripple, Litecoin and Ethereum are three of the most popular cryptocurrencies that, along with Bitcoin, have become the most serious contenders for a viable alternative to the greenback (dollar bill) and other government-backed currencies.
Ethereum has expanded on Bitcoin’s elimination of third-party intermediaries to also allow users to create “smart contracts” that are maintained on a decentralized network and automatically come into effect upon the occurrence of a preset condition.
For example, if a salesperson and his employer agree that if the salesman improves his sales by 10% over the previous year he will get a 5% raise, they could construct a contract using Ethereum that would automatically send the extra 5% to the salesperson at the exact second his sales account registered the 10% increase.
Ethereum has a much faster transaction time and a significantly lower transaction fee than Bitcoin. However, critics express concern about inflationary repercussions due to the fact that there is no limit of the number of Ethereum coins (known as Ether) that can be put into the marketplace. Bitcoin has a cap at 21,000,000 coins that will ever be put into the marketplace.
Litecoin is capped to only ever allow 84,000,000 coins into the marketplace. This means that for as long as Litecoin exists, there will only ever be 84,000,000 Litecoins. The goal behind this limit is to prevent a situation in which the coins are continually mined and their value is thus diminished due to an ever-increasing supply.
The number 84,000,000 was originally selected because Bitcoin was limited to 21,000,000 and Litecoin was intended to be four times as fast as Bitcoin. However, like Bitcoin, Litecoin is also infinitely divisible. That means that it can theoretically be divided into as many smaller fractions as are necessary. Whereas a dollar can only be divided into 100 pennies as the smallest denomination, in theory Bitcoin and Litecoin could be divided into even smaller sizes so that instead of being limited to one one hundredth of a Bitcoin, you could continue to divide it into one one thousandth, one ten thousandth and so on. Essentially, Litecoin can be seen as a revised version of Bitcoin that has faster transaction times and lower transaction costs.
Ripple is the odd coin out in this comparison. Unlike the other coins mentioned here, Ripple does not use a public blockchain technology to facilitate transactions. Instead, it utilizes its own, centralized, internal crypto-processing method.
Ripple also allows users to hold, send and receive other currencies through its internal blockchain network, and even allows traditional financial institutions, such as banks, to utilize its payment system.
Ripple transactions take place much faster than those of Bitcoin. Ripple has a maximum 100 Billion coins (not all currently in circulation), whereas Bitcoin is limited to 21 million. Ripple, unlike many other cryptocurrencies, also complies with many prominent banking regulations and may therefore have an edge in achieving an accepted mainstream status.
Where to Securely Store your Cryptocurrency
One of the most important decisions all holders of cryptocurrencies should carefully consider is where to holdtheir cryptocurrencies. One of the easiest methods for storing your cryptocurrency is to simply keep it in one of many “wallets.”
Cryptocurrency wallets are online ledgers that are both protected by the wallet’s security system and through the use of your own private password. You can hold all of your cryptocurrency on various wallets. However, if the wallet is hacked or someone discovers your password, you could lose all of your cryptocurrency and would have a very slim chance of recovering it. Likewise, if you keep your cryptocurrency in one of these wallets, you could lose access to it if the server simply went down.
While wallets are a very common and convenient means for storing cryptocurrency, they are not the most secure. “Mobile” wallets are also an option. A mobile wallet is a wallet that you can download onto your phone. While more secure than wallets controlled by third party entities online, mobile wallets do pose risks associated with losing your phone. Mobile wallets allow you to check your cryptocurrency anytime you are with your phone, but also require that you make sure that your phone is secure and that you do not ever lose it.
Another option is to download an “offline wallet” onto your computer. This allows you to keep your cryptocurrency very secure since it is not stored with a third party, you are unlikely to lose your computer and because you can also still protect it with a password.
Avery secure option for storing your cryptocurrency is to maintain it on a “hardware wallet.” A hardware wallet is a wallet that is downloaded to a usb drive, or other removable device, that you can store in a secure location and then plug into your computer when you need to access your cryptocurrency. This allows you to keep the wallet in a safe or even a bank’s security box if you prefer, and then simply plug it in to your computer when you need access to your cryptocurrency.
Please note – the lawyers at Fourscore Business Law are experienced in business matters of many kinds, which give us the opportunity to be involved in tax discussions on a regular basis. However, we are not CPAs or “tax” lawyers. We have many great contacts and refer our clients to them when needed. Please do not take the summary set forth in this article as tax or business planning advice!
Based in the Research Triangle region of North Carolina, Fourscore Business Law serves entrepreneurs and businesses in Raleigh, Durham, Chapel Hill, Wilmington, Charlotte and throughout the Southeast. We also represent venture capital funds and other investors who invest in companies located in New York, Silicon Valley and everywhere between.
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