In this module, we'll be talking about cryptocurrency and initial coin offerings, otherwise known as ICOs. The legal and regulatory environment surrounding cryptocurrencies and ICOs is complex, uncertain, and changing by the day. While I could not possibly summarize every law and regulation that applies to cryptocurrencies and ICOs in the module, I do hope to impart you an understanding of the key issues that any business operating in this space must consider. You need to understand and consult applicable rules and regulations could prove fatal to any cryptocurrency business. In this lecture, we'll develop a baseline understanding of distributed ledger technology. Because cryptocurrencies and ICOs run on some form of distributed ledger. From there, we'll recount some of the early problems associated with cryptocurrencies. Before we end by examining some of the factors that have led to a surge in demand for cryptocurrencies over the past several years. A distributed ledger is a database that is spread across several nodes or computing devices. Each node replicates and saves an identical copy of the ledger. Each participant node of the network updates itself independently, and the ledger is not maintained by any central authority. The most prominent form of distributed ledger technology is blockchain, which powers the well-known cryptocurrency, Bitcoin. But blockchain is also used to enable a number of public and private virtual currencies, as well as other applications. The bitcoin blockchain is an immutable record of every single transaction that ever occurred in a Bitcoin network. Often referred to as a public ledger, a blockchain is a log that contains metadata about when and how each transaction occurred. The ledger is publicly accessible and to prevent tempering with current and past transactions, the database is cryptographically secure. Encryption allows developers to trust the transaction history, and build applications from and around transaction information. Blockchain can be both public and private. So in a public blockchain, like the bitcoin blockchain, anyone has access to it. It's available universally, and you don't need permission to become a node and see all the transactions that occur on the bitcoin blockchain. It is also possible for a blockchain to be private, or what they refer to as permissioned, where access is controlled. And this is the type of blockchain that is being increasingly deployed in the financial services industry, as well as other sectors. Because certain business segments do not want everyone to be able to access the distributed database. Blockchain powers the bitcoin software, and the decentralized computing network of users running that software. The Bitcoin software and protocols were first described in a white paper released in 2008, by an author using the pen name Satoshi Nakamoto. And Bitcoin itself was released in a proof-of-concept software client in January 2009. The bitcoin community progressively built out a decentralized network of computers that exert a tremendous amount of computing power toward the singular purpose of validating and clearing transactions on the bitcoin network. The distributed and decentralized network allows each individual user to verify the validity, of individual transactions, and the systems as a whole. For the cryptographic protocols and the transaction history of the bitcoin network which is stored by each user on the blockchain. Information or transactions are added to the blockchain through the proof-of-work mining process. Users running a special mining variant of the bitcoin software expend a great amount of computing power in order to win the right to add another block to the blockchain, which the company buyer rewards in bitcoins. The concept of proof-of-work mining ensures and adjusted amount of work and computing power must be expended to solve a block. With a block reward of a certain amount of bitcoin providing economic incentive for honest mining. The expenditure of computing power, serves to secure the integrity of the blockchain. While the miners themselves verify through public/private key cryptography, the validity of each transaction they include in a block. When a transaction is included in a block, the transaction has been validated and cleared by the miner. Bitcoin is different from traditional fiat or government-sponsored currency in a variety of ways. The first is that it's decentralized, meaning, there is no central authority controlling the currency's issuance. The second difference is that accessing the bitcoin network is relatively easy. Anyone with the laptop or computer can become a node on a bitcoin network and begin sending transactions through it. Bitcoin is also pseudo-anonymous, mean that you personal information is not identified on the bitcoin network. Instead, users are only referred to by their public key or address, a long string of alphanumeric characters. Bitcoin is not fully anonymous because every transaction ever conducted by a single address is stored forever in the blockchain. If your address is ever linked to your identity, every transaction will be linked to you. Bitcoin is as unique because it is completely transparent. Every transaction in the history to the bitcoin network is available to all nodes on the network. And finally, unlike fiat currencies, bitcoin transactions are irreversible. Once a bitcoin is sent to another node on the network, there is no way for that transaction to be reversed. Unless a node who receive the original bitcoin is willing to send it back. But Bitcoin today is a widely known and utilized cryptocurrency, it did not get to this point without experiencing some significant growing pains. The first high profile case was an online black market known as Silk Road. Silk Road was a marketplace for selling illegal drugs and other illicit goods that operated on the dark web. And utilized bitcoin as its preferred method of payment because of the pseudo-anonymity it provides. On October 2013, the FBI shut the website down and arrested its founder for omnibus violations of federal drug and anti-money laundering laws. He was sentenced to a lengthy prison term in order to pay restitution of $183 million, representing all sales of illegal items on Silk Road. 2013 is also when the price of bitcoin began to increase. Climbing from $13 at the start of the year to nearly $1,000 at its peak towards the end of the year. At the time, online exchange Mt Gox handled 70% of the world's bitcoin trades. Beginning in April, Mt Gox started experiencing technical difficulties and had to suspend trading for a few days for what they called a market cool down. By November of 2013, Mt Gox customers were experiencing delays of weeks to months for withdrawing funds from their accounts and cashing out had become difficult to impossible. Finally, in February of 2014, Mt Gox halted all withdrawals. And less than two weeks later, it suspended trading, closed its website and exchange service, and filed for a form of bankruptcy protection under Japanese law to allow courts to seek a buyer. Mt Gox then announced that around 850,000 of their customers bitCoin, valued at roughly $480 million at the time, were missing and had likely been stolen. This checkered past makes bitcoin and other cryptocurrencies' subsequent price increases and mass adoption all the more remarkable. I should also note that the problems highlighted by Silk Road and Mt Gox have not gone away. Cryptocurrencies are still used to facilitate illegal transactions and ransomware hackers frequently demand payment in bitcoin. Cryptocurrency exchanges are also still vulnerable to hacks. In January 2018, Japanese exchange Coincheck surpassed Mt Gox as target of the largest cryptocurrency theft in history, when hackers stole over $530 million of the cryptocurrency nam from user account. Despite these obvious perils, bitcoin has experienced a meteoric rise over the past couple of years, as shown on this graph. In addition, the growth in bitcoin ushered in an exposure of new digital currencies. Currently, there are over 1500 unique cryptocurrencies. What is driving this apparently insatiable demand for cryptocurrency? The answer is not entirely clear. But there are several contributing factors that are worth mentioning. The first is the ease with which you can now acquire cryptocurrency. In the early days of bitcoin, buying and selling a cryptocurrency required a fairly high degree of technological specification. But now if you live in a major metropolitan area, chances are you can walk to a nearby bitcoin ATM, where all you have to do is download a free digital coin wallet. Insert the desired amount of cash, place your phone up to the scanner, and voilà, you own bitcoin. In addition, consumers have access to dozens of online exchanges and make buying and selling cryptocurrencies pretty easy. Increased technological familiarity along with network effects have also been factors fueling the demand for cryptocurrencies. There are now many online resources that are designed to teach people about cryptocurrencies, as well as popular bitcoin related documentaries on platforms like Netflix. As more and more consumers become aware of cryptocurrencies through these channels, as well as through an influx of new stories, network effects start to kick in. The network effect describes a phenomenon where by technology or innovation becomes more valuable simply because more people are using it. It is certainly the case that the more people are familiar with and willing to accept cryptocurrencies as payment, the more valuable cryptocurrency has become. Another factor that is driving market demand for the most popular cryptocurrencies like bitcoin and ether is the red hot initial coin offering market. Where a company issues digital coins or tokens, and provide access to a service often called a utility or app token. Or that representing an investment opportunity in the company like a traditional security. Purchasing these digital tokens requires the buyer to remit either bitcoin or ether, which therefore increases the demand for these cryptocurrencies. Another demand factor that has been suggested is a continuing post financial crisis distrust of the traditional banking sector in governmental institutions. Traditional currencies are typically issued and controlled by country central bank. And payments utilizing these currencies must go through bank intermediaries. The Cryptocurrencies are not controlled by one central authority. If you send from one user to another without having to go through any kind of intermediary. In addition, large cryptocurrencies set a cap on the total amount that can ever be circulated, thereby preventing their value from being inflated away. Along these lines, political instability in countries like, Venezuela, Zimbabwe, and Syria, have created demand for cryptocurrencies. These countries have seen bouts of hyperinflation, which has eroded the purchasing power of the official currency. Bitcoin has become an attractive option for consumers in these countries because it lies outside the government's control, and is considered to have a more stable value. Another reason for the run up in the price of cryptocurrencies particularly bitcoin is its ability to facilitate criminal activity and make transactions anonymously, away from the information or reach of the government and regulators. Many of these transactions are explicitly illegal, like money laundering, while others are controversial, like donating to WikiLeaks. In addition to fueling illicit activity, cryptocurrencies can also be involved in more traditional securities market fraud, like pump and dump and Ponzi schemes. While cryptocurrencies are clearly used for nefarious purposes, it's difficult to determine exactly how much this activity contributes to the price. Cryptocurrency, in particular bitcoin, does remain for the moment, the criminal currency of choice for hackers because of its anonymity and the ability to convert it into to cash or wash it in the dark net. The final and most important reason, in my opinion, for the extraordinary rise in cryptocurrencies is simply human psychology. Over the past several years, consumers have been fed a steady stream of news headlines about individuals striking it rich by investing in cryptocurrencies. As a case and point, consider the following headlines from The Telegraph in Forbes, respectively. Idaho teenager becomes millionaire by investing $1,000 gift in bitcoin and wins bet with his parents. And, meet the man travelling the world on $25 million of bitcoin profits. These stories entice more people to invest in cryptocurrencies, which push these prices even higher. Those that appears that many people invest in cryptocurrencies. Simply because they think they will be able to sell it for a higher price in the future. This observation has led many people to call the cryptocurrency market a massive bubble that will soon pop. In fact, the cryptocurrency market, particularly bitcoin, did cool off after reaching peak hysteria in December of 2017. On December 16th, 2017, the price of one bitcoin reached an all-time high of $19,343. As of mid-April 2018, the price was close to $8,000, and volatility in the bitcoin market had come down substantially from levels seen in 2017. Regardless of what happens to their price, cryptocurrencies are here to stay. In the next lecture, we'll explore how various regulatory agencies in the US have reacted to the sudden emergence of cryptocurrencies.
