An analysis of cryptocurrency and their functioning

Neha Soni│ Research Scholar │Neha98soni@gmail.com

Meaning of cryptocurrency-

Cryptocurrency is a digital currency which acquires cryptography to secure the transactions. It is

designed to make payments anonymously and in more secured way. Cryptography is the process
transforming information into inaccessible codes to avoid counterfeit. Most of the
cryptocurrencies are based upon block chain technology on decentralized networks. Features of
this technique include the zero involvement of any governmental authority. It allows the users to
secure their affairs against government interference. This way the users get to store their money
anonymously and without the need to go through the proceedings of the banking institutions.
This mode of virtual currency provides the users to make payments without any additional
charges of any value. The block chain technology keeps the records in form of a decentralized
ledger which is operated by the miners 1 and held by currency holders. It is derived from
encryption technique to secure the network. Block chains are essential component to ensure the
integrity and secrecy of transactional data. For the functioning of cryptocurrencies, virtual tokens
are used to secure the online payments, presented by ledger entries to the system. The word
‘Crypto’ refers to the encryption algorithm to safeguard the payments or other transactions such
as:

1. Public - Private key pairs

2. Elliptical curve encryption
3. Hashing functions

It is believed that block chain technique has potential to disrupt many industries such as finance,
law, banking or accounting. Crypto currencies are often used for illegal activities such as drugs
exchange or other illicit functions. It also faces criticism for vulnerabilities of the infrastructure
and volatility of exchange rates. Being the nature of anonymous, cryptocurrency becomes a host

1
Miners can be defined as accountants who record and arrange every transaction to the block chain. They are
record keepers who keep the system updated of new and existing transactions.

Electronic copy available at: https://ssrn.com/abstract=3683771

for money laundering, tax evasion and other illicit activities. The market price of
cryptocurrencies are based upon demand and supply, the rates of exchange fluctuate at high
range cause of the design of crypto currencies ensuring a high degree of scarcity.

According to some economists, cryptocurrencies are believed to be short lived speculating

bubble, climbing or collapsing at a very high rate in a very little span of time. They are also
considered to be not rooted in any material goods. Researches noticed the cost of producing a
cryptocurrency is directly related to its market price and requires a very high energy amount.
Cryptocurrencies are not immune to the threat of hacking as well. Several online transactions of
cryptocurrency have been a victim of hacking of millions of dollars from block chain wallets2.

Types of cryptocurrency-

Today there are thousands of cryptocurrencies with various functions and specifications. Some
of these currencies are clones to original. Some of the cryptocurrencies were originally
originated for government applications. But the right for general public to use was secured on the
bases of freedom of speech. Some of the very first and famous cryptocurrencies are:

• Bitcoin (BTC) - Bitcoin was the first and most popular cryptocurrency, created by
Satoshi Nakamoto in 2009. It is the most commonly trade cryptocurrency in the history
of cryptocurrencies. Bitcoin operates in a network that allows anyone in the world to sell
and buy bitcoin without help of any intermediate such as banks. It is holding market
capitalization of $213,333,771,167 USD as of August 2020. Bitcoin is now circulating
supply of 18,473,975 BTC. However, all of the transaction requires a centralized system
for its operations. It works by sharing the transactions to every user of bitcoin across the
globe anonymously. Users need to send the bitcoin to other user on their bitcoin address
excluding their personal information. It works by ensuring that the transactions are valid
and recorded in the ledger.

2
Block chain wallets are type of a digital wallet enabling users to store, manage and transfer the crypto currencies
to other users. Block chain wallets can maintain the balance of two crypto currencies: Bitcoin and Ether. Wallets
charge a fee based upon the transaction size.

Electronic copy available at: https://ssrn.com/abstract=3683771

 • Ethereum (ETH) - Ethereum was introduced in 2015. It is believed to be second most
3
valuable cryptocurrency in the world. Ether has a market capitalization of
$45,309,709,038 USD as of August 2020. It is now circulating supply of 112,378,611
ETH. Ethereum is supported by Ethereum foundation. In 2016, Ethereum broken into
two currencies after a major hack. It has even crashed as low as 10 cents that time. On
the Ethereum blockchain, smart contracts act like a self operating computer system,
automatically executing after meeting the required condition. Smart contract code run on
blockchain avoiding any possibility of interference or fraud. In 2017, Ethereum proved
itself to be as a launching pad for other cryptocurrencies.

• XRP – XRP currently runs on a digital payment platform called RippleNet. While
RippleNet is run by a company called Ripple. XRP is not based upon blockchain
technique but is an open source ledger. XRP being native to XRP ledger, any currency
could be used to transact on this platform. Market capitalization of XRP is
$12,412,174,698 USD as of August 2020. It is now circulating supplies of
44,994,863,318 XRP. It was created by Ripple to be fast, less costly alternative for
digital assets and monetary payment platforms. XRP can be purchased at any digital
currency platform. It can be stored at exchange or wallet. The RippleNet payment
platform is a real time gross settlement system which enables the monetary transactions
instantly and globally.

Timeline of Cryptocurrencies market growth-

Many attempts at making of digital currency were made prior to the cryptocurrencies. This idea
of digital currency is not new. The fear of double spending remained the concern of most. A
digital currency is not meant for copying and counterfeiting in an effective way.

3
Ether is the currency blockchain used in the Ethereum blockchain.

Electronic copy available at: https://ssrn.com/abstract=3683771

In 1998, Wei Dai a computer engineer introduced the concept similar to cryptocurrencies. He
published a paper mentioning the word ‘B-Money’. In his paper he discussed the idea of digital
currency. The paper circulated among the group of untraceable digital pseudonyms. However the
idea never took place into reality, but it was a part of inspiration behind cryptocurrencies.

The same year, Bit Gold was introduced and attempted by Nick Szabo 4. Bit Gold was focused
onto creating a decentralized digital currency. Szabo’s idea was to reduce the amount of trust
needed to create the transaction. Just like Wei Dai, it never practically took place into function.

On 31st October 2008, Satoshi Nakamoto published the white paper5 with the name Bitcoin: A
peer to peer electronic cash system. This paper introduced the functionality of bitcoin
blockchain system.

On 3 January 2009, Satoshi Nakamoto mined the first block of bitcoin network. It effectively
piloted the technology of blockchain. The very first mined block is also called as Genesis Block.
But the identity of Satoshi Nakamoto remains a mystery to this day.

On 2 May 2010, Laszlo Henyecz first recorded the purchase of two pizzas through Bitcoin. This
day is known as Bitcoin Pizza Day. May 2 is celebrated with a limited edition ledger Nano S6.

On March 2010, first cryptocurrency exchange came into existence with the name of
Bitcoinmarket.com. Later in July 2010, Mt.Gox 7 was launched.

By July 2011, Bitcoin reached the parity with The US dollar. A few rival cryptocurrencies
emerged that year. 10 digital assets were into function in the market by May 2013. Litecoin was
first introduced that year. XRP (Ripple) joined the market in August 2013.

4
Nick Szabo is a computer scientist, legal scholar and cryptographer. He is famously known for his research on
digital currencies and digital contracts. He introduced the concept of ‘Smart Contracts’. Smart contracts are major
feature of crypto currency and programming language E.
5
A white paper is an authoritative report which informs readers concisely about a complex issue and presenting a
philosophy into the matter.
6
The limited edition ledger nano S stands a value of $60M USD as of today.
7
Mt.Gox became the largest cryptocurrency exchange in 2013. Mt.Gox handled 70% of bitcoin transactions that
time.

Electronic copy available at: https://ssrn.com/abstract=3683771

In February 2014, Mt.Gox got hacked by Alexander Vinnik 8 . Mt.Gox had its 850,000 BTC
(valued at $460,000,000) stolen from it and declared to be bankrupt. It was the largest hack in the
bitcoin history.

From 2014, bitcoin prices were plunged by 50%. It could not recover the losses until late 2016.
Cryptocurrency exchange witnessed many hacks since then but none had the caliber similar to
Mt.Gox hack.

On 30 July 2015, Ethereum was first introduced. It currently holds the number two position in
crypto assets. It introduced the smart contracts to the cryptocurrencies.

On August 2015, First Initial coin offering (ICO) was launched. It was an augur crypto asset. It
used Ethereum network’s smart contract techniques, which are known as ERC-20 tokens.

From 2015 to present, there are more than 200,000 ERC-20 tokens capitalized in the market.

In January 2018, crypto assets price reached highest. The market manages around 2000 digital
currencies up to now. From then many new and popular crypto assets joined the cryptocurrencies
market such as: EOS (2017), Tron (2017), Cardano (2017). The list is expanding at a rapid rate.

Basic concepts of Cryptocurrency-

To understand the functioning of cryptocurrency, let us know a few basic terminologies related
to cryptocurrencies-

• Public ledgers- Public ledger stores all confirmed transactions from the introduction of
cryptocurrencies. Since the identities of users remain unknown or encrypted, the
legitimacy of records is ensured by cryptographic techniques. The accurate balances of
these digital wallets are ensured by these ledgers. The ownership of the coins which are
to be transacted can also be checked. This type of public ledger is called ‘transaction
block chain’.

8
Alexander Vinnik is a Russian computer expert. He worked at BTC-E from 2011 to 2017.

Electronic copy available at: https://ssrn.com/abstract=3683771

 • Transactions- Transaction is a transfer of funds between two digital wallets. Public
ledger accepts these transactions and awaits the confirmation. An encrypted electronic
signature is use to make the transactions. The electronic signature is an encrypted piece
of data which is called cryptographic signature. It provides a mathematical proof the
transaction which is processing from owner’s wallet. The process of confirmation takes
around 10 minutes while the miners do the mining process. The mining process confirms
the transaction and adds it to public ledger.

• Mining- In the mining process, transactions are confirmed and added to public ledger. In
this process, miners get to solve a very complicated computational problem, like a
mathematic puzzle. Mining being an open source, anyone can confirm the transaction.
First miner adds a block to the ledger to solve the puzzle. To make sure that no individual
adds or makes changes to a block, transactions, blocks and blockchain ledger works
together. Once, a block is added to the ledger, all transactions are stabilized. It adds a
small transaction fee to the miner’s wallet. Mining process gives a value to coins and is
called proof of work system.

Scenario of cryptocurrency in India-

From 2012, many cryptocurrency exchanges started their operations in India providing much
needed value to the market in India. Including popular exchanges like ZebPay 9 , Coinsecure,
Unocoin and Bitxoxo.

In 2013, Reserve Bank of India (RBI) issued a press release addressing the public against the use
of digital currency.

After demonetization in November 2016, the volume of adoption and transaction in

cryptocurrency picked up pace. Indian cryptocurrency exchanges started acquiring users at
much higher speed.

9
Zebpay is the first Indian bitcoin exchange, launched in 2015.

Electronic copy available at: https://ssrn.com/abstract=3683771

In February 2017, Reserve Bank of India issues another press release cause of growing
popularity and adoption of cryptocurrencies in India.

In October and November 2017, Siddharth Dalmia and Dwaipayan Bhowmick filed public
interest petition to the Supreme Court of India for restricting trade of cryptocurrency in India.

In November 2017, Inter ministerial committee was constituted by Government of India under
the chairmanship of Subhash chand garg 10 , Ajay prakash sahni 11 , Ajay tyagi 12 and B. P.
kanungo13.

In December 2017, RBI and Ministry of Finance issued a press release addressing the general
public about danger and risks of cryptocurrency, declaring cryptocurrencies as Ponzi schemes
and they are not currency or coins.

On 6 April 2018, RBI issues a circular preventing commercial banks, co-operative banks, small
finance banks, NBFCs to deal in digital currencies and directed them not to provide their services
to all entities which are dealing in digital currency.

On 15 may 2018, the exchanges who were member of Internet and mobile association of India
(IMAI) filed a writ petition to the Supreme Court with facing the existential threat.

In July 2019, the committee formed in November 2017 submitted its report recommending a ban
on private cryptocurrencies in India. The reason given by RBI was that the digital currency might
disrupt the existing financial institutions.

In January 2020, Final arguments of the case IMAI vs. RBI were heard by Supreme Court of
India. In March 2020, Supreme Court of India found the ban invalid and allowed the trade in
cryptocurrency. Cryptocurrency is now expecting a big boost in Indian market with the virtual
assets already popular in global market.

10
Secretary, Department of economic affairs (Ministry of Finance)
11
Secretary, Ministry of electronics and information technology
12
Chairman, Securities and exchange board of India
13
Deputy Governor, Reserve Bank of India

Electronic copy available at: https://ssrn.com/abstract=3683771