Decrypting Cryptocurrency

Ask 10 different people what they think about cryptocurrencies, and you'll get 10 different answers.

Known for being highly secure, decentralized virtual currencies have experienced wild fluctuations in value as the bulls and the bears duke it out in the virtual marketplace. In the first half of 2018 alone, the value of a single Bitcoin - one of the most popular and well-known cryptocurrencies - touched as low as $6,070 and as high as $17,094.

Price points aside, the very idea of cryptocurrencies' role in the global marketplace is something of a philosophical debate. Is a loosely regulated global currency - one which cuts out the banks that traditionally play the role of middlemen - a clear and revolutionary next step for our increasingly globalized world? Or is it a risky new venture waiting to ensnare those who don't understand it?

Some experts are eager to sign on to the idea's potential. Microsoft mogul Bill Gates told Bloomberg that Bitcoin is "better than [traditional] currency," former Vice President Al Gore said at the 2013 Innovation Project conference that he was a "big fan of Bitcoin" and former Federal Reserve Chairman Ben Bernanke said in a 2013 letter to Congress that virtual currencies "may hold long term promise."

Then, of course, there are the detractors. Janet Yellen, also a former head of the Federal Reserve, warned at a 2017 conference that she thinks cryptocurrencies "will come to a bad ending." Billionaire investor Warren Buffett also predicted doom, telling Forbes: "I think it's going to implode."

Why is there such a sharp divide on the fate of Bitcoin in particular and cryptocurrencies in general? Perhaps comedian John Oliver stumbled onto the underlying truth when he described digital currencies as "everything you don't understand about money combined with everything you don't understand about computers" on his show, "Last Week Tonight." Just like any investment, investing in cryptocurrencies purely based on speculation can be dangerous. But investing based on educated decisions can help investors capture value.

The bottom line? Interested potential investors should educate themselves on what, exactly, their money is buying when it comes to cryptocurrencies.

The Origin Story

While cryptocurrencies have only recently begun to make their way into the mainstream, they've actually been around for almost a decade. Bitcoin has existed since 2009, and its origin story is shrouded in mystery. Even today, nobody knows who invented Bitcoin. The coin slowly rose to prominence after an anonymous drafter, going by the pen name Satoshi Nakamoto, released a now famous white paper detailing the logic behind Bitcoin and blockchain, the technology that powers it.

It's no coincidence that the mysterious Nakamoto's idea found strong footing. Around that time, the backdrop of the financial world was one of intense distrust toward major financial institutions. The markets were in the midst of the Great Recession, with prominent individuals pointing fingers at "too big to fail" banks. Investors around the world worried that central bank interventions could devalue traditional currencies worldwide.

Under these circumstances, traders were ready for something different. A peer-to-peer currency free of third party intermediaries and outside regulation was intriguing to those looking for an alternative investment. Thus, Bitcoin was born.

The basis for Bitcoin was the fact that, even without a third party, the currency is extremely secure. While a traditional bank holds data in a central repository, blockchain technology allows cryptocurrency data to be decentralized. Because the data exists across many different computers, it's nearly impossible to hack.

At first, cryptocurrency didn't generate much interest outside of a niche online community interested in cryptography and computing. Among those in the know, Bitcoin was playfully referred to as "nerd money."

Call it a revenge of the nerds, then, that someone who invested just $100 in Bitcoin in 2010 - when one Bitcoin was worth 6 cents - would net more than $28 million if they sold their investment at this year's peak.

The "Initial Coin Offering" Explosion

As with any other success story, the incredible rise of cryptocurrencies like Bitcoin led to a scrambling of copycats hoping to profit from the craze. Using the same blockchain technology as Bitcoin, companies began to put out their own "Initial Coin Offerings," or ICOs, where investors could get in on the ground floor.

Some ICOs truly offer an innovative or distinguishing twist on cryptocurrencies. The highly popular coin Ethereum, released in 2014, is one of them. Ethereum is more than just an alternative to currency. By building in a programming language that allows users to create "smart contracts," users can transfer money according to predetermined stipulations. Today, Ethereum is the second most popular cryptocurrency by market capitalization.

Other coins, however, aren't much more than nearly identical offerings touted by often kitschy marketing campaigns. As long as people kept buying, companies kept releasing all types of coins - both those trying to bring something new to the market as well as copycat coins with catchy names. The long list of past and present cryptocurrencies includes memorable offerings like JesusCoin, Coinye and even PonziCoin.

Either way, as news about people making millions from Bitcoin and cryptocurrencies traveled, more and more people wanted to jump on the bandwagon. Entrepreneurs and profiteers alike were ready to oblige them, and favorable interpretations of the Securities and Exchange Commission's (SEC) stance on the need to register ICOs as securities made the process of setting up a new coin even easier.

"Until the SEC said they believe that ICOs are required to be registered as security offerings, a lot of companies were really hoping that tokens and coins were not really securities," says Rebecca DiStefano, a shareholder at Greenberg Traurig in Boca Raton and a member of the firm's Blockchain Task Force.

Since those companies in question weren't considering them securities, they also refrained from completing registration requirements and other relevant requirements and limitations.

Those liberal interpretations of laws empowered an explosion of ICOs. In 2017 alone, estimates of total funds raised from ICOs vary from anywhere between $4 billion to $7 billion. There are more than 1,000 different cryptocurrencies. Compare that to only 180 real-world global currencies recognized by the countries that belong to the United Nations.

Regulators Step In

As cryptocurrencies rise in prominence, the Wild West days of ICOs appear to be fading away.

"A lot of companies were flying beneath the radar. They were not registering," DiStefano says.

Now, things are different, she says: "The SEC has been very, very clear now that an investment in an ICO should be viewed the same as an investment in corporate stock or bonds, just like any other securities investment, and the company should either register the investment with the SEC or explain why it's not required to register or why it's exempt."

In some cases, the SEC has issued subpoenas to companies that it suspects conducted ICOs without registering when they should have. Several companies have responded by making recessional offers, in which they offer to send money back to investors in light of the subpoena process.

On a state level, Florida officials in particular have also expressed interest in instituting checks on the growing industry. On June 26, Florida's Chief Financial Officer Jimmy Patronis released a statement declaring his intent to increase oversight of cryptocurrencies by appointing a statewide cryptocurrency chief.

"My goal is to keep pace with demand and not deter innovation while monitoring for fraudulent behavior and scams," Patronis said in the statement.

That attitude of balancing innovation with regulation could be key to preventing the ICO explosion from giving all cryptocurrencies a bad name.

Christian Martin is the CEO of TeraExchange in New Jersey, a company launching 11 cryptocurrency indices approved by the Commodity Futures Trading Commission (CFTC). He agrees that there are risks involved with such a new process but believes that recent steps will help mitigate those risks going forward.

"Regulators and market participants are already adopting new rules of the road to protect the process and participants moving forward, and that is certainly welcome," Martin says.

Long-Term Direction

While cryptocurrencies still raise their fair share of concerns, Martin's optimism about future potential is common. At the same time as Florida intends to increase oversight, for example, state government entities are increasingly accepting Bitcoin as a form of payment. Most recently, in Central Florida, the Seminole County tax collector said that residents may pay their property taxes in Bitcoin.

The list of places where buyers can pay in Bitcoin is longer than it was just a year ago and includes everything from preschools to pizza shops.

Yet some companies that previously accepted Bitcoin are starting to backtrack. Popular travel website Expedia accepted Bitcoin for four years until June, when it quietly pulled the option after the currency experienced a period of particularly large fluctuations in value.

While it's impossible to tell when and whether the currency will become mainstream, most experts agree that the industry will look much different 10 years from now than it does today.

Perhaps the best analogy for the cryptocurrency market lies with the unpredictable results of the dot-com era, Martin suggests. The period's booms and busts brought great failures for some and great successes for others. While the dot-com bubble sometimes defines the period, the whole process ultimately completely reshaped the way the world does business. Now, with cryptocurrency at a crossroads, it could be poised to do the same. O