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The Economics Behind Stablecoins

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A common argument for the value of bitcoin is the hyperinflation of fiat currencies in countries like Venezuela or Zimbabwe, but bitcoin’s high volatility isn’t necessary the answer.

In fact, the high volatility that comes with all the speculation in the area is what scares off a lot of users. These people see the value in the technological innovation, but have no interest in dealing with the massive ups and downs most cryptocurrencies have gone through. This is where the need for a more stable cryptocurrency has spawned from.

Low Volatility Solutions Are Required

Some countries, such as Canada, have been working on their own brand of digital currency, but are missing the fact that although “digital”, the currency doesn’t solve any of the same problems that bitcoin does. Instead, a solution is necessary that is decentralized and trustless, which is where stablecoins come in.

Stablecoins have a massive use case because there are many users who are looking for currencies that present all the benefits and utility of blockchain technology, but without the same market volatility.

Clearly, there is market demand for low volatility cryptocurrencies, and stablecoins are the class of cryptocurrencies attempting to address the problem.

The goal of these companies is to package all the benefits of bitcoin into a cryptocurrency, but avoid all the speculation nonsense that scares off potential users of the technology.

How a Stablecoin Works

A stablecoin essentially works by tying the value of the token to the value of a security. The simplest manifestation of this is having users buy a “digital” version of the USD that is decentralized.

Stablecoins can generally be sorted based on how they are collateralized. This means that the company backing the coins has to have some sort of assets on hand in order to support the value of the cryptocurrency.

There are three types of stablecoins, but the most popular type is fiat-collateralized. These companies hold deposits in fiat currency, and issue tokens at a 1 to 1 ratio. Other pegs are possible, but the simplicity of the USD as a peg is what makes these easy to facilitate.

Aside from those, you have crypto-collateralized coins that hold cryptocurrency in deposits. Because of the heightened risk in holding cryptocurrency, the value of the deposits must be larger than the value of the tokens to mitigate potential losses. Finally, you have non-collateralized stablecoins which work much like a decentralized version of a fiat currency in that they have limited volatility, but depend on the expectation of retaining value.

The Basics of the Stablecoin Market

Tether may be the most well-known example of a stablecoin, but this is mostly because of the controversy surrounding regulators subpoenaing them in regards to their USD reserves. Tether is meant to be “tethered” to the value of a single USD, and is an example of a fiat-collateralized token.

MakerDAO is another project that seems more viable due to its decentralized management and heightened transparency. It is collateralized with Ether and seen as a frontrunner in the industry.

Another popular project is TrueUSD, which is fully collateralized with fiat currency, and is much more transparent than Tether. The Tether controversy raises questions about whether you will need to speculate on the capitalization of a company, which is why transparency is such a key component.

Extrapolating into the Future

Right now, the stablecoin market is mostly focused on backing a few of the major fiat currencies (USD, EUR, etc.) or gold (the original store of value). As the model proves it has viability, it is likely that stablecoins will be devised for the backing of alternative assets.

In a world that is looking for tokenized assets that are provably solvent, stablecoins are the answer, and have the potential to lead us to the “next generation” of the Internet. With low volatility solutions as a viable unit of account, it will become possible to move stable assets like houses or loans to the blockchain. From there, the whole financial world may experience disruption.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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How ICOs Changed the Way Companies Are Built

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With cryptocurrencies now becoming a household name, investors are starting to look into plays they can make that are more off the beaten path. The market for initial coin offerings (ICO) offers just that, albeit with a dash of risk that traditional initial public offerings (IPOs) do not offer. 

Restrictions on Venture Capital

If you want to make money in Silicon Valley, you need two things: connections and capital. Connections are required, because a lot of projects end up oversubscribed anyways, and you need an advantage over many of the other investors. It also helps if you can provide aid to the company additional to just giving them your capital (e.g. advising on product, marketing, or hiring). The unspoken rule is that you do usually have to be located in Silicon Valley to do well as a startup investor.

Large amounts of capital are also required for regulatory and convenience reasons. Venture capital is considered to be very risky, and as such, it is generally restricted to be accessible only to accredited investors, who must have either an income greater than $200,000 per year or a net worth greater than $1,000,000.

Additionally, most companies didn’t have the bandwidth to deal with having hundreds or thousands of smaller investors, because of the meetings, due diligence, and paperwork required. It was much easier to take larger investments from a small group of people, and keep things simple.

Democratizing Venture Capital

For both these reasons, the number of people who have benefited from the gains in massive technology startups have been very few. Now, with ICOs the possibility arises that investors may join in on the gains, thus democratizing the gains and spreading them out throughout the country and world.

The ability to make asymmetric bets (wagers where there is a high possible upside, but limited downside) has been restricted for a long-time. Lottery tickets are the closest example of a purchase you can make that could result in a 10,000x return, but with the downside capped at the size of your investment.

In a world where income inequality and wealth distribution is a constant source of conflict, the spreading out of these returns could prove to be increasingly important for making sure it doesn’t get worse.

Structure of an ICO

As Hacked readers are no doubt aware, an ICO generally occurs when a cryptocurrency startup wants to raise money. They either have something they’ve already built, or they have a white paper that outlines their business plan and how much money is needed to create and scale the project.

The ICO is carried out by exchanging fiat currency or other cryptocurrency for the “token” in question. A token is considered equal to equity in the company in this analogy, although most firms contend that the tokens are not securities for regulatory reasons (see: Howie test).

ICOs are popular for both investors and traders, as there is an expectation in an increase of market price after the ICO, as well as high volatility (which traders love). Looking at a website like Coin Schedule, you can see the amount of hype that is floating around ICOs at the moment.

Recent Trends in Fundraising

As ICOs become more popular, many companies are going through similar experiences during the fundraising process. Some companies are asking for such high valuations right off the bat that there is little upside for the investors, and a greater chance they will lose money.

If excessive amounts of money are raised before a product has even been built, there is much greater risk in the project. Additionally, there are fewer investors who have made enough money on a project to justify staying invested during a bear market. Compare this to Bitcoin, where some have owned it since its price was in the single digit range, and you can see the difference.

Projects that are heavily inflated upon ICO’ing are losing out on the longer-term opportunity, unfortunately. Some people forget that the most well-known cryptocurrency of all began using an organic mining process rather than an ICO. Although there is almost no money inflow when this is done, it creates a rabid community of supporters who believe in the product, rather than short-term speculators. This solution would not work for all ICOs, but for some, it might be a viable solution.

More than Just an ICO

The ICO is the most well-known part of the process, but often these projects will require money to get them to that point. This is where the Pre-ICO and Pre Sale come from. The Pre-ICO is similar to the “friends and family” money that any business starts off with. It is what is required to get the project off the ground. Then you have the Pre Sale, which is where larger investors who are going to help build the companies product and profile get to buy tokens at a lower price than the ICO price in exchange from their help.

Finally, and it is very necessary to make this clear, all of these projects carry a ton of inherent risk, and a significant amount of research should be undertaken before any investment is made. Where many of the past IPOs had undergone a massive amount of due diligence and had backers who understood the technology, we are seeing many investors hop on the investing train without fully understanding how everything works.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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Understanding the Risks of Mining Bitcoin

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At this point of your journey into the cryptocurrency world, you probably have a strong grasp of the fundamental mechanics of the coin, and maybe understand the basics of “proof-of-work” systems.

Assuming you already have this understanding, you know that the robustness of the network is what secures the entire bitcoin protocol. As such, there is an opportunity for money to be made if you are able to add value to the network, you will be compensated for your time. This is essentially what mining bitcoin is, and it is very possible for you to make a good return on your capital if you go about it intelligently.

Cloud Mining for Lower Risk

Mining has advanced quite a bit since bitcoin’s creation in 2009. It used to be that you could use any PC to mine cryptocurrency. The algorithm is designed to adapt the level of difficulty and work required to be done so that the average block time stays at approximately 10 minutes.

The most important decision you’ll make in terms of bitcoin mining is whether to mine using cloud services, or if you are going to buy your own rig instead. Each method comes with different levels of risk due to the varying risk structures.

Cloud mining has you rent mining hardware from a company or just get a portion of their hashing power. There are many different operators in the field, and it is important you perform some heavy research to figure out what the best investment of your capital is. Cryptocompare has a list of all the different companies you can use and how they have been rated and reviewed recently.

Personal Mining for Higher Potential

When you make the decision to go the personal mining route, you are taking a much bigger risk in terms of upfront investment. There is a significant cost involved, and you are buying some very specialized hardware. The top consideration should be whether you have access to cheap electricity, because without that, you are putting yourself in a terrible position.

Once you choose your hardware, it is all a matter of selecting the type of hardware you are going to use (there are many review sites, and this is outside the scope of this article) and then choosing a mining pool and software provider. Research is your friend, so you would do well to not neglect it.

Determining the Logistics

No matter what route you decide to go, you are going to have to make some decisions that will affect your overall workflow significantly. First, you must select a mining pool, which means you need to adjust for the amount of risk you are willing to take. Mining can be very profitable on your own, or you could go months without making any money at all. Going with a larger group will increase your likelihood of making money, but cap your earnings at a certain point.

There are pools that are set up to allow switching from mining one currency to another, depending on which is the most profitable, but we are going to stick to Bitcoin for the purposes of this article. One common point to watch out for with pools is whether they are paying out before the block properly verified, since that can cost the pools significant amounts of money.

Payout methods are the most relevant factor to consider when assessing mining pools, since they will determine the risk and return of your payments. There are ten or so variations, but it is only necessary to understand the three most common: Prop, PPS, and PPLNS.

Prop (or proportional) mining pools you are paid for the amount of valid shares you contribute to the pool when a block is found. Basically, you would be getting paid an exact amount based on the “work” you submitted. This is the best deal for the miner, but carries risk to the pool operator, since bad shares still get paid here.

PPS (or Pay Per Share) rewards miners for each submitted share. The miner knows the estimated number of shares to get the reward, and takes the risk of paying out per share before the reward is earned. As such, these generally have the highest fees.

Finally, PPLNS (or Pay Per Last N Shares) works like Prop pool, but instead of just rewarding miners for the last block, it rewards based on long-term contribution.

Afterwards, you also need to make sure you trust the wallet the cryptocurrency is being deposited into. The last thing you want is to leave a vulnerability for any of your earnings. This is an often-emphasized point, but you shouldn’t overlook it just because your past solution has worked for the small investments you put in.

Control the Risk

Never forget the fact that nothing is certain in investments, especially with bitcoin. This should steel you against the fact your investment may be lost. The fluctuations in the price of hardware, as well as the continuing increases in computing power, have turned bitcoin mining into somewhat of an arms race.

If you do find yourself feeling too risk averse to put significant funds into mining bitcoin, it might be better for you to just purchase bitcoins directly. This way, you are at least guaranteed to receive cryptocurrency.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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The Sharding Solution

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In recent months, the news has been rife with cryptocurrency detractors quick to point out flaws in bitcoin or Ethereum, and this has created the need for the development community to come up with novel solutions to the problem at hand.

First – What’s the Problem?

Bitcoin and Ethereum both currently operate on a proof-of-work protocol. This protocol offers a very high level of security; however, this comes at the catch of being very resource intensive. As these cryptocurrencies continue to scale, this is becoming an issue.

The three big issues that are presenting themselves are latency, throughput and scalability (inability to perform at an even higher volume). With some transactions taking between a few minutes and a few days (depending on the transaction fee you pay), it is hard to imagine how this model could handle higher traffic. Bitcoin is currently limited, to 3-7 transactions per second, and Ethereum is limited to 7-15. Neither of these figures are encouraging.

As a result, novel solutions like “proof-of-stake” protocols are being invented in order to improve the speed at which transactions can be processed. Sharding is an offshoot that shows promise, and the founder of Ethereum has indicated it will likely be implemented in the future for the network.

Explaining Sharding

A common engineering solution is to split a bigger problem into smaller problems and solve them one at a time. Sharding is a solution that follows a similar train of thought. The way it works is by taking the entire network and splitting it into a bunch of smaller subsets. Each subset of nodes is called a shard, and this takes away the need for each node to go through the entire transaction history in order to verify a transaction.

The term “shard” comes from the idea of a fragment of glass or pottery. The whole is split into smaller component pieces that govern themselves much like states do within a larger country.

One possible means to split up the network is based on the first digits of the public addresses, but there are many other methods that are being floated around.

By requiring its own set of validators, proof-of-stake becomes a prerequisite for the functioning of a shard. By requiring a proof-of-stake protocol to properly function, sharding becomes more practical for Ethereum in the short-term when you examine Vitalik Buterin’s recent comments on the scaling of Ethereum.

Benefits of Sharding

Sharding is necessary for the key reason that these networks need to find a way to grow, otherwise their value will be significantly limited. Implementing a solution like sharding serves to both increase the flexibility of the network while limiting the amount of storage required for it to function.

The difficulty in changing the networks from their current proof-of-work protocols is that they need to keep maintain their security, otherwise they lose all value. Sharding seems to be one of the few solutions that solves the scalability problems while still being secure.

Potential Risks

Every solution comes with downsides, and it is important we address those of sharding. As with proof-of-work, the problem comes from the same thing that makes sharding powerful. Shards are designed to make it easy to transact with other users on the same shard. However, transactions between shards becomes complicated and add an extra layer of complexity to the solution.

If facilitating communication between the shards proves to be too difficult, then the solution has no merit. There are several workarounds that have been theorized (such as transaction receipts), although a lot of work must be done before this is brought to fruition.

Another potential issue is what happens when you create all these small shards. Will they be vulnerable to 51% attacks because of their size, or will the proof-of-stake method still make this too costly to be feasible? The value of the bitcoin and Ethereum network is in their security, so they need to be able to guarantee sharding’s efficacy before implementation.

The final thing to make clear is that this is only a potential solution, and it has not been tested yet, so we have no idea how well it would work or what the results of its implementation will be. For that, only time may tell.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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