What is Cryptocurrency?

What Is Cryptocurrency?

What Is Cryptocurrency? – Over the past few years, the term cryptocurrency has become a well-used term in financial circles, new business plans, and news headlines. Often the term is associated with criminal activity on the so-called “dark web,” but more recently with the increasing value of currencies like Bitcoin, the word, concept, and products are entering mainstream consciousness.

But what really is a cryptocurrency and how does it work? In this blog , we will examine the concept, the history, and the uses for cryptocurrencies and look at how to set up a Bitcoin trading node.

Why does an investigator need to know this? Understanding the concept of these online currencies can help you form a good foundation to build a more comprehensive technical understanding. It can also help you to see the criminal uses of these currencies.

In the far western Pacific region of Micronesia is a tiny cluster of islands named Yap. Conspicuous against the deep blue of the ocean, this tiny group of “highislands” comprises rolling hills covered with dense, lush forest.

The islands share a coral reef that provides sustenance for the islanders from the fish that seek protection from ocean predators.

What is Cryptocurrency?

As far back as the thirteenth century, the sultan of Egypt referenced islands at the far east of the Persian Empire, where the only currency was millstones. This was later confirmed by the Spanish when they “discovered” the island group in 1528. If you visit today, you can still see the stone coins that made up the primary currency of the islanders for many centuries; in fact, they are still used today in trades involving land or marriages.

The stones are a variety of sizes—some as small as 3.5 centimeters—but the ones that draw the most attention are up to 4 meters in diameter.

The Internet boasts many pictures of tourists standing next to these vast doughnut-shaped disks of calcite named Rai coins.

The stones do not originate on Yap but are mined and shipped from other islands such as Palau, which is 450 kilometers away. For centuries, these coins were loaded onto sail-driven rafts, and brought across the open ocean to the island, unloaded, and moved to a location somewhere on the island where they would generally stay put forever.

You may be wondering: How do the islanders use such huge coins in actual transactions? How do they value them? How do they know who owns each coin? The Rai coins are interesting because they almost exactly prefigured the way a blockchain in a cryptocurrency works—in fact, similar questions can be asked about a cryptocurrency. How can you trade something that doesn’t really exist, such as a Bitcoin? How is a blockchain-based coin valued, and how can you know who owns a coin with no central bank controlling the movement of
funds? Examining the Yapese currency helps us to understand the blockchain currency concept.

So why does a large stone disk have value? Let’s say that Bob from Yap wants a 3-meter coin. First, the coin must be mined. Consider the difficulty involved. Workers have to be employed and sent in boats to an island 450 kilometers away.

What is Cryptocurrency?

Calcite must then be mined, and the resulting stone carved into the distinctive doughnut shape. This final “coin” must then be loaded onto a boat and sailed back across the stretch of Pacific Ocean with its obvious dangers. The work and considerable expense involved to mine the coin are what gives it its perceived and agreed value to the islanders. Indeed, the bigger the coin, the higher the difficulty—so the value is commensurately greater.

One of the first questions I am asked about cryptocurrencies is where does the money come from? The answer, of course, is that the money comes from nowhere, but that is not really a fair answer. If you know anything about any cryptocurrency, you will know that new coins are “mined.”

This concept will be discussed later, but in simple terms, computers work to solve really, really hard mathematical problems, and when they find a solution, they are rewarded with “new” coins. But just like mining a Yapese Rai coin, work is involved that carries a very real cost. Although Bitcoin miners, for example, are not chartering a ship and crossing oceans, they must spend real money on expensive, specialized custom ASICs (application specific integrated circuits) capable of carrying out trillions of calculations a second. They must then spend money on providing considerable amounts of electricity for running the computers and keeping
them cool.

Just like their stone counterparts, it’s difficult and expensive to mine cryptocurrency coins, which gives them a perceived and generally agreed value due to their scarcity and the fact that eventually Bitcoin will “mine out,” where all coins will be mined and no more can be produced. It is notable that in 1874, a captain named David O’Keefe imported a large number of coins from Palau to trade with the Yapese. Interestingly, this “had its disadvantages, not least the introduction of inflation, caused by the sudden increase in the stock of money” (see https://www.smithsonianmag.com/­history/david-okeefe-the-king-of-hard-currency-37051930/ ). In the same way, if the “difficulty of work” to mine cryptocurrency coins became easier, it would directly affect their accepted value.

What is Cryptocurrency?

How do the Yapese trade their coins? Most of the coins are too big to move, so the Yapese use a very simple but effective form of what we would now call a distributed ledger. For example, let’s say there was villager named Bob, and when Bob’s coin arrived by boat from Palau, it would be placed near a pathway or some other visible place. All the villagers would know that the coin “on the path by the beach” belonged to Bob, because everyone would be told this and would add it to their individual mental note that included the other large coins on
the island.

If Bob wanted to buy some land from Alice, they would agree on the transfer of coin for land, and they would then tell all the villagers that the coin “on the path by the beach” now belonged to Alice. With no centralized person keeping a record or ledger, the possibilities of fraud are massively reduced. If a pretender named Nick told others that he owned the coin “on the path by the beach,” the majority of villagers could reject the claim due to their collective knowledge of ownership.

Leading Currencies in the Field

It was tempting to write an investigations book about Bitcoin since, at the time of writing, it is the brand synonymous with the word cryptocurrency in the public mind.

However, as I spent more time with Monero, Litecoin, Ethereum, and others, I realized that although they were all subtly or sometimes significantly different and set out to provide certain abilities to their users, for an investigator, they all worked in the same fundamental way.

When you consider that technology is a hard taskmaster and that online services hit the proverbial fan almost as fast as they spend their venture capital money (MySpace anyone?), will Bitcoin still be valuable and newsworthy in two years, or even a year? Could Ethereum be the next Facebook of the currency world and become the default choice for transactions and contracts of all types? Only the future will answer that question, but the methods of investigating crime involving a cryptocurrency will remain basically the same.

So, although Part II of this book deals with investigations that are focused on tools for Bitcoin with its spin-offs and alt-coins, and Ethereum, this is only because tools are available for them. Should Monero take the limelight in a few years’ time, undoubtedly an investigator will be able to find similar tools to help them investigate effectively.

In late 2017, investopedia.com, the world’s largest financial educational website, named Litecoin, Ethereum, Zcash, Dash, Ripple, and Monero as the best investable cryptocurrencies aside from Bitcoin, but that should not necessarily drive research by an investigator. Some of the new breeds of currency lend themselves to criminal uses. For example, Zcash offers “shielded” transactions where the sender’s and receiver’s details are hidden, and Dash provides increased anonymity over Bitcoin. It is more likely that these features, rather than Bitcoins’ burgeoning value, would attract someone with the need to hide his or her transactions for nefarious purposes.

I should be clear that I am in no way accusing these companies of deliberately attracting a certain type of client any more than Tor (which was partly developed and funded by the U.S. government) was designed to hide terrorists and pedophiles. However, if you, as an investigator, are aware of the specific security and anonymity features of a particular currency, you may be more prepared to research and ultimately exploit them during an investigation.

What is Cryptocurrency?

Due to these issues, I will decline from the obvious inclusion of a list of available cryptocurrencies, since by the time you read this, there may be a new pretender in town being used by our suspects. Instead, this book will try to both be specific as to investigation methods you can use now and look at the generic principles behind this type of analysis.

The website Coinmarketcap.com maintains a constantly updating list of the primary cryptocurrencies, almost 900 were listed at the time of writing. If you are interested in launching your own cryptocurrency and becoming wildly wealthy, you will find an excellent tutorial at www.ethereum.org/token. (And once you are a billionaire, please remember who gave you the tip and at least invite me onto your boat!)

Is Blockchain Technology Just for Cryptocurrencies?

Although we look in detail at what a blockchain is in Chapter 3, suffice it to say that it is simply a list of transactions, distributed to many nodes on a network, grouped into clusters called blocks, and—using a physical analogy—stacked on top of one another like a LegoTM brick tower.

The concept of a virtually anonymous, distributed ledger, contract-led blockchain-based system certainly has some significant possibilities, but believing what you read in the press and in a company’s marketing materials would be a major mistake. In 2018, you need to include two terms in your prospectus to float your company on the stock market or add to your brochure to sell your latest product: artificial intelligence (AI) and blockchain! In fact, throwing a bit of “cloud” in there couldn’t hurt either.

I saw the marketing headline “The First A.I. Big Data Marketing Cloud for Blockchain” on a software website recently. It seems that any system that adds up 2 + 2 or includes an “if . . . then” decision tree is now considered AI that may take over the planet at any moment. It’s not and it won’t, even if it’s got a lot of “big data in the cloud”! It is the same issue with the blockchain: Business analysts have watched the extraordinary rise in the value of Bitcoin, read an article on the technology it is based on, and then added the word to any system that needs to sound a bit more hip and cool (although I am well aware that the words “hip” and “cool” themselves are no longer considered “hip” or even “cool”).

A quick search of the Internet reveals insurance companies that will put your insurance agreement on the blockchain, delivery companies that will use smart contracts to deliver your parcel, auction sites that use the blockchain to reduce fraud, and security companies that promise the blockchain will prevent you from ever being hacked again. Sound far-fetched? Most are. But consider the following auction-house example.

Several years ago, I bought an old book at auction—or at least I thought I had bought it since I was the final bidder. However, the auction house told me later that it did not have a record of my final bid, and since the previous bid hadn’t reached the reserve, the book would be put up for sale again.

Because the auction software was hosted in a single location and the auction house controlled it, I had no recourse or way of proving otherwise. However, I had taken a screenshot of my browser with my high bid and my successful purchase message. The auction house then told me that it had “lost the book.” After a few choice words and threats of legal action from me, it “found” the book and honored the bid.

It was clear that the auction house wanted more from the auction and simply wanted a chance to sell again with a better audience. How would a blockchain-based system have improved this situation? A blockchain auction system could work as follows: Every bidder is a node on the blockchain. A product to be auctioned is set up as a token with a contract of sale connected to it, based, for example, on the Ethereum network. Each bid made is a transaction between the auction and the highest bidder with the “token” moving seamlessly from high bidder to high bidder. Whoever is the final bidder when the real or virtual gavel comes down is left as the owner of the token.

What is Cryptocurrency?

Everyone on the blockchain can see the final transaction, and the contract is set. I own the item because I own the token, and it’s proven by every node on the network. The sales contract can also form part of the blockchain contract, minimizing paperwork. (If anyone sets this system up and makes a million, please once again remember me when you are out on your yacht.) How does this affect the investigator? Blockchain transactions on Bitcoin are one aspect of the technology and require a skill set that you will learn about in this book. However, in the future expect to find blockchain-based systems with transaction-centered contracts in a wide variety of business sectors.

An analyst will need to have the skills to learn how a blockchain functions, and be able to decode contracts, and follow the flow of contract transactions. I will cover contracts in a little more detail later in the book, but if you choose to carry out further research on the smart contract-based platforms such as Ethereum, it would not be a waste of time.

Summary

In this chapter, you learned what a cryptocurrency is, how the generated coins can have a perceived value, and how the concept of the blockchain can be used for many differing applications. The history of the stone coins of Yap helped to explain how a decentralized ledger can work in a community setting and how this concept is used in the distributed ledgers of a global blockchain.

You learned how to set up a Bitcoin Core full node and how to practice coin transactions without costing anything by using the Bitcoin Testnet. The chapter introduced you to concepts that you need to understand in much more detail, such as cryptography, blocks, and transactions, which we will delve into in the
coming chapters.

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