Have you thought about investing in blockchain? Are you holding back because you’re not quite sure what blockchain is, or how it works? Perhaps you’ve heard about scams involving cryptocurrency, or that it’s a trustless economy. What does that mean, anyway? Here are some answers to common questions about the blockchain economy.
What is blockchain?
Blockchain is a network (or chain) of computers. Every computer in the network has the same database of records, which is called a block. This network is decentralized: transactions don’t run through an intermediary, but are verified by software code, with no middleman. Blockchain transactions are secure because every file on the network is encrypted, and they can’t be erased or altered. As for blockchain being trustless, early adopters of blockchain technology used the term to refer to the open-source and decentralized nature of its transactions, and it stuck.
What is Bitcoin?
Bitcoin, developed in 2009, is the first cryptocurrency, or secured digital currency. It is a coin that operates on a blockchain. Blockchain technology allows users to transfer coins directly to other users, without going through an intermediary.
What about Ethereum? How is it different from Bitcoin?
Ethereum is a newer type of blockchain — it was developed in 2015. Rather than the database of accounts stored on Bitcoin, the Ethereum blockchain stores specific applications that are powered, or run, by the computers on the network. The computing power of the network is represented by the Ethereum token, known as Ether. Currently, Ethereum is used to run applications known as smart contracts. Smart contracts are agreements that are automated in such a way that they are executed when each party agrees that specific conditions have been fulfilled. Blockchain networks created using the Ethereum protocol may be public or private, and they allow for the creation of other cryptocurrencies, or tokens. These tokens can represent a variety of things, including shares, voting rights, or identity.¹
What are tokens?
All coins and tokens are cryptocurrencies, even though most cryptocurrencies don’t function as a currency (or a medium of exchange). Coins possess their own native blockchain, where transactions that relate to their native coins reside.
Tokens are a digital representation of an asset or utility, and they usually operate on top of another blockchain. Tokens can represent any assets that have value, and may be traded. Some tokens are utility tokens — they are issued for a specific purpose, such as accessing the service that a company provides.
Security tokens are more akin to traditional stocks, as they derive value from representing an external, tradeable asset. This can include shares or units of ownership in the company issuing the tokens. Companies seeking to issue security tokens must follow securities regulations.
How do security tokens differ from traditional stocks?
Security tokens are how traditional assets (shares, equity, real estate) may be exchanged via blockchain. In July 2017, the SEC released a report stating that tokens could be subject to federal securities regulations, and interest in security tokens grew as a result.
A market based on security tokens offers some clear advantages. Fees are lower since there aren’t any middlemen handling the transactions. It provides easy access to global markets, and global investors. It allows for early investment in emerging companies, without the need to be an accredited investor (a requirement in the US for investment prior to listing on an exchange). It also offers no restrictions on the number of trades that day or pattern traders can make.²
How do I invest in blockchain?
In the past year, several regulated issuing platforms have emerged, such as the Polymath Network, and there are also now regulated exchanges, such as the Gibraltar Blockchain Exchange. These offer stringent KYC and AML processes, as well as a governed environment.
Investors can also consider a range of blockchain exchange-traded funds. Because these funds can often leverage large investment volumes to gain discounts and greater equity, as well as tokens, they offer significant advantages to investors. In contrast, single investors making contributions directly to an ICO would generally receive only utility tokens in exchange.³
Blockchain technology is new, and we haven’t yet fully uncovered all its potential. As applications and use-cases are developed, it’s likely to transform the ways we conduct transactions, and how we interact with data. In this still-developing economy, it is even more important than usual that the crypto-curious investor should have a degree of understanding and knowledge about the product or technology they will be investing in.