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An Analysis of the Cryptocurrency Industry

Ryan Farell
University of Pennsylvania

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An Analysis of the Cryptocurrency Industry

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wharton_research_scholars/130
 An Analysis of the Cryptocurrency Industry
by Ryan Farell

INTRODUCTION
The cryptocurrency market has evolved erratically and at unprecedented speed over the
course of its short lifespan. Since the release of the pioneer anarchic cryptocurrency,
Bitcoin, to the public in January 2009, more than 550 cryptocurrencies have been
developed, the majority with only a modicum of success [1]. Research on the industry is
still scarce. The majority of it is singularly focused on Bitcoin rather than a more diverse
spread of cryptocurrencies and is steadily being outpaced by fluid industry developments,
including new coins, technological progression, and increasing government regulation of
the markets. Though the fluidity of the industry does, admittedly, present a challenge to
research, a thorough evaluation of the cryptocurrency industry writ large is necessary.
This paper seeks to provide a concise yet comprehensive analysis of the cryptocurrency
industry with particular analysis of Bitcoin, the first decentralized cryptocurrency.
Particular attention will be given to examining theoretical economic differences between
existing coins.

Section 1 of this paper provides an overview of the industry. Section 1.1 provides a brief
history of digital currencies, which segues into a discussion of Bitcoin in section 1.2.
Section 2 of this paper provides an in-depth analysis of coin economics, partitioning the
major currencies by their network security protocol mechanisms, and discussing the long-
term theoretical implications that these classes entail. Section 2.1 will discuss network
security protocol. The mechanisms will be discussed in the order that follows. Section 2.2
will discuss the proof-of-work (PoW) mechanism used in the Bitcoin protocol and
various altcoins. Section 2.3 will discuss the proof-of-stake (PoS) protocol scheme first
introduced by Peercoin in 2011, which relies on a less energy intensive security
mechanism than PoW. Section 2.4 will discuss a hybrid PoW/PoS mechanism. Section
2.5 will discuss the Byzantine Consensus mechanism. Section 2.6 presents the results of a
systematic review of 21 cryptocurrencies. Section 3 provides an overview of factors
affecting industry growth, focusing heavily on the regulatory environment in section 3.1.
Section 3.2 discusses public perception and acceptance of cryptocurrency as a payment
system in the current retail environment. Section 4 concludes the analysis.

A note on sources: Because the cryptocurrency industry is still young and factors that
impact it are changing on a daily basis, few comprehensive or fully updated academic
sources exist on the topic. While academic work was of course consulted for this project,
the majority of the information that informs this paper was derived from White Papers or
synthesized using raw data.

A note on terminology: When used in its conceptual or possessive sense, “Bitcoin” will
be capitalized, but when used in its unit sense, it will not be (i.e., “Bitcoin protocol”
versus “2,000 bitcoins”). The abbreviation “BTC” will also be used to refer to Bitcoin
units. All other altcoins will be referenced by their capitalized names.
SECTION 1: INDUSTRY OVERVIEW

1.1 A BRIEF HISTORY

Although the concept of electronic currency dates back to the late 1980s, Bitcoin,
launched in 2009 by pseudonymous (and still unidentified) developer Satoshi Nakamoto,
is the first successful decentralized cryptocurrency [2]. In short, a cryptocurrency is a
virtual coinage system that functions much like a standard currency, enabling users to
provide virtual payment for goods and services free of a central trusted authority.
Cryptocurrencies rely on the transmission of digital information, utilizing cryptographic
methods to ensure legitimate, unique transactions. Bitcoin took the digital coin market
one step further, decentralizing the currency and freeing it from hierarchical power
structures. Instead, individuals and businesses transact with the coin electronically on a
peer-to-peer network. It caught wide attention beginning in 2011, and various altcoins – a
general name for all other cryptocurrencies post-Bitcoin – soon appeared.

Litecoin was released in the fall of 2011, gaining modest success and enjoying the
highest cryptocurrency market cap after Bitcoin until it was overtaken by Ripple on
October 4th, 2014. Litecoin modified Bitcoin’s protocol, increasing transaction speed
with the idea that it would be more appropriate for day-to-day transactions. Ripple,
launched in 2013, introduced an entirely unique model to that used by Bitcoin and
currently maintains the second highest market capitalization of approximately $255
million (April 22) [1] [3]. Another notable coin in the evolutionary chain of
cryptocurrency, Peercoin, employs a revolutionary technological development to secure
and sustain its coinage [4]. Peercoin merges the PoW technology used by Bitcoin and
Litecoin along with its own mechanism, proof-of-stake (PoS), to employ a hybrid
network security mechanism. More recently NuShares/NuBits have emerged, introduced
in August 2014, which rely on a dual currency model almost entirely divorced from the
single currency model used by previous coins [5].

At the time this paper was written, the cryptocurrency industry consisted of over 550
coins with varying user bases and trade volumes [1]. Because of high volatility, the
market capitalization of the cryptocurrency industry changes dramatically, but is
estimated at the time of this paper to be just over $3.5 billion, with Bitcoin representing
approximately 88% of the market cap [1].

1.2 IN THE BEGINNING WAS BITCOIN

Bitcoin is an open source, peer-to-peer digital currency first proposed in a 2008 white
paper published under the name of Satoshi Nakamoto. Nakamoto begins his paper by
stating that “Commerce on the Internet has come to rely almost exclusively on financial
institutions serving as trusted third parties to process electronic payments. While the
system works well enough for most transactions, it still suffers from the inherent
weakness of the trust based model” [2]. Further, the existence of a trusted intermediary
increases transaction costs, “cutting off the possibility for small casual transactions.”
Additionally, the trusted intermediaries are pressured to gather as much information
about the parties as possible in order to control transaction costs. Hence, Nakamoto
sought to create a coin that completely removed any trusted central authority and replace
trust with cryptographic proof. This system would have the added benefits of having low
transaction fees, low latency (time to make transactions), and pseudo-anonymity.

A bitcoin, and every subsequent cryptocurrency, is merely “a chain of digital signatures”

where “Each owner transfers the coin to the next by digitally signing a hash of the
previous transaction and the public key of the next owner and adding these to the end of
the coin” so that ownership can dynamically be programmed into the coin [2]. Further,
these lines of computer code are stored in a program called a “wallet” on personal hard
drives and/or via online wallets like Coinbase. Like cash or commodities, bitcoins can be
lost, stolen or destroyed. One British man became famous for throwing out his hard drive,
and with it his wallet containing over 7,000 BTC, which had a market value of
approximately $7 million at the time [6]. The prominent Bitcoin exchange, Mt. Gox, had
nearly $350 million worth of bitcoin stolen in February 2014, forcing the exchange to
declare bankruptcy and highlighting security issues within the cryptocurrency world [7].

Bitcoins can only be sent or received by logging the transaction on the public ledger, also
known as the “blockchain.” Bitcoins lack intrinsic value; rather, Bitcoin’s value is purely
a function of supply and demand [8]. Unlike paper “fiat currency” that derives value from
a government, Bitcoin is neither created by, nor backed by, any government. Bitcoin
protocol seeks to solve the double-spending problem (essentially, spending the same coin
more than once) inherent in non-cash payment systems resulting in the need for a trusted
third party (such as a bank or credit card company) to verify the integrity of the
transaction. Double-spending occurs when an asset is duplicated, and thus can be spent
multiple times. This problem does not exist in physical currencies, since transactions
involve changing possession of property. However, a digital file has the potential to be
copied. The security of cryptocurrency, however, and its ability to safeguard against such
digital copying, is inherent in its blockchain or public ledger systems. These systems
keep records of ownership and transaction timestamps, eliminating the possibility of
digital copying and, thus, double-spending. The mechanism used to secure the network is
discussed deeply in section 2. In the case of Bitcoin, a transaction is only complete and
added to the blockchain once a required amount of computational power is used so as to
satisfy the proof-of-work (discussed in section 2.1). The transaction at this point is
considered complete, and ownership of the coin has been absolutely transferred, without
fear of double-spending, because the entire network becomes informed of which wallet
the coin currently resides in.

Bitcoin was introduced to the public on January 3rd, 2009, but traded for less than a
dollar until February 2011 [1]. Bitcoin reached an all-time high of $1151/coin on
December 4th, 2013, and has since steadily declined (see figure 8). Despite this decline, it
is apparent that daily trading volume has held steady for the past year (see figure 5).
Further, the number of unique transactions, including (see figure 1) and excluding
popular addresses (see figure 2), is increasing steadily, despite a sliding price [9].
SECTION 2: COMPETING CRYPTOCURRENCIES
According to coinmarketcap.com, there are just over 550 distinct cryptocurrencies at the
time this paper is written [1]. Thus, the cryptocurrency industry includes much more than
just Bitcoin, although Bitcoin has a market capitalization of approximately 3.3 billion
compared to the total market capitalization of the cryptocurrency industry of 3.8 billion
(86%) [1]. This section seeks to analyze how competition in the cryptocurrency industry
has evolved since the inception of Bitcoin in 2009. Specifically, it explores the evolution
of network security protocols and changing trends in coin economics.

2.1 NETWORK SECURITY PROTOCOL

Perhaps Bitcoin’s greatest technological achievement (and the sine qua non of every
altcoin) is building a peer-to-peer transaction system that relies on “cryptographic proof
rather than trust” [2]. However, replacing a central authority presents a unique problem
with a solution that is not obvious. First, the coin needs to be able to change ownership.
Transactions are recorded by combining the digital signatures of each party and a
timestamp, so that the transaction date is recorded. This new code represents the coin and
its path through the network. This code is then broadcasted to all nodes (computers
connected to and running the cryptocurrency network software) on the network.
However, it is necessary that the majority of the nodes agree on transactions that have
occurred, otherwise double-spending and denial-of-service (DoS) attacks can occur. The
mechanism used to reach consensus among nodes puts integrity in the system by
verifying that the transaction is indeed legitimate. Hence, transactions are verified, and
the system made secure, by implementing certain mechanisms that make it too costly to
violate the integrity of the system. Larry Ren, developer of Reddcoin, notes, “The
underlying principle of such a mechanism is the necessity of expending resources when
confirming transactions” [10]. Various cryptocurrencies have developed novel resources
to use as a means of network security. The resource can be a combination of electricity,
time, or temporary surrender of coinage, and represents the cost to secure the network.
Miners - those who own the underlying resource, and thus expend it - secure the network,
and are compensated for their work in the form of either transaction fees or newly minted
coins. The mechanism used to secure the network determines the resource chosen and the
method used to pay the miners. Thus, the underlying network security mechanism of each
coin has a significant impact on the underlying economics of the coin. Sections 2.2
through 2.5 explain the most widely used mechanisms in the industry. Section 2.6
presents the results of a systematic literature review of 21 coin white papers and resulting
conclusions.

2.2 PROOF-OF-WORK
First proposed by Cynthia Dwork and Moni Naor in 1993, “A Proof-of-Work (PoW) is a
piece of data which is costly to produce so as to satisfy certain requirements but is trivial
to verify” [11]. That is, PoW adds an economic cost to perform a given function. In the
case of cryptocurrencies, transactions are not considered verified until a certain amount
of energy has been expended. Most altcoins that use the PoW mechanism are direct
copies of, or are very similar to, Bitcoin’s protocol. The following section will focus on
how the mechanism is implemented by Bitcoin.
2.2.1 BITCOIN
Under the Bitcoin protocol, all transactions during a certain time period are collected into
something called a block. This block is then broadcasted to all the nodes currently
connected to the Bitcoin network. Bitcoin uses the Hashcash PoW mechanism, first
proposed by Adam Back in 1997 [12]. Under this mechanism, in order to agree upon a set
of broadcasted transactions, each node essentially takes the block and begins adding a
piece of data to the block called a nonce, such that the (block+nonce), when put into a
hashing algorithm, has a hash that meets certain requirements - in this case, it begins with
a certain number of zeros. Thus, each node attempts to solve a complex mathematical
computation, the result of which can be easily verified by computing a single hash. The
Bitcoin protocol requires that nodes use the SHA-256 hashing function [2]. Once a node
finds a solution to the problem, the PoW requirements are considered satisfied, and the
new (block+nonce+hash) is added to the blockchain and broadcasted to all nodes.
Because only one block can be verified at a time, the probability a node will solve for the
correct hash increases proportionally with the amount of CPU power expended. Hence,
the resources consumed in this instance are electricity and time, which are indeed scarce.

2.2.2 BITCOIN MINING

The entire process undergone by each node is called mining, because in each block that is
verified, the node (now the miner) receives a payment for his service. Miners are rational
profit seekers, so in order to incentivize individuals to mine, the Bitcoin protocol offers
rewards in two forms: transaction fees and newly minted coins, called mined coins [2].
Each block that gets verified under the Bitcoin protocol introduces new coins to the
market, which are given to the miner as payment for the energy and time expended [2].
This number decreases with time so that there will never be over 21 million BTC in
existence [2]. In this way, Bitcoin functions similarly to commodities like gold: “The
steady addition of a constant amount of new coins is analogous to gold miners expending
resources to add gold to circulation” [2]. Hence, in the long run, transaction fees will
likely have to increase to compensate miners appropriately. A major criticism of the PoW
mechanism is the massive amounts of energy it consumes, with no other benefit than to
verify transactions. Thus, as the mint rate slows in the Bitcoin network, “eventually it
could put pressure on raising transaction fees to sustain a preferred level of security”
[13]. It is already evident that miners’ revenue has been declining dramatically (see figure
6).

2.2.3 HASHING ALGORITHMS

In addition to the network security mechanism, hashing algorithms also affect the coin.
For PoW mechanisms, the hashing algorithm and the target difficulty of the hash dictate
how many hashes - how much energy - is expected to be spent. Because miners are
incentivized to find ever more powerful computing equipment, this has created a mining
arms race. For instance, mining originally was carried out by CPU (Central Processing
Unit); however, the same functions could be carried out by GPU (Graphics Processing
Unit) at a much faster rate. GPUs then gave way to Application Specific Integrated
Circuits (ASICs), designed to carry out PoW mining at incredible speeds - magnitudes
higher than could be done through GPUs. The SHA-256 algorithm used in Bitcoin and
various altcoins felt the brunt of this arms race, and many coins have introduced
alternative hashing algorithms that are often praised as being ASIC-resistant [10].
However, this is not the case, as ASICs can be designed to carry out any hashing
algorithm. It is expensive to do so, so until miners receive enough incentive to build
ASICs for a particular hashing algorithm other than SHA-256, like Scrypt, they will
likely not. There has been a dramatic increase in the number of giga hashes per second
expent on the Bitcoin network (see figure 7).

Another problem with this is that economies of scale are created. In order to be
decentralized, coins need to have the security distributed among many users. However,
small-scale investors no longer see it as profitable to connect their home computers to the
coin network, as they would then be forced to compete with much faster ASICs. Hence,
this arms race has had the side effect of essentially centralizing network authority into the
hands of the largest miners.

2.3 PROOF OF STAKE

An alternative to the PoW mechanism is the Proof-of-Stake (PoS) mechanism. Instead of
relying on computational power as its “scarce resource,” the resource that the network
security depends on is ownership of the coin itself – “proof-of-stake means a form of
proof-of-ownership” [4] – which is also scarce. Hence, in order to verify a transaction
and receive the coin reward (whether new coins or transaction fees), a miner must own
some coin himself. Further, the probability that he succeeds in creating a new block is a
function of the amount of coin he owns, not of computational power. Hence, there are
very little energy costs in this transaction. Further, in order to undermine the integrity of
the system, one would have to own more than 50% of the coin currently being staked, in
which case violating the coin security would be very costly [4]. Generally, payment takes
the form of an “interest” on the amount of coin staked to verify the transaction [4].
Hence, most PoS coins do not have a capped money supply, and are thus inflationary.
However, PoS systems are faced with the challenge of how to initially distribute the coin.
Whereas PoW distributes the coins to the miners who add value to the network, a coin
that relies purely on PoS must decide whom to distribute the coins to. This can create a
host of problems. In fact, most pure PoS coins have turned out to be fraudulent, as the
creator often gives himself the majority of the coins [10].

2.4 HYBRID POW/POS

A hybrid PoW/PoS system uses the PoW mechanism for initial coin minting and
distribution. That is, PoW allows the network to distribute new coins to miners. However,
over time, the PoS mechanism phases out the PoW mechanism, creating a long-term
energy efficient cryptocurrency. Sunny King and Scott Nadal, in their white paper
“PPCoin: Peer-to-Peer Crypto-Currency with Proof-of-Stake,” are the first to propose and
then implement such a hybrid PoW/PoS system. In this hybrid-design, block generation,
instead of relying on one CPU per vote, relies on a concept of “coinage” [4]. Coinage is
roughly the amount of coin owned multiplied by the life of ownership by the current
owner of the coin. Block generation thus goes to the block with the most coinage.
Further, coins are minted according to one percent per coin-year consumed, which
functions as an interest rate for staking coin [4]. The main advantage, however, is that
this system does not rely on high-energy consumption in the long run. Hence, the design
is cost-competitive to that which relies on PoW and avoids the distribution problem
inherent in PoS.

2.5 BYZANTINE CONSENSUS

Ripple and Stellar offer an alternative security mechanism entirely, which are both
implementations of the Byzantine Consensus Protocol [13] [3]. The infrastructure of the
coins is that of a distributed network, where each server in the network is faced with the
problem of deciding whether other servers in the network are sending accurate messages.
The messages in this case are transactions. This system is tolerant of a class of failures
known as the Byzantine Generals problem and is thus deemed Byzantine fault tolerant
[14]. In the Byzantine Generals problem, the Byzantine army is divided among multiple
lieutenants who receive an order of attack or retreat from a commanding general.
However, there are a number of traitors - potentially the commanding general himself -
yet all loyal generals need to reach consensus despite a small number of traitors working
to foil this plan. The problem is that the loyal lieutenants need to reach consensus on
which order to obey by sending each other signed messages. Various algorithms have
been proposed that provide solutions to the above problem.

The distributed networks created by Ripple and Stellar face a problem analogous to the
Byzantine Generals problem. First, individuals engaging with one of these coins would
have to join a server. Each server in the network is faced with the problem of deciding
whether other servers in the network are sending accurate “messages,” which in this case
are transactions. Ripple’s protocol requires that entities join a server. Each server
maintains a Unique Node List (UNL), whereby the server only communicates with the
nodes on its UNL. This allows servers to be in contact with only trusted servers. Any
server can broadcast transactions, and the servers then vote on the transactions. However,
servers vote only on transactions that came from other nodes on its UNL. Every few
seconds, the servers all send messages back and forth, until the algorithm terminates with
consensus or failure to reach consensus. The specific algorithm used in Ripple requires
that a transaction be accepted by 80 percent of the servers in order for consensus to be
reached. This security mechanism is both much more energy efficient than the PoW
mechanism, requires at least an 80% attack on the network in order for the network
security to be violated (the algorithm terminates without consensus if there is not 80%
agreement), allows for flexible trust, and offers faster transaction times [3].

The main features of each mechanism are summarized below:

Mechanism Decentralized Low Flexible Long-run Low
control latency trust Energy Cost

PoW ✔

PoS ✔ maybe ✔

Byzantine ✔ ✔ ✔ ✔
consensus

PoS/PoW ✔ maybe ✔
Table 1: Information Derived/ Reproduced From [13]
2.6 RESULTS
This section presents the results of a systematic review of coins which meet two criteria:
they have a market capitalization, as measured by coinmarketcap.com, of at least $1
million as of April 2015, and they were released prior to January 1st, 2015, so as to allow
a maturity time. There were 21 coins that met these parameters. The primary method of
review was through their white papers, although several coins did not have white papers,
in which case the material was gathered from the coins’ websites. Answers to the
question “how has network security mechanisms in the cryptocurrency industry evolved
since the inception of Bitcoin in 2009?” can now be drawn from the information that
follows. The table below summarizes the major characteristics of each coin, listed in
descending order of market capitalization numbers.
Release Currency Market Cap Hash Mechanism Supply Deflationary Theoretical Source
(April 23rd) Algorithm Long Term
Inflation

Jan-09 Bitcoin $3,312,281,631 SHA-256 POW 21,000,000 yes [2]

Sep-13 Ripple $255,536,445 ECDSA Byzantine 100,000,000,000 yes [3]

Consensus

Oct-11 Litecoin $55,662,783 Scrypt POW 84,000,000 yes [15]

Jan-14 Dashcoin $19,482,137 X11 POW & POS 22,000,000 yes [16]

Aug-14 Stellar $13,115,557 Undefined Byzantine Unlimited no 1% [13]

Consensus

Jul-14 Bitshares $11,688,038 Undefined Undefined [17]

Dec-13 Dogecoin $10,841,501 Scrypt POW Unlimited no 0% [18]

Nov-13 Nxt $9,606,282 Curve25519 and POS 1,000,000,000 yes [19]

SHA-256

Aug-12 Peercoin $5,073,573 SHA-256 POW & POS Unlimited no 1% [4]

May-14 Monero $4,433,105 CryptoNight POW 18,400,000 yes [20]

Jul-12 Bytecoin $4,199,290 CryptoNight POW 184,470,000,000 yes [21]

Apr-11 Namecoin $3,845,575 SHA-256 POW 21,000,000 yes [22]

Jun-13 Ybcoin $2,991,777 Scrypt POW & POS 3,000,000 yes [23]

Jan-14 Counterparty $2,402,854 SHA-256 POB 2,650,000 yes [24]

Aug-14 NuShares/NuBits $3,901,430 Undefined POS 1,000,000,000 yes [5]

Dec-14 Paycoin $2,294,250 SHA-256 POW & POS 12,500,000 yes [25]

Sep-14 ARCHcoin $2,228,501 Scrypt POS 16,200,000 yes [26]

Mar-14 Monacoin $1,798,198 Scrypt POW 105,120,000 yes [27]

Nov-14 Faircoin $1,201,450 Undefined POS Unlimited no 1.50% [28]

Jul-14 BitcoinDark $1,133,283 SHA- 256 POW & POS 22,000,000 yes [29]

Feb-14 Blackcoin $1,113,916 SHA- 256 POS Unlimited no 1% [30]

Table 2: Breakdown of 21 coins

 
 
 
 
 
 2009 2010 2011 2012 2013 2014 Total
POS 1 4 5
POW/POS 1 1 3 5
POW 1 2 1 1 2 7
Byzantine Consensus 1 1 2
Other 2 2
Table 3: Evolution of Network Security Mechanisms

Mechanism Combined
Market
Capitalization
POS $18,051,579
POW/POS $30,975,020
POW $3,393,062,083
Byzantine $268,652,002
Consensus
Table 4: Market Capitalizations by Mechanism (Data from April 23, 2015 [1])

The final results of the systematic review of each coin suggest that a standalone PoW or
PoS system is not feasible by itself. The PoW system is not feasible long-term as it is
energy intensive, typically deflationary, and tends to create economies of scale within the
mining community. Similarly, PoS can be feasible in the long run, but it faces the
logistical issue of how to initially distribute the coins. A hybrid system, however, is much
more flexible regarding inflationary and deflationary tendencies, is energy efficient long-
term, and relies on the successful PoW distribution system for initially distributing
coins. The trend in the industry appears to be growing consensus of the hybrid
mechanism among the cryptocurrency community, as measured by the number of
successful coins introduced recently. However, alternative methods have also been
proposed with noteworthy success. Ripple and Stellar are two such examples. However,
the value of a coin today is largely a function of acceptance and network size, so even if
Bitcoin’s current characteristics render it functionally suboptimal, it will likely take time
for an alternative coin to outpace it in terms of user base and trading volume.

SECTION 3: FACTORS THAT AFFECT GROWTH

Despite the traction that cryptocurrency has gained over the last half decade, its path has
been turbulent. Many argue that the performance of anarchic cryptocurrency has been
underwhelming in comparison to the hype it stirred when it publicly emerged in 2009
[31]. This section will address two of the main factors that have affected the growth of
the cryptocurrency industry and will continue to influence its development and
integration into the broader financial scheme well into the future: international
government regulatory attempts, and ambivalent public perception in moving toward its
wider adoption.

3.1 GOVERNMENT REGULATIONS

While the expanding cryptocurrency market has the potential to revolutionize the way
money is exchanged, its introduction into global venues is fraught with challenges and
potential pitfalls. Because virtual currencies are not universally recognized as official
means of paying for goods and services, developing standardized systems for their use is
critical. For the currencies to be sustainable, their legal status must be established.
Regulatory systems are burgeoning, with myriad approaches being taken by various
governments. Current regulatory measures are in their infancy and continue to evolve
with the rapidly expanding industry.

Regulations will offer greater legitimacy to a currency struggling to gain mass

acceptance. They will standardize elements of the market and minimize at least some of
the volatility. While governments are testing an amalgam of regulatory steps, their end
goal is the same: to limit fraud, protect consumers, respect economic sanctions, and
institute viable taxation methods [32]. A brief detail of current cryptocurrency policy in
various states will offer clarity and a broad overview of contemporary regulation
attempts. Because of the infancy of virtual currency, available data is in flux and subject
to frequent change.

The United States takes a permissive, slightly neutral stance on cryptocurrencies. The
current challenge faced by regulators is expanding existing laws to allow for the unique
aspects and challenges of the virtual currency world. For taxation purposes, virtual
currencies are handled as property rather than as currency, and transactions are subject to
the same taxation norms as other types of property.

At a federal level, the Financial Crimes Enforcement Network (FINCEN) has taken the
forefront on implementing regulatory methods. The FINCEN’s early attempts to clarify
cryptocurrencies’ place in the financial market came in 2013 with its announcement that
while individual use of virtual currencies is not to be considered a money service
business (MSB), exchanges and conversion of virtual currencies do fall under the
definition of a money service business [33]. As such, virtual currency transmitters must
follow the government requirements already established for MSBs, including reporting
techniques, record-keeping and abiding by the Bank Secrecy Act of 1970. This is
significant in that it demands a degree of accountability from virtual currency
transmitters, as well as one more layer of security against fraud.

Individual U.S. states also have a large role in establishing regulations for the emerging
currency. As of April 2015, 12 states and Puerto Rico have instituted licensing protocol
for virtual coin operations [34]. Currently, California has more cryptocurrency activity
than any other state, and has been proactive in incorporating digital currencies into
existing financial frameworks [35]. In January of 2015, cryptocurrency gained legal
status in California, leading to predictions that other states would follow suit [35]. New
York has also taken note of the emerging market, currently in the final stages of
instituting its own regulatory framework [36].

Australia, whose citizens account for roughly 7% of Bitcoin users, has not formally
adopted regulations for virtual currency, but has established a system of taxation for the
coinage [37]. Trading done in the form of cryptocurrency is subject to the country’s pre-
existing tax rules relating to goods and services. While the Australian government has
been clear that “Bitcoin is not a legally recognized universal means of exchange and form
of payment by the laws of Australia or the laws of any other country,” it has provided
space for the cryptocurrency to comfortably exist [38].
Canada perhaps has the most cohesive and developed system of regulation, being the first
country in the world to establish a tax on virtual currencies. This taxation system seeks to
minimize the risks most frequently associated with cryptocurrencies: money-laundering
and terrorist-funding. The Bank of Canada has expressed a willingness to acknowledge
the developing virtual currency market, but currently recognizes cryptocurrencies as
investments rather than currency [33].

Russia has reacted less favorably to the emergence of cryptocurrencies. The Bank of
Russia shared concerns that the currency could facilitate money-laundering attempts, as
well as be convenient means to transport funds to terrorist organizations. Additionally,
the bank argued that virtual currency violates federal law mandating one central bank and
currency [39]. Last year, the Ministry of Finance announced its intent to restrict use of
cryptocurrency as a means of payment. In February of 2015, Russia’s Prosecutor
General’s Office claimed that Bitcoin “cannot be used by individuals or legal entities.”
And in April, Deputy Minister of Finance Alexei Moiseev reiterated that position, stating
“The law, which provides measures for penalizing the usage of monetary surrogates, will
finally be passed this year” [40]. Indeed, Russia’s crackdown on the currency is already
evident, with at least half a dozen cryptocurrency websites blocked at the beginning of
2015 [41].

This skepticism towards “money surrogates” is shared by China, which has also taken
steps to restrict the use of virtual coinage. In December of 2013, China’s Central Bank
prohibited financial institutions from handling Bitcoin transactions, limiting legal trade of
the coin to individuals and private parties [42]. Citizens are being encouraged to treat
bitcoins and other cryptocurrencies as a good rather than a viable currency.

The trend towards restriction is mirrored in other countries. Vietnam has firmly cautioned
its citizens on the use of cryptocurrencies. While there is no regulation specifically
relating to virtual currency usage, the Bank of Vietnam has warned that Vietnam does not
consider virtual currency to be a legitimate form of currency [33]. Transactions utilizing
forms of cryptocurrency are not covered by legal protections.

The following chart summarizes attempts made by various governments to define legal
parameters for cryptocurrency and to regulate its activity and usage:

Content/Scope Country Additional Information

December 5th, 2013, China’s Central Bank prohibited financial institutions from
Prohibition China handling Bitcoin transactions. Individuals and private parties can legally trade
Bitcoin. [43]

In February 2015, Russia’s Prosecutor General’s Office claimed that Bitcoin

Russia “cannot be used by individuals or legal entities.” [44]

The Icelandic Central Bank said "it is prohibited to engage in foreign exchange
Iceland trading with the electronic currency bitcoin, according to the Icelandic Foreign
Exchange Act"[3]
 Approval for Bitcoin ATMs refused.
Prohibition of ATM’s Taiwan

Financial intermediaries to verify the identities of their customers and report

Protection from Singapore suspicious transactions.
money laundering &
illicit activities
Bitcoin exchanges and most miners obliged to collect information on
USA potentially suspicious transactions and report these to the federal government

The sale, exchange or use of Bitcoin for payment in a real-world economy

Taxing Bitcoin transaction may result in tax liability.

The tax will cover gains from trading bitcoins, purchases made with bitcoins
Japan and revenues from transactions. Banks and securities firms will be prohibited
from Bitcoin trades.

Rules on taxation of capital gains apply when profits are in Bitcoin after it was
Finland obtained as payment is also taxable.

Profits from mining or trading subject to capital gains tax unless hoarded for at
Germany least one year

Unclear The Bank of Israel, the Capital Market, Insurance and Savings Department, the
Israel Israel Tax Authority, the Israel Securities Authority, and the Israel Money
Laundering and Terror Financing Prohibition Authority issued a joint statement
warning of the risks cryptocurrencies posed to users. However, no regulation
has been established.

The Reserve Bank of India’s Secretary General, Ajit Prasad, said “The creation,
India trading or usage of virtual currencies including bitcoins, as a medium for
payment are not authorized by any central bank or monetary authority.”
However, cryptocurrencies are currently not regulated.

Table 5: Information Derived/Reproduced From [45] [33]

3.2 PUBLIC PERCEPTION

While retailers are starting to officially respond to the virtual currency market, the scope
of the currency’s success is ultimately contingent on gaining public acceptance. The
intrinsic value of cryptocurrency is in its number of users; without public trust, the
system of virtual currency as an alternative payment method is unsustainable. This road is
complicated and will require massive amounts of education and assurance to assuage a
skeptical public, particularly in light of recent events indicating the volatility of
cryptocurrency. This section will highlight both positive and negative factors related to
public perception that have and will likely continue to affect the growth of the
cryptocurrency industry.

Slowly, through news stories and pioneering individuals championing its virtues,
cryptocurrency is gaining a presence in the global market. However, despite the recent
surge in media coverage, cryptocurrencies are still widely unknown by the general public.
Coincenter.com has conducted a monthly survey for the past eight months, tracking
American public sentiment towards Bitcoin. Since Bitcoin is by far the most prominent of
the cryptocurrencies, much can be inferred about attitudes towards cryptocurrency as a
whole. April’s results indicate that the average person is still largely unaware of Bitcoin’s
existence. Only 4.5% of those surveyed had ever used the currency [46]. This statistic,
coupled with survey results indicating skepticism regarding Bitcoin’s usefulness today,
forms an underwhelming picture.

Users and Transactions

Gauging public perception of a nascent concept - particularly one that involves a certain
level of risk and the potential to significantly alter the status quo - is typically difficult, as
many factors contribute to shaping it. Quantifiable evidence of success or failure,
however, plays a role in informing public opinion. In the cryptocurrency industry, the
three largest indicators of success are the market capitalization, the estimated number of
cryptocurrency users, and daily transaction volume. Market capitalization was introduced
in the table in section 2.6. The estimated number of users and transaction volume will be
discussed below. All three factors lend legitimacy to the system as they indicate the level
of trust that has been placed in it. These numbers will serve as indicators of the extent to
which cryptocurrency has already been accepted by the public, which is one metric for
gauging public perception.

An exact number of cryptocurrency users is impossible to obtain. Even estimates are

difficult to determine with strong confidence, as one of the key characteristics of the
cryptocurrency industry is the degree of anonymity afforded to its users; though
transaction history is transparent, personal identity remains difficult to trace. Arguably
the most accurate way to estimate the number of users is to examine the number of
wallets created. As of May 2015, the number of Bitcoin wallets in created in My Wallet,
a large online wallet, is approximately 3.3 million [9]. The number of wallets increases
by approximately 5,000 wallets per day in April 2015 (see figure 4) [9]. Though this
provides some indication of the number of users, it is also important to bear in mind that
it is possible for a single user to own multiple wallets or to open a wallet without
necessarily having Bitcoin in it. Data on altcoin users is even more difficult to obtain.

While the user count is unclear, there are exact figures relating daily transaction volume.
With a market cap currently at $3.3 billion, the transaction volume of Bitcoin on a
monthly basis has held steady over the past year (see figure 5), and has averaged just
under $50 million USD [9] [1].

Retailers
Within the six years since Bitcoin and altcoins emerged in the public sphere, several large
retailers have begun to accept cryptocurrency as a valid form of payment. Major retailers
that accept Bitcoin, for example, include TigerDirect, Overstock.com, and Zanga [47].
Considering that cryptocurrency is still in its infancy, this can be perceived as a positive
development.

But many more are reluctant to do so barring a significant increase in the estimated user
base. In their 2013 paper “Bitcoin is Memory,” William J. Luther and Josiah Olson write,
“Few retailers accept Bitcoin as a form of payment due to the small user base; and many
consumers will not consider using Bitcoin until a significant number of retailers accept
Bitcoin payments. Simply put: network effects favor the status quo.... Bitcoin may fail to
gain widespread acceptance even if it were superior to existing monies” [48].

Fear has driven many companies, including banks, to thus far reject the embedding of
cryptocurrency into their systems. While Bitcoin was founded as an anarchic alternative
to the stiff policies and inhibitive regulatory nature of centralized currency schemes, this
is ironically one of the main factors causing concern among financiers. The system
operates on proof rather than trust, but overcoming a dependence on the latter seems to
have proven difficult. Other concerns include the possibility of fraud, the sharp price
volatility of Bitcoin, settlement risk, the potential for tax evasion, speculation over
security, and recent instances of bankruptcy (see Mt. Gox below).

Aswath Damodoran, a finance professor at New York University, writes “While it may
conflict with the vision of some Bitcoin revolutionaries, the Bitcoin economy may need a
banking system of its own that is regulated and perhaps even insured by a centralized
entity” [49]. This, however, would not only challenge the vision of “some” Bitcoin
pioneers, but the grand purpose of Bitcoin to begin with. This would reintroduce the
concept of “trust” into the system, which is exactly what Bitcoin’s founders aimed to
eliminate by substituting cryptographic proof mechanisms.

Mt. Gox
The highly publicized Mt. Gox theft has likely not furthered public trust in the currency.
This breach in security resulted in massive losses for legitimate coin owners, and further
paints virtual currency as a volatile and insecure “other” rather than a currency for
everyday use. Much of these concerns could be mitigated with the right regulations.
Guidelines and rules lend a degree of security and standardization to a volatile market;
having federally mandated frameworks for cryptocurrency use strengthens the appeal to
the average consumer, bringing the currency to the forefront of the market rather than a
fringe hobby of eclectic Silicon Valley programmers.

SECTION 4: CONCLUSION
The cryptocurrency industry is rapidly moving forward. It has shown itself to be resilient
in the face of major thefts, including Mt. Gox, and government shutdowns. Further, the
industry has expanded dramatically in the number of coins currently in circulation. The
industry has also shown its creativity in implementing workable solutions to deficiencies
in the development of new coins. Bitcoin may not dominate the industry in the long run,
but the industry owes its existence to the pioneering anarchic coin.
 INDEX
Data for figures 1 to 8 was gathered from the website blockchain.info [9]. Figure 9 was
gathered from the website Bitnodes [50].

Unique  transactions  (7  day  

moving  average)  
120000  
Number  of  unique  transactions  

100000  

80000  

60000  

40000  

20000  

0  

Figure 1: Number of unique transactions

Unique  transactions  excluding  

100  most  popular  addresses  (7  
day  moving  average)  
120000  
Number  of  transactions  

100000  
80000  
60000  
40000  
20000  
0  

Figure 2: Number of unique transactions excluding popular addresses

 Number  of  unique  bitcoin  
addresses  used  (7  day  moving  
average)  
300000  

250000  
Number  of  Addresses  

200000  

150000  

100000  

50000  

0  

Figure 3: Number of unique addresses used

Number  of  Bitcoin  wallets  using    

My  Wallet  Service  
3500000  
3000000  
Number  of  Wallets  

2500000  
2000000  
1500000  
1000000  
500000  
0  

Figure 4: Number of wallets on My Wallet

 Estimated  daily  Bitcoin  
transaction  volume  (7  day  moving  
average)  
$300,000,000  
$250,000,000  
$200,000,000  
$150,000,000  
$100,000,000  
$50,000,000  
$0  

Estimated  daily  Bitcoin  transaction  volume  (7  day  moving  average)  

Figure 5: Transaction Volume USD

Miners'  Revenue  (USD)  (7  day  

moving  average)  
5000000  
4500000  
4000000  
3500000  
3000000  
USD  

2500000  
2000000  
1500000  
1000000  
500000  
0  

Figure 6: Bitcoin miners’ total revenue (USD)

 Giga  hashes  per  second  (7  day  
moving  average)  
400000000  
350000000  
Giga  hashes  per  second  

300000000  
250000000  
200000000  
150000000  
100000000  
50000000  
0  

Figure 7: Increased Bitcoin mining competition (giga hashes per second)

Bitcoin  Price  (7  day  moving  

average)  
1200  

1000  

800  
USD  

600  

400  

200  

0  

Figure 8: Bitcoin price in USD

 Number  of  Bitcoin  Nodes  
2500  

2000  

1500  

1000  

500  

0  

Figure 9: Number of Bitcoin nodes by country

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