Cryptocurrencies have exploded in number and popularity over the last few years, and legal practitioners need to start familiarizing themselves with the essentials
In the first Part of this series on what legal practitioners need to know about cryptocurrency, we discussed the recent explosive growth and diversification in cryptocurrencies and reviewed what they actually are. In this Part, we discuss how cryptocurrencies work and why people use them.
As noted in the first Part, cryptocurrencies are built using blockchains, but what is a blockchain? A blockchain is a special kind of public, shared database. The database is shared peer-to-peer, and since it’s stored in many places at once, it has no single point of failure. The database is updated through the addition of new sequential “blocks” of data that are linked together. Each new block’s accuracy and timestamp are verified by other users in the peer-to-peer system before it gets added to the chain. Once a block is added through this process, it is practically unchangeable. Since blockchains contain a complete history of every transaction executed through them, they get longer and larger over time. For example, back in August 2014, the blockchain for Bitcoin was only around 20 gigabytes in size, but by December 2017, it had reached around 149 gigabytes in size.
As also noted in the first Part, cryptocurrency systems rely on cryptography. All transactions, records, et al., in blockchains are protected using “strong cryptography”. Each user of a system will have a digital “wallet” in which is stored their private and a public encryption keys. Much as with email cryptography, the public key allows you to receive transfers to you from others, and the private key allows you to make transfers from you to others.
Before the current draw of speculative investment, cryptocurrencies were initially intended to accomplish three main goals. First, to enable arms-length parties who don’t know or trust each other to engage in financial transactions reliably. Second, to enable them to do that without reliance on a bank or brokerage firm or escrow service acting as a middleman (which would involve both higher cost and government oversight). Third, to enable them to engage in such transactions anonymously when desired.
From that point of origin, blockchain processes have been adapted for use in a wide range of activities and applications including smart contracts, public record keeping, virtual banking, secure data management, and much more. Back in 2016, there were more than 800 ventures representing more than $1 billion in funding just related to Bitcoin. Today, a single recent launch of a new cryptocurrency raised $1.7 billion just from purchase agreements with 200 wealthy investors, and a patent arms race related to the technology has begun, which we will discuss further in the next Part. Blockchain proponents wax poetic about a future where all your medical records follow you around on a blockchain and businesses can replace management with self-executing rulesets on a blockchain.
Upcoming in this Series
Next, in the final Part of this series, we will review what is happening legally regarding cryptocurrencies and what the discovery implications are.