Conscious (and Cautious) of Cryptocurrency
Tips to understanding virtual currency
Glen Kratochvil, president of Alaska Computer Guy, bought his first cryptocurrency in 2014. He purchased Bitcoins as a personal investment.
Today, his company—an IT support and computer services provider—allows customers to pay with several cryptocurrencies. The Anchorage business gladly accepts Bitcoin, Ethereum, DigiByte, credit cards and, of course, cash.
Kratochvil’s gravitation to cryptocurrency is simple: Not everyone has a credit card, many people don’t use checks anymore, and more people use third-party payment systems such as Apple Pay. Plus, accepting cryptocurrencies is generally more cost-effective for business owners. For instance, Alaska Computer Guy’s transaction fees with Bitcoin are about less than one half of one percent. That’s significantly less than the 2 percent to 3 percent businesses typically pay in credit card processing fees. “Cryptocurrency is tremendously cheaper,” Kratochvil says. “I think that it is going to revolutionize the financial industry.”
Alaska Computer Guy is among a small but growing number of businesses that accept cryptocurrencies in Alaska. Lately, cryptocurrencies have been causing quite a bit of controversy—positive and negative—as they gain popularity worldwide. They’re stimulating interest among would-be investors in Alaska and increasing concerns among financial industry regulators.
What Are Cryptocurrencies?
Simply put: Cryptocurrencies are a type of digital record created and stored electronically in a “blockchain,” a distributed database that keeps a permanent record of digital transactions, according to the Alaska Division of Banking and Securities, a division of the Department of Commerce, Community, and Economic Development. When cryptocurrency is used to pay for goods or services, each transaction is securely encrypted and recorded in a blockchain, which serves as a ledger.
Unlike traditional currency, cryptocurrencies have no physical form and typically are not backed by tangible assets. They are not insured or controlled by a central bank or other governmental authority; cannot always be exchanged for other commodities; and are subject to little or no regulation.
Alaska Computer Guy
Alaska Computer Guy payments accepted sign.
Types and Uses
Among cryptocurrency, Bitcoin and Ethereum have the largest market capital by a significant lead. Bitcoin—the most recognizable cryptocurrency—uses peer-to-peer technology to operate with no central authority or banks. The management of transactions and the issuance of Bitcoins are carried out collectively by the network. Bitcoin is open-source; its design is public.
Ethereum is an open-source decentralized application platform with features capable of supporting “smart contracts.” These applications, which run on a custom-built blockchain, can run exactly as programmed without any possibility of downtime, censorship, and fraud, or third-party interference. In the race for market dominance among cryptocurrencies, Ethereum is considered to be an evolution of Bitcoin, according to Benjamin Craig, executive vice president and chief information officer for Northrim Bank. “It reconciles faster, is scalable, and allows you to build applications, to include tokens, on top of it,” he says.
Alaskans are employing cryptocurrencies in a variety of ways. “I believe there is a small but growing number of Alaskans using cryptocurrency as a direct payment to each other or third-party commercial entities, but the technology still has a steep adoption curve for cryptocurrency consumers and businesses,” Craig says. “I also believe that Alaskans are buying cryptocurrency as an investment, or using it as a low-cost and fast way to send money both to US and international recipients.”
According to Craig, person-to-person money transfer is one of the most underappreciated aspects of cryptocurrency. Historically, financial institutions such as banks and credit unions relied on industry alliances to send money abroad. “These systems have not changed in decades. Corporations like Western Union, PayPal, and even retailers like Wal-Mart have more recently implemented their own money transfer systems, but these, too, are expensive, reliant on proprietary infrastructure, and require recipients to be on their network.”
Craig adds: “Cryptocurrencies like Ripple and Steller are specifically targeting these challenges, touting nearly instantaneous, extremely low-cost payments across the globe—with no dependencies on legacy or proprietary networks. For people who frequently send money home to family abroad, this is game-changing technology.”
The acceptance of cryptocurrency as a payment tool varies among businesses. While most companies in Alaska are not yet accepting digital currency as a form of payment, there is broader acceptance among large national companies. For example, NewEgg and Amazon—two of the largest out-of-state resellers in Alaska—both accept cryptocurrency as a form of payment. Cryptocurrency is also being widely embraced by Overstock, which allows payment from about fifty different cryptocurrencies. Interestingly, Alaska is Overstock’s top state for cryptocurrency by percentage of purchases.
However, cryptocurrency’s usefulness extends far beyond its commonly-perceived role of simply being a method of payment. “That was its genesis, but today it is in its second epoch,” Craig says. “It is a vehicle to quickly and cheaply transfer funds, a speculative investment, a self-executing digital contract, [and] an engine to permanently record [not necessarily financial] transactions over a distributed network.”
“And the future of cryptocurrency is being developed right now: ‘third generation’ cryptocurrencies are in development that can serve as entire operating systems, allowing for distributed hosting of decentralized applications across the globe,” he adds. “The ephemeral state of this technology will require a different mindset than how we used and regulated legacy fiat currency. That said, cryptocurrency was close to US$800 billion earlier this year, a sizeable number to be sure, but the world’s economies are in excess of hundreds of trillions USD, so it’s still an evolving technology and should be treated as such.”
Risks and Benefits
Cryptocurrency comes with a unique set of risks and rewards. Bitcoin, for example, carries benefits and risks in three parts: as a utility, as a currency, and as a speculative investment, according to Craig. As a utility, all cryptocurrency is built on blockchain technology—which can sometimes be challenging for non-mathematicians and non-technologists to fully comprehend. But this is the single most exciting thing about cryptocurrency, and it is the motivation for high-tech developers, very large companies, and even governments to get involved with cryptocurrency, Craig says. “With blockchain, every transaction is converted into a mathematically-verifiable sum that ‘proves’ the integrity of your transaction,” he explains. That sum is then incorporated with other transactional sums into immutable “blocks” of data forming a “chain” that is then copied and distributed across many other computers. “This blockchain process ensures that all transactions are, therefore, mathematically-verifiable, cannot be altered once they are recognized, and are stored in multiple places.”
According to Craig, there are many uses for blockchain beyond transferring currency, such as maintaining the authenticity of goods in transit through multiple waypoints, memorializing intellectual property rights, or even authoring digital contracts that conditionally self-execute once predefined criteria are met. Currently, there are more than 1,500 different cryptocurrencies, and most of them differentiate themselves based on the technology and use case of their blockchain. “However, like all things new that are still in development, the blockchain technology used in these cryptocurrencies is still being vetted, and there have been some bugs along the way,” he says. “Even some of the largest names in cryptocurrency have had to ‘fork’ into two different cryptocurrencies to patch the underlying technology.”
As a currency, cryptocurrency is superior in many ways to traditional fiat money (currency the government has declared to be legal tender but is not backed by a physical commodity), Craig says. Many cryptocurrencies can be sent or received almost instantly from the sender to the receiver—without third-party or government oversight. Because cryptocurrency transactions are immutable, they are less likely to be altered by a fraudster or dependent on one institution’s record keeping. And because they are distributed, there are multiple copies of the transaction, proving its legitimacy.
However, Craig says, there is a public perception that cryptocurrencies are used for illicit purposes. That is true, but not more so than traditional fiat currency. A common misconception is that cryptocurrency transactions cannot be tracked, when, in fact, they are recorded into a permanent and distributed ledger. “However, because it’s so easy to create a cryptocurrency wallet, connecting those transactions to verifiable people is difficult,” he says. “Each cryptocurrency must have its own wallet. If you try to transfer one cryptocurrency [such as Bitcoin] to a different wallet [such as Ethereum], best-case scenario it will fail, worst case scenario it’s gone forever.”
Craig adds: “Also, because cryptocurrency is digital by definition, it’s exposed to the same risks as other Internet-connected devices and hackers who would like nothing more than to empty your wallet. This has led to many active cryptocurrency users creating a “cold wallet,” an offline storage medium not connected to a computer network.”
As a speculative investment, dealing with trading cryptocurrency is like operating in the “wild west,” Craig says. It’s similar to trading Forex or speculative commodities before regulators placed (some) safeguards on the market. He explains: “Cryptocurrency is somewhat subject to traditional financial principals, such as Elliott Wave patterns, Fibonacci retracements, and doji candlestick forms, but it is also more heavily influenced by social media, international traders with a multitude of motivations, and ‘cryptowhales,’ traders with massive ownership stakes who can drive the market up or down at will.”
Interestingly, although cryptocurrency trading borrows standard industry terms like “bulls” and “bears,” it has its own peculiar language. Crypto traders might make references to FOMO, “fear of missing out”; HODL, an intentional misspelling of “hold”, also abbreviating “hold on for dear life”; FUDster, a disseminator of fear, uncertainty, and doubt trying to influence the market; Moon, when a cryptocurrency price spikes abnormally high, such as 100 to 1,000 percent; Lambo, short for Lamborghini, jokingly what investors that moon will buy with their earnings; and P&D, pump and dump pyramid schemes attempting to boost a cryptocurrency’s value in order for the organizers to sell it, leaving regular investors with an overvalued coin.
Kristy Naylor, acting director of the Alaska Division of Banking and Securities, also associates a variety of risks and benefits with cryptocurrencies.
Because cryptocurrencies are a digital medium of exchange created independent of banks or governments, there is currently very little regulatory oversight over them. Naylor says: “So if you have a problem, who do you complain to? With traditional investments, you might go to a regulatory agency to complain.”
One of the most common risks related to cryptocurrency is market volatility. Crypto prices fluctuate rapidly, with big highs and big lows, Naylor says. And cryptocurrencies are not insured by the Federal Deposit Insurance Corporation, which insures bank deposits up to $250,000. Also, investors must have a key to access their cryptocurrency. “If you lose your key, it’s gone forever,” she explains. “If you try to use a digital wallet to save your key, that software can be susceptible to hacking.”
There’s also risk stemming from the tremendous buzz around cryptocurrency. Naylor explains: “Any time there is the next big new thing out there people who are bad actors tend to use that as a means of perpetuating fraud. It’s just a convenient vehicle. People might devise Ponzi or pyramid schemes around a cryptocurrency. Pump and dump scams have also been used. But the same thing happens when oil and gas prices get very high.”
Naylor adds, “I think people let their guard down a little bit when they start to hear stories of the incredible wealth that can be made. They don’t ask as many questions and are not as skeptical as they should be.”
Concerns over potential fraud led the Alaska Division of Banking and Securities to issue an official warning earlier this year. In January, the agency reminded Alaskans to be cautious about investments involving cryptocurrencies. It also advised people to be wary of these common signs of investment fraud: “guaranteed” high investment returns, unsolicited offers, projects that sounds too good to be true, pressure to buy immediately, and unlicensed sellers.
The division’s warning about cryptocurrency investing was part of its ongoing mission to protect consumers of financial services and to promote safe and sound financial systems. “Whenever something like cryptocurrency is in the news a lot, it draws a significant amount of attention,” Naylor says. “That’s when we see investors of all different experience levels turn to different potential investments. We just wanted to alert people to some of the risks that are out there that could be associated with investing in something that’s a little bit non-traditional.”
Incidentally, the North American Securities Administrators Association (NASAA) identified initial coin offerings and cryptocurrency-related investment products as emerging investor threats for 2018.
While Kratochvil recognizes the potential risks surrounding cryptocurrencies, he relishes the ease and speed of using digital currency. Cryptocurrency transactions can clear in as few as 15 or 20 seconds, while credit card payments can take a day or two to post to an account. Making international payments is also easier, faster, and cheaper with cryptocurrency. “It’s direct from one person to another person; it doesn’t have to go through a bank wire,” he says. “International payments can take hours instead of days to clear with cryptocurrency.”
However, Kratochvil understands that using cryptocurrency can be intimidating for people who are unfamiliar with the concept. So he teaches informal classes using DigiBytes to educate the public about cryptocurrency. His classes are designed to offer assistance from a computer support standpoint. “I help people with technical questions and issues relating to using cryptocurrency, but I do not offer investment advice.”
There is an explosion in the number of cryptocurrencies being developed. There is also an increase in people conducting ICOs to raise money to start new cryptocurrencies. And that’s where Naylor is seeing some of the fraud popping up. “I’m not saying that all ICOs are fraudulent,” she says. “But some people are saying invest your money and you can get an exchange of the early coin, and it turns out that it is a fraud; there is no new cryptocurrency being created at all.”
Like Naylor, Craig has noticed the exponential growth of new cryptocurrencies, some of which are driven by get-rich investment schemes (Bitconnect), jokes (Garlicoin), and satire (Dogecoin).
He says Bitcoin continues to serve as the de facto “index,” significantly influencing the value of other alternative cryptocurrencies (Altcoins). However, there is a groundswell of support for many of the top twenty-five coins by market capitalization to replace Bitcoin due to its relative high-cost of transaction fees and long reconciliation times. “There are many cryptocurrencies vying for market dominance based on the underlying merits of their technology, corporate backing, and market ubiquity. Those are worth keeping an eye on,” Craig says.
As an Alaska-specific development, regulations are being reviewed as a result of the growing using of cryptocurrency. In October 2017, Alaska Governor Bill Walker signed a revision to the Fiduciary Access to Digital Assets Act into law, establishing a legal framework that defines how a person’s digital assets—including cryptocurrency—can be handled by a trusted custodian. The act also spells out the laws regulating what that custodian can and cannot do with the digital assets in question. Interestingly, the revised act includes a section dedicated to cryptocurrency holdings.
And in March 2017, the state of Alaska introduced House Bill 180 defining digital currency, as well as broadening its definition of money transmission to include digital currency. A wide array of business functions would require money transmission licenses, including buying and selling through a third party, transmitting, controlling, and issuing digital currencies. On January 31, the bill was referred to the Judiciary Committee.
Alaska has attempted to include “virtual currency” in the definition of ‘money transmission’ before, but those bills did not survive.
If this latest bill gets approved, many digital currency businesses will have to obtain an annual money transmission license from the Alaska Division of Banking and Securities. Given the fact that strict transmission requirements have caused some players to pull out of Hawaii and Washington, the passage of such legislation in Alaska could negatively impact the further development of cryptocurrency.
At least that’s what Craig thinks could happen. He believes it will be nearly impossible to stop the unregulated use of cryptocurrency, as it was designed to be accessible to all for this very reason. Generally speaking, he says he is not in favor of legislation over complex burgeoning technologies, without people fully understanding the ramifications of that legislation. “History has proven that early adoption of legislation to complex topics is often instigated for a specific reason, but has consequences that are punitive to the growth and adoption of new technologies,” he says. “This specific bill addresses one aspect of digital currency, but cryptocurrency has many uses and is still evolving; this bill could unintentionally stifle an emerging technology vital to Alaska’s economic future.”
Naylor points out that the bill primarily defines what digital currency is in relationship to money transmission. “Our ‘definitions’ related to digital currency are from papers on Virtual Currency published by the Financial Action Task Force,” she says. “We are not licensing Bitcoin companies, we are licensing companies who offer to accept and transmit currency, funds, or other value that substitutes for currency to another location or person by any means.”
She adds: “If the bill were to pass, I think it would have the effect of modernizing our law to catch up to the current state of the money transmission industry to help us appropriately regulate the industry and fulfill the division's mission to both protect consumers of financial services and promote safe and sound financial systems.”
Cryptocurrency Investing Tips
As a general piece of advice, Naylor cautions Alaskans to give careful consideration before investing in cryptocurrency. “People need to be educated about what they are investing in and understand the potential risk associated with any type of investment before they make that investment,” she says.
Kratochvil of Alaska Computer Guy encourages crypto investors to start small. To someone who isn’t familiar with technology, getting into cryptocurrency can be dangerous, he says. “There is some room to make some expensive mistakes.”
Craig advises people to never invest more than they are willing to lose. “If you plan on ‘day trading,’ don’t plan on [sleeping] because the cryptocurrency market is highly volatile, open twenty-four hours a day, and is influenced by three time zones of traders that don’t think alike. Consider using an offline-wallet for substantial holdings,” he says.
He also encourages people to research and trade on paper before investing any real money in the crypto market. They should also avoid sketchy cryptocurrency exchanges. “There have been several failed currency exchanges in the last two years, resulting in cybercriminals absconding with cryptocurrency worth millions of dollars,” he says.
The Alaska Division of Banking and Securities can help investors research the background of those selling or advising the purchase of an investment. The division can be reached at (907) 269-8140 or firstname.lastname@example.org.
Tracy Barbour has been an Alaska Business contributor since 1999. As a former Alaskan, she is uniquely positioned to offer in-depth insight and enjoys writing about a variety of topics.