Digital Assets and Blockchain Technology: General FAQ
Benzinga – Digital assets and blockchain technology have received a lot of attention in recent years, and for good reason. These innovations have the potential to revolutionize the way the world thinks about digital infrastructure. But they pose many questions to financial advisors and their clients.
This blog post addresses some of the most common questions encountered when discussing digital assets and blockchain technology. In the process, we highlight why we believe this space has such great disruptive potential.
How do blockchains work and why are these networks considered disruptive?
A blockchain is a distributed database that can be viewed, accessed, and updated by any participant in the network. In blockchain, data is aggregated into individual blocks and linked together with previous blocks to form a chain. This data can represent the transfer of value or the settlement of activities in the application. Together, the chains of individual blocks make up all the historical data of the network. Thanks to the advanced blockchain cryptographic architecture, it is nearly impossible to retroactively change historical data.
By requiring a database to be stored on all network computers and all ledgers to be updated for consensus among users, blockchain provides a secure and decentralized method of data management. It demonstrates true irrevocable digital ownership and creates a trustless and neutral payment layer for your data.
The applicable use cases for this technology are many and varied. Many of today’s most popular blockchains support smart contract technology, the building blocks of decentralized applications (dapps), making blockchains viable for functions far beyond peer-to-peer value transfer. It is a data payment layer. To learn more about smart contracts, check out our blog post exploring the disruptive potential of smart contracts.
What is a digital asset?
Digital assets leverage blockchain and smart contract technology to represent value in digital form, perform functions, or encourage certain activities. These assets are built on a code that governs all aspects of economic value, utility and ownership.
Digital assets can be divided into two subclasses: cryptocurrencies and tokens. Cryptocurrencies are native blockchain assets used as digital commodities to power network activity. For example, Ether (ETH) is the native cryptocurrency of Ethereum, used to pay for data settlements on the blockchain. Tokens are smart contract-based digital assets with various functions. Tokens may or may not be fungible and can have many different use cases. These include powering specific dapp activities or representing unique data such as digital assets on the blockchain or real-world assets.
What are the main features of cryptocurrencies?
Cryptocurrencies act as decentralized and flexible programmatic capital within blockchain networks. They incorporate encryption technology that prevents double spending and allows individuals to verifiably prove ownership of their assets. Cryptocurrencies can be used as digital currency for peer-to-peer payments, as a payment medium for intra-block data payments, as collateral for decentralized finance (DeFi) applications, and many other uses.
Another major function of cryptocurrencies is to motivate blockchain security participants to act according to network rules. This is important in arranging and deriving consensus on the state of the network. Instead of proposing valid data proofs to the network, blockchains offer rewards in the form of cryptocurrencies. Fraudulent data proofs that do not gain consensus from the network do not earn rewards and may be subject to penalties. As such, cryptocurrencies provide an incentive mechanism, allowing blockchains to operate securely without a central control point. For more information on how the consensus mechanism works, see the Proof of Work and Proof of Stake: Why Their Differences Matter blog posts.
Why are there multiple cryptocurrencies?
Cryptocurrencies serve different purposes and have different functions. Some cryptocurrencies, such as Bitcoin (BTC), are primarily positioned as custodians of value assets due to lack of supply. Others, such as Ether (ETH), are positioned as the valuable commodity required for data payments and as the medium of exchange required to interact with the growing ecosystem of dapps.
The open-source nature of blockchain infrastructure allows developers to build different cryptocurrencies positioned for different use cases, each with its own value proposition.
What are the differences between the Bitcoin and Ethereum networks and why are their respective assets valuable?
The Bitcoin Network is a globally accessible database that enables storage and peer-to-peer transfer of value for its native asset, Bitcoin (BTC). BTC is divisible, fungible and easily transferable with a program defined monetary policy that guarantees its scarcity. Bitcoin is often referred to as a type of digital gold due to its store of value properties.
Ethereum has extended the use of Bitcoin’s revolutionary blockchain technology by creating a platform that can host sophisticated applications on the blockchain using Ethereum’s native asset, Ether (ETH). . This innovation introduced the concept of smart contracts and laid the foundation for the invention of decentralized applications (dapps). Dapps have the potential to reshape the application layer of today’s internet. These applications are powered by his ETH and settle data into his Ethereum network, positioning Ethereum as the payment layer for the new Internet of Value.
Who controls digital assets?
No single party or network participant controls the digital asset space. Major cryptocurrencies and tokens are maintained by a network of users working together to verify and record transactions on the blockchain.
Importantly, participation in these decentralized networks is open to anyone and requires only the right hardware and software know-how. Software development and maintenance usually belong to a group of developers . Governance votes are delegated to a group of global participants, often deciding on software implementations. However, not all digital assets work the same, and cryptocurrencies and tokens can be highly centralized and manipulated by specific actors.
If digital assets are based on code that lives on a blockchain, can they be hacked? How secure are they?
Digital assets can be hacked and are exposed to cybersecurity risks. However, the blockchain design makes it very difficult for attackers to tamper with historical data. Blockchain uses advanced cryptography to ensure data integrity and security. It also has inherent defense mechanisms that require significant resources and funds to commit fraudulent activities. Ensuring proper decentralization and a strong consensus mechanism is paramount to network security when investigating cryptocurrencies.
Additionally, failures in smart contract code can become vulnerabilities for dapps built on the blockchain. Hackers often try to exploit gaps in the code or infrastructure applications that these dapps may rely on. When researching a token, it is important to consider the smart contract behind the token, the developer team, the token’s economic model, supply dynamics, infrastructure dependencies, and related on-chain activities.
How will regulation affect the digital asset space?
Regulation of digital assets is an important and complex topic. The regulations applicable to these assets will vary depending on the location and specific details of the subject asset, protocol or investment. A comprehensive regulatory framework may help allay public skepticism and attract users to this fascinating industry, but overly restrictive regulation can hinder growth and innovation. . While the future regulatory landscape in the U.S. and abroad remains uncertain, regulation should ultimately be structured to provide investors and users with the protections necessary to enable this nascent industry to thrive. I believe it is.
How can investors start investing in digital assets?
Investors have regulated and unregulated ways to invest in digital assets. Regulatory vehicles may offer greater protection to investors, but may also impose stricter investor requirements and reduce direct exposure to underlying assets. Management fees, custody infrastructure, and customer contracts are important considerations when considering a regulated investment vehicle.
Key regulated vehicles include private funds, separately managed accounts (SMAs), directly backed exchange traded products (ETPs), derivatives-based exchange traded funds (ETFs), and crypto stocks such as public miners and exchanges. It is included.
Unregulated vehicles are not subject to government surveillance. This means that it can be risky for investors and cannot protect them. The safest way to manage direct investments in digital assets is with a self-custody wallet. While this approach provides investors with direct exposure to underlying issues, the inherent challenges and risks associated with managing self-custody wallets and directly investing in unregulated digital assets should be carefully considered. should be considered.
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