What is Cryptocurrency?
Drop the word “cryptocurrency” into a conversation and wait for a waterfall of opinions. Some say it’s the greatest technological breakthrough since the internet, some say it’s a scam. But how many people can actually explain what the darn thing is?
Our boisterous friend Bitcoin has carried the word to the least likely of places, even echoing around retirement homes as grandmas tune in for their post-supper news fix.
But here’s the thing. While the likes of “Bitcoin” and “Cryptocurrency” hit news bulletins, boardroom agendas, and billboards with the force of a tsunami, most folk find this cryptic “cryptocurrency” a tough nut to crack.
Your average citizens are being forced to don a suit, tenderly take the hand of cryptocurrency at the altar and say their vows, but they haven’t even gone through the awkward banter of a first date. Take a step back, a deep breath, and prepare to start again the days of wining and dining. Let’s sit down to romance cryptocurrency over a candlelit dinner, and really get to know her.
Soon you will know exactly what cryptocurrency is, what it isn’t, where it came from, and where it’s going.
Definition of “Cryptocurrency”
At first glance, the strange-looking word contains a couple of clues that can be deciphered easily enough: “crypto” and “currency.”
Crypto: Taken from cryptography, this is the practice of encrypting plain text or data; converting it into an unrecognizable and unintelligible form of gibberish. Only its intended recipient is able to decrypt the information, offering two parties a confidential, secure means to exchange information or assets.
Currency: Traditionally, this word is most commonly associated with a nation’s money, but in reality, currency is any system of money used as a means to exchange value.
Put the two together, and lo and behold, you have cryptocurrency, a digital form of currency where cryptography regulates the generation of new funds as well as securing transactions.
So is cryptocurrency just an encrypted form of digital money?
You wouldn’t be wrong to ask this question, but the answer is a resounding no. To understand why and how cryptocurrency is so much more, let’s wind the clock back a few years.
Where Did Cryptocurrency Come From?
The thing is, cryptocurrency isn’t the first form of digital money. Attempts to create digital currencies started back in the early 90s, yet all of them failed to compete with plain old electronic bank money, or third-party systems like PayPal.
David Chaum paved the way for digital currency when he started DigiCash in 1989, an electronic network used to send currency anonymously. After the bankruptcy of DigiCash nearly a decade later, efforts like E-gold and Liberty Reserve also fell flat on their face after criminal charges. Soon enough, the very idea seemed about as far-fetched as a hoverboard.
Why did these all fail? A philosophical answer might be “you’ve got to crack a few eggs to make an omelette.” But a more plausible explanation is that the demand for digital currency simply wasn’t there, with ecommerce yet to hit the scene, let alone widespread internet access.
Fast-forward to 2008, when a mysterious figure known as Satoshi Nakamoto came up with an entirely different explanation: all of these systems were centralized and therefore based on trust. And according to the enigmatic Nakamoto, this was a big, big problem.
He went on to explain exactly why in a 2008 paper dubbed Bitcoin: A Peer-to-Peer Electronic Cash System. Breaking it down, Nakamoto highlighted two fundamental flaws: the workings of conventional finance systems, and the qualities of fiat currency itself (e.g., USD).
What’s the Problem with Regular Money?
You may not have considered this, but holding your assets in USD, GBP, EURO, AUD, CAD, or any other fiat puts you at the mercy of your government. Most fiat currencies once represented real, tangible assets in holding (such as gold), but those days have long passed and cash has no inherent value other than your faith in it. This is why they can be easily controlled, manipulated, and interfered with by the governments that produce them.
And indeed governments do; devaluing the currency as they churn out billions of new notes to curb inflation or toying with interest rates, and other unsavory activities. The 2008 global financial crisis and its aftermath is an example of how governments have the power to manipulate our money supply and economy.
The skullduggery of American banks led to the financial crisis, yet instead of punishment the banks received a $4 trillion allocation of credit from the US government. The Federal Reserve’s magical “Quantitative Easing” program allowed this by purchasing securities from the market in order to lower interest rates. The cost? Depriving the US economy of a natural economic recovery. Instead, the US government pumped borrowed money into the very institutions that caused the depression.
Given fiat currency itself is problematic, what about the centralized systems we use to store and transfer them? Systems such as banks, trust funds, and online payment merchants? They’re problematic as well.
Some of the issues with centralized systems include:
- Transactions can be reversed in the event of a dispute
- High transaction fees
- Fraud is an accepted reality of these systems
At the end of the day, all of these systems are based on trust. You are trusting that your chosen centralized bank and/or service will act fairly, ethically, transparently, and keep your assets safe at all times.
Can we say this is the case? Can we trust an economy controlled by governments and banks? Well, these questions weren’t satisfactorily answered before 2008 and the global financial crisis may very well have put the final nail in the coffin.
All in all, a trust-based system using fiat currency has more holes in it than Swiss cheese. But what’s the solution?
A system that is trustless, immutable, and decentralized. You guessed it: cryptocurrency.
The 3 Key Characteristics of a Cryptocurrency
The systems governing cryptocurrencies are trustless, meaning no third party is involved. They replace trust with verification; a peer-to-peer network where assets are fully possessed and controlled by each individual and sent directly to one another without the permission and control of a governing authority (e.g., a bank).
By its very nature, blockchain technology makes cryptocurrency transactions immutable. They cannot be undone, reversed, double-spent, hidden, or altered. There can be no cooking the books for foul play or human error, making cryptocurrency infinitely more transparent than plain old electronic bank money.
The creation of new cryptocurrency units are hardwired into the system of a cryptocurrency, unlike a nation’s government (or central authority) that can alter the value of fiat by pumping new currency into circulation or altering interest rates.
By design, new cryptocurrency is systematically and transparently created by the system. Take Bitcoin — its very infrastructure guarantees just 21 million units will ever exist versus the randomly expanding and contracting supply of fiat currencies like the Euro.
So How Does Cryptocurrency Work?
Having a conceptual solution is all very well, but how can cryptocurrencies achieve all of this? What’s the chef’s secret sauce?
Enter: blockchain, the breakthrough technology underpinning the entire crypto-revolution.
In plain English, a blockchain is a network of several thousand computers (a.k.a. nodes) that all share the same information — this is a distributed ledger. Each time a transaction takes place on the network, the majority of nodes must agree that transaction was legitimate, thus reaching consensus. Each block is then sealed securely with a number of historical transactions and linked to a fresh block.
As long as 51% of the nodes remain legitimate, you have a system that records transactions securely, free of bias or any foul play. Blockchains have a number of ways to incentivize their users to uphold the integrity of the network.
Bitcoin, for example, dishes out a portion of bitcoin to its miners, who solve computational puzzles to expand the network and verify transactions. This process is known as Proof-of-Work, but the game has changed and a number of alternate consensus mechanisms have emerged as new blockchains have been created. Some other consensus systems in use today are Proof-of-Stake (PoS), Byzantine Fault Tolerance (BFT), Directed Acrylic Graph (DAG), and Hybrid Consensus.
This is a simplistic explanation, but the point is that blockchain facilitates a decentralized, immutable, trustless network where transactions can’t be tampered with or double-spent.
Where do cryptocurrencies come into play? Cryptocurrencies are a means to transact within decentralized apps that are built on blockchains.
The Evolution of Cryptocurrency
Having come up with these three propositions and building a blockchain, Nakamoto became the founding father of the first cryptocurrency, Bitcoin. Mining the first block in January 2009, he wryly embedded it with the text: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.”
Bye-bye banks, hello Bitcoin.
Like any new disruptive technology, it took a frontrunner to open up the floodgates to innovation. Nearly ten years after Bitcoin’s invention, you’re looking at a whopping 1,500+ cryptocurrencies in circulation in a pool of $500 billion (at time of writing).
Competition is fierce as coins jostle to claim a bigger slice of the pie; but you’ll do well to remember the top 5 coins: Bitcoin, Ethereum, Ripple, Bitcoin Cash, and Litecoin, in order of market size. Take a look at the top 50 cryptocurrencies if you’re ready to bulk up on knowledge.
The basic of idea of Bitcoin is simple enough to wrap your head around, as first and foremost it is a means to store and exchange value. Yet, this is but the tip of the iceberg as cryptocurrencies have other nuanced uses and roles.
Bitcoin paved the way, but it wasn’t too long before innovators quickly dreamt up entirely new uses for cryptocurrency, perhaps many of which our old friend Satoshi couldn’t have imagined in his wildest dreams.
Take the second biggest cryptocurrency, Ethereum. As an early adopter of Bitcoin, Vitalik Buterin proposed this platform in 2013. Unlike Bitcoin, Ethereum was built to allow anyone to build dapps (decentralized apps) and execute smart contracts on the platform.
Bitcoin itself was the original dapp designed to serve a specific purpose (a decentralized peer-to-peer cash system with its own currency). Dapps must exist on a blockchain, much in the same way a PC program exists on an operating system such as Windows.
Instead of having to build a new blockchain every time someone wants to create a dapp, they can simply use Ethereum’s pre-existing framework. Imagine building a house from the ground up versus using a kit-set. While explaining Ethereum is a whole article in itself, you’ll do well to understand that Ethereum gave out the keys to the crypto-kingdom, allowing just about anybody to build their own cryptocurrencies and dapps without much trouble at all.
It should come as no surprise then that hundreds of cryptocurrencies are built on Ethereum, with individuals, institutions and start-ups coming up with all sorts of creative uses. It’s the path of least resistance.
Yet, many have done the heavy-lifting needed to create their own blockchains, such as NEM, NEO, Qtum, or Litecoin.
Why would they bother? While building your cryptocurrency or dapp on a pre-existing blockchain is less of a hassle, you’re limited by the platform’s capabilities. You’re still bound by the laws and limitations set out by that blockchain. That’s why, generally speaking, the projects with the most radical visions build their own blockchains.
The evolution of cryptocurrency use cases means that most cryptocurrencies in circulation today are essentially assets; representing a valuable commodity (the technological solutions they offer) instead of simply being a currency backed by faith in a government. Plus, the value of cryptocurrencies is likely to be volatile until they reach an established equilibrium in the global economy – this tends to make users hold onto them instead of spending them like a currency, further cementing their current status as assets.
What Can Cryptocurrency Be Used For?
We’ve come to terms with the fact that the likes of Bitcoin and Ethereum are revolutionary pieces of technology, but what are cryptocurrencies good for in reality?
What makes cryptocurrencies useful is not so much the things themselves, but the problems that they solve — the value that they provide to the end consumer. It’s no coincidence that the most valuable cryptocurrencies are innovators.
Take Bitcoin, which revolutionized the way we pay and store value, allowing us to send money to anyone, anytime, anywhere we please, without anybody’s permission.
Just like any great idea, there are a number of followers trying to one-up Bitcoin. Players like Litecoin, Dash, IOTA and Ripple quickly sped onto the scene – offering faster transaction speeds at lower cost, improved scalability, and superior efficiency (Bitcoin mining is rumored to chew up more electricity than Denmark).
While to some degree these altcoins compete to be the fairest payment system of them all, their subtle nuances see them take hold in different markets. Monero, for example, is a privacy-focused cryptocurrency with anonymous transactions — allowing businesses and individuals to maintain confidentiality around their sensitive transactions and keep their balances safe from prying eyes.
The first and most obvious usage of cryptocurrencies is payment, with a growing list of companies accepting bitcoin for goods and services, and bitcoin ATMs dotted around the globe. The race to make cryptocurrency a standard form of payment has begun, with crypto-debit cards like Bitpay allowing their holders to spend cryptos freely at Point-of-Sale terminals and withdraw from conventional ATMs.
While all of this is great, blockchain technology is no one-trick pony limited to finance. It can be used to solve myriad of problems existing in today’s digital world, and this is why hundreds of new projects have come out of the woodwork with some truly incredible ideas.
Following Ethereum, dozens of smart contract platforms are offering innovative solutions to problems plaguing agriculture, medicine, IT, logistics, and nearly any sector imaginable. Here’s a list of 25 industries set to be transformed by blockchain.
Sia, for example, allows you to rent out your unused hard drive space on their cloud storage platform; the Airbnb of cloud storage, if you will. In return for connecting that empty space of yours to the blockchain, you’ll be paid in Siacoin, their native cryptocurrency.
We should note here the difference between coins and tokens. Coins exist solely as a form of digital cash on their own blockchains. Bitcoin and Litecoin are examples of coins.
Tokens, on the other hand, sit on top of another blockchain and serve a number of purposes – such as representing a digital asset, a share, a payment for using a system, etc. Dragonchain, Waltonchain, and Civic are all ERC-20 tokens, meaning they exist on Ethereum’s blockchain and all serve their respective utilities.
While this is a lot to wrap your head around, it’s important to note that the use case for a cryptocurrency is absolutely key — if it has a practical use and solves an existing problem, it’s more likely to grow in value.
In saying that, plenty of gimmicky coins and tokens have made it much further than they should have. For one, Dogecoin was invented as a pointed joke — the joke being that anyone could create a cryptocurrency with no inherent value or real market utility. With a market cap of nearly $600 million (at the time of writing), this may just be the world’s most profitable joke.
In spite of some poor-quality (or gag) projects, it’s fair to say that cryptocurrencies do not exist independently, rather they depend on the value of the dapp, platform, or blockchain they are based on.
Once you make it past all the confusing jargon, you can start to see that cryptocurrency is, quite simply, a darn good idea. So why then are we ten years on, and still not buying burgers with bitcoin?
Challenges to Mass Adoption of Cryptocurrency
For all their revolutionary properties, the cryptocurrency industry faces a number of challenges which is making mass adoption a slow, somewhat painful process. Cryptos are still riding a bucking bronco that is slowly coming to terms with its rider. Let’s break down the biggest hurdles that cryptocurrency must overcome to gain mass approval and adoption.
With any means of payment, stability is absolutely paramount. The volatility of most cryptocurrencies is hair-raising at best, with values spiking and plummeting in a matter of minutes. This may be exhilarating for prospective investors, but your average merchant or consumer won’t touch cryptocurrencies with a ten-foot pole, as long as they cannot be confident in their value.
Speed and transaction costs are another thorn in the side of mass adoption, with few coins being able to beat Point-of-Sale systems such as Visa. For instance, Bitcoin currently has an average transaction time of an hour and fees upwards of $15. This makes Bitcoin useless for everyday transactions, both hopelessly slow and too costly for small purchases. Not to mention the scalability problem, which is the ability of networks to handle a large number of users and transactions at any one time.
Next there comes the question of security. There’s been a large number of multi-million-dollar exchange hacks, like the Mt Gox hack, resulting in millions stolen. Plus it’s all too common for users to simply misplace their funds accidentally. While cryptocurrencies themselves are incredibly secure, best practices are still developing. Think about email — it took decades for users to eliminate the worries of spam, hacks, and phishing.
Aside from issues with the technology itself, the way that new cryptocurrencies raise funds has caused increased scrutiny and led to talk of regulation. China and South Korea have suspended Initial Coin Offerings (ICOs), and a number of other nations may well follow suit, some with more permanent measures.
Why? Unfortunately, a few bad players have cooked up support for their new coins, received funds from around the globe, and vanished into the sunset. Legitimacy is key for the acceptance of cryptocurrencies, because these cowboy-style antics are giving cryptos a bad reputation and causing skepticism about its long-term viability.
Even after ICOs are regulated, there is the question of the legality of usage. Uncle Sam, John Bull, or any other government won’t be happy if their citizens are using cryptocurrencies to evade tax or fund criminal activities.
The Future of Cryptocurrency
We can poke as many holes in it as we want, but the boat is still floating. Each and every one of the above challenges has more than one solution on the horizon, with some of the best minds in the world working around the clock to solve them.
The technological challenges seem to be the easiest to overcome. Recent additions such as IOTA appear to have it all, boasting unlimited scalability, and nearly instant transactions with no cost. So-called ‘stable coins’ are solving the volatility issue, with different ingenious methods to create a cryptocurrency that doesn’t fluctuate in value. Security measures are being beefed up, with exchanges like NEX making Fort Knox look like a playground.
In spite of all this rapid progress, at the end of the day it is largely up to those in power to decide the role that cryptocurrencies will play in global society. For now, they stand awkwardly trembling in the spotlight, as if waiting for Simon Cowell’s begrudged yay or spectacularly vitriolic nay.
Luckily, one thing that is crystal clear to governments is that cryptocurrencies have a titanic amount of value, much of which is yet to be realized. As trillions of dollars flow into the crypto-economy, other nations are likely to quickly follow suit as they attempt to cash in and get in on the action.
Where there’s money, the taxman will come knocking — as the economy develops, investors, corporations, and users will be subject to new regulations by governments. It is inevitable that we will move on from the frenetic anarchy of unregulated ICOs, and a number of nations are already laying the groundwork to make this happen.
While China and South Korea are taking a breather court-side, Switzerland has just released guidelines that build out the legal framework for having an ICO. The race to become the most crypto-friendly nation has begun.
This is where things get exciting. Once the bureaucrats have shuffled their papers and given the thumbs-up, businesses of all shapes and sizes will be jumping on the bandwagon with all the ardent determination of a reality show contestant. Naturally, the infrastructure will follow as governments, banks, merchants, corporations and technology providers build the framework that will see your grandma buying her Christmas crackers with crypto in no time.
The lights are dimming, so you’d better take a front-row seat. It may take months, years, or even decades before mass adoption, but cryptocurrency is the star actor in a show you really don’t want to miss.
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