A cryptocurrency is a digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of this security feature. Many cryptocurrencies are decentralized systems based on blockchain technology, a distributed ledger enforced by a disparate network of computers. A defining feature of a cryptocurrency, and arguably its biggest allure, is its organic nature; it is not issued by any central authority, rendering it theoretically immune to government interference or manipulation.
The first blockchain-based cryptocurrency was Bitcoin, which still remains the most popular and most valuable. Today, there are thousands of alternate cryptocurrencies with various functions or specifications. Some of these are clones of Bitcoin while others are forks, or new cryptocurrencies that split off from an already existing one.
Table of contents:
- 1 A General Description of Cryptocurrency
- 2 What’s Behind Bitcoin: Blockchain Technology
- 3 What are cryptocurrencies really?
- 4 The Origin of Cryptocurrency
- 5 Why should I use cryptocurrency?
- 6 Legality of cryptocurrencies
- 7 Cryptocurrency Benefits and Drawbacks
- 8 Future of cryptocurrency
A General Description of Cryptocurrency
Cryptocurrency is a lot like the theoretical rock currency described above:
- Every cryptocurrency has a public ledger that contains the past and present ownership of each coin.
- If you want to make transaction, you simply broadcast to the cryptocurrency’s network that you’re transferring ownership of some cryptocurrency of yours to someone else.
- The network then spends computational power on both verifying your transaction (that you do own the cryptocurrency your spending and that you haven’t spent it before), and adding it to the ledger.
- In the process, this computational time and effort creates new cryptocurrency as a reward to the community members who helped make the transaction possible.
Below is a list of six things that every cryptocurrency must be in order for it to be called a cryptocurrency;
- Digital: Cryptocurrency only exists on computers. There are no coins and no notes. There are no reserves for crypto in Fort Knox or the Bank of England!
- Decentralized: Cryptocurrencies don’t have a central computer or server. They are distributed across a network of (typically) thousands of computers. Networks without a central server are called decentralized networks.
- Peer-to-Peer: Cryptocurrencies are passed from person to person online. Users don’t deal with each other through banks, PayPal or Facebook. They deal with each other directly. Banks, PayPal and Facebook are all trusted third parties. There are no trusted third parties in cryptocurrency! Note: They are called trusted third parties because users have to trust them with their personal information in order to use their services. For example, we trust the bank with our money and we trust Facebook with our holiday photos!
- Pseudonymous: This means that you don’t have to give any personal information to own and use cryptocurrency. There are no rules about who can own or use cryptocurrencies. It’s like posting on a website like 4chan.
- Trustless: No trusted third parties means that users don’t have to trust the system for it to work. Users are in complete control of their money and information at all times.
- Encrypted: Each user has special codes which stop their information from being accessed by other users. This is called cryptography and it’s nearly impossible to hack. It’s also where the crypto part of the crypto definition comes from. Crypto means hidden. When information is hidden with cryptography, it is encrypted.
- Global: Countries have their own currencies called fiat currencies. Sending fiat currencies around the world is difficult. Cryptocurrencies can be sent all over the world easily. Cryptocurrencies are currencies without borders!
This crypto definition is a great start but you’re still a long way from understanding cryptocurrency. Next, I want to tell you when cryptocurrency was created and why. I’ll also answer the question ‘what is cryptocurrency trying to achieve?’
Terms you may encounter with cryptocurrencies
- 51% attack. An attack on the blockchain, whereby a group of miners controls more than half of a network’s computing power and can refuse to verify transactions and pay users. It hasn’t happened, but it’s a possibility discussed in the market.
- Block. Each record or series of records on the blockchain.
- Block reward. An amount of bitcoin given to the person who adds a new block to the blockchain.
- Blockchain. A digital public ledger on which the entire history of a cryptocurrency is recorded.
- Proof of stake. A system that replaces the concept of “mining” with a consensus algorithm, whereby miners put up a stake of their currency to verify a block of transactions.
- Proof of work. A hash that is so difficult, it could only have been solved through significant work or power.
What’s Behind Bitcoin: Blockchain Technology
In the most basic terms, blockchain is a type of digitized and public ledger. Bicoin uses blockchain technology to maintain information on how much Bitcoin is owned and who owns it. Rather than possessing physical currency, or even a digital file that’s representative of the currency, individuals have a claim to a piece of information contained in the blockchain ledger.
So when a Bitcoin transaction is made, the currency is transferred between parties as a block of information that gets added to the historical chain of transaction data. This “ledger” is a public file—anyone can download a copy of it. Individual’s identities are encrypted, however, and this feature of the technology is among the many reasons it is so highly touted.
Just as Bitcoin and cryptocurrencies are gaining in stature, blockchain is expected emerge as an important technology with a wide array of potential applications, too. Blockchain could be used in everything from expedited transfer of title in real estate sales to international transactions—not to mention those that haven’t even been thought of yet.
So while the outlook for both cryptocurrencies and blockchain aren’t entirely well defined and the concepts may initially be difficult to grasp, one thing is likely: consumers of all stripes can be sure that these technologies will likely impact the financial futures of consumers of all stripes in the years to come.
What are cryptocurrencies really?
If you take away all the noise around cryptocurrencies and reduce it to a simple definition, you find it to be just limited entries in a database no one can change without fulfilling specific conditions. This may seem ordinary, but, believe it or not: this is exactly how you can define a currency.
Take the money on your bank account: What is it more than entries in a database that can only be changed under specific conditions? You can even take physical coins and notes: What are they else than limited entries in a public physical database that can only be changed if you match the condition than you physically own the coins and notes? Money is all about a verified entry in some kind of database of accounts, balances, and transactions.
How miners create coins and confirm transactions
Let‘s have a look at the mechanism ruling the databases of cryptocurrencies. A cryptocurrency like Bitcoin consists of a network of peers. Every peer has a record of the complete history of all transactions and thus of the balance of every account.
A transaction is a file that says, “Bob gives X Bitcoin to Alice“ and is signed by Bob‘s private key. It‘s basic public key cryptography, nothing special at all. After signed, a transaction is broadcasted in the network, sent from one peer to every other peer. This is basic p2p-technology. Nothing special at all, again.
The transaction is known almost immediately by the whole network. But only after a specific amount of time it gets confirmed.
Confirmation is a critical concept in cryptocurrencies. You could say that cryptocurrencies are all about confirmation.
As long as a transaction is unconfirmed, it is pending and can be forged. When a transaction is confirmed, it is set in stone. It is no longer forgeable, it can‘t be reversed, it is part of an immutable record of historical transactions: of the so-called blockchain.
Only miners can confirm transactions. This is their job in a cryptocurrency-network. They take transactions, stamp them as legit and spread them in the network. After a transaction is confirmed by a miner, every node has to add it to its database. It has become part of the blockchain.
For this job, the miners get rewarded with a token of the cryptocurrency, for example with Bitcoins. Since the miner‘s activity is the single most important part of cryptocurrency-system we should stay for a moment and take a deeper look on it.
What are miners doing?
Principally everybody can be a miner. Since a decentralized network has no authority to delegate this task, a cryptocurrency needs some kind of mechanism to prevent one ruling party from abusing it. Imagine someone creates thousands of peers and spreads forged transactions. The system would break immediately.
So, Satoshi set the rule that the miners need to invest some work of their computers to qualify for this task. In fact, they have to find a hash – a product of a cryptographic function – that connects the new block with its predecessor. This is called the Proof-of-Work. In Bitcoin, it is based on the SHA 256 Hash algorithm.
You don‘t need to understand details about SHA 256. It‘s only important you know that it can be the basis of a cryptologic puzzle the miners compete to solve. After finding a solution, a miner can build a block and add it to the blockchain. As an incentive, he has the right to add a so-called coinbase transaction that gives him a specific number of Bitcoins. This is the only way to create valid Bitcoins.
Bitcoins can only be created if miners solve a cryptographic puzzle. Since the difficulty of this puzzle increases the amount of computer power the whole miner’s invest, there is only a specific amount of cryptocurrency token that can be created in a given amount of time. This is part of the consensus no peer in the network can break.
The Origin of Cryptocurrency
In the early 1990s, most people were still struggling to understand the internet. However, there were some very clever folks who had already realised what a powerful tool it is
Some of these clever folks, called cypher punks, thought that governments and corporations had too much power over our lives. They wanted to use the internet to give the people of the world more freedom. Using cryptography, cypher punks wanted to allow users of the internet to have more control over their money and information. As you can tell, the cypher punks didn’t like trusted third parties at all.
At the top of the cypher punks to-do list was digital cash. DigiCash and Cybercash were both attempts to create a digital money system. They both had some of the six things needed to be cryptocurrencies but neither had all of them. By the end of the
nineties, both had failed.
The world would have to wait until 2009 before the first fully decentralized digital cash system was created. Its creator had seenthe failure of the cypher punks and thought that they could do better. Their name was Satoshi Nakamoto and their creation was called Bitcoin.Understanding cryptocurrency means first understanding Bitcoin…
The Story of Bitcoin
No one knows who Satoshi Nakamoto is. It could be a man, a woman or even a group of people. Satoshi Nakamoto only ever spoke on crypto forums and through emails.
In late 2008, Nakamoto published the Bitcoin whitepaper. This was a description of what Bitcoin is and how it works. It became the model for how other cryptocurrencies were designed in the future.
On January 12, 2009, Satoshi Nakamoto made the first Bitcoin transaction. They sent 10 BTC to a coder named Hal Finney. By 2011, Satoshi Nakamoto was gone. What they left behind was the world’s first cryptocurrency.
Bitcoin became more popular amongst users who saw how important it could become. In April 2011, one Bitcoin was worth one US Dollar (USD).
By December 2017, one Bitcoin was worth more than twenty thousand US Dollars! Today, the price of a single Bitcoin is 4,550 US Dollars. Which is still a pretty good return, right?
Why should I use cryptocurrency?
You already use debit cards and credit cards — two tools that “digitize” your dollars, pounds or euros. But there are a few advantages to using cryptocurrency over your standard government-issued currency.
- Low transaction fees. Because miners are simply rewarded cryptocurrency from the network itself, there are typically little to no fees for core transactions.
- Ownership. With your digital key, access to your currency is yours alone. Unlike money you store at a bank, your use of your cryptocurrency cannot be frozen or limited by any entity.
- Identity protection. Paying with credit or debit cards requires submitting sensitive banking information that could be stolen or compromised. Cryptocurrency can be sent directly to a recipient without any information other than total amount you want to send.
- Accessibility. Billions of people can access the Internet, but not everyone has access to banks or money exchange systems. Cryptocurrency requires no bank or line of credit to make or receive payments electronically.
- Risk-free for sellers. Payments using cryptocurrency can’t be reversed, which means merchants don’t have to worry about stopped payments. The blockchain makes it difficult for you to be defrauded.
How can I buy and use cryptocurrency?
Cryptocurrency is a volatile market, with exchange rates that can wildly fluctuate by day, and sometimes by hour. Bitcoin is the better-known and most valuable cryptocurrency out there, but there are many others to explore, including litecoin, ethereum, dogecoin, monero and ripple.
How to buy
There are a lot of different options when it comes to buying Bitcoins. For example, there are currently almost 4,000 Bitcoin ATMs in 58 countries. Moreover, you can buy BTC using gift cards, cryptocurrency exchanges, investment trusts and you can even trade face-to-face.
When it comes to other, less popular cryptocurrencies, the buying options aren’t as diverse. However, there are still numerous exchanges where you can acquire various crypto-coins for flat currencies or Bitcoins. Face-to-face trading is also a popular way of acquiring coins. Buying options depend on particular cryptocurrencies, their popularity as well as your location.
How to store
Unlike most traditional currencies, cryptocurrencies are digital, which entails a completely different approach, particularly when it comes to storing it. Technically, you don’t store your units of cryptocurrency; instead it’s the private key that you use to sign for transactions that need to be securely stored.
There are several different types of cryptocurrency wallets that cater for different needs. If your priority is privacy, you might want to opt for a paper or a hardware wallet. Those are the most secure ways of storing your crypto funds. There are also ‘cold’ (offline) wallets that are stored on your hard drive and online wallets, which can either be affiliated with exchanges or with independent platforms.
When you buy or receive cryptocurrency, you are given a digital key to the address of that currency. You can use this key to access and validate or approve transactions.
You need a place to keep your key safe, which is where a cryptocurrency wallet comes in.
You have a variety of cryptocurrency wallets to choose from:
- Desktop wallets. Software like Cryptonator allows you to send and store cryptocurrency addresses and also connects to the network to track transactions.
- Online wallets. Cryptocurrency keys are stored online by exchange platforms like Coinbase or Circle and can be accessed from anywhere.
- Mobile wallets. Apps like Blockchain store and encrypt your bitcoin keys so that you can make payments using your mobile device.
- Paper wallets. Some websites offer paper wallet services, generating a piece of paper with two QR codes on it. One code is the public address at which you receive cryptocurrency, and the other is your private address you can use for spending.
- Hardware wallets. You can use a USB device created specifically to store bitcoin electronically and your private address keys.
Are there drawbacks to using cryptocurrency?
Aside from the difficulty of understanding the concept of cryptocurrency itself, there are a few drawbacks to using it:
- General awareness. More people and businesses are starting to accept cryptocurrency, but it’s a small number compared to those accepting debit and credit cards.
- Volatility. Cryptocurrency exchange rates can vary greatly. Which means the amount you pay or receive one day could be wildly different the next. The market should eventually settle down, but it’s hard to predict where the rates will be.
- Newness. Even popular bitcoin is new and growing. It could take time before the various cryptocurrencies reach their potential. Similarly, some may fall by the wayside, while others come to dominate the market.
Legality of cryptocurrencies
As cryptocurrencies are becoming more and more mainstream, law enforcement agencies, tax authorities and legal regulators worldwide are trying to understand the very concept of crypto coins and where exactly do they fit in existing regulations and legal frameworks.
With the introduction of Bitcoin, the first ever cryptocurrency, a completely new paradigm was created. Decentralized, self-sustained digital currencies that don’t exist in any physical shape or form and are not controlled by any singular entity were always set to cause an uproar among the regulators.
A lot of concerns have been raised regarding cryptocurrencies’ decentralized nature and their ability to be used almost completely anonymously. The authorities all over the world are worried about the cryptocurrencies’ appeal to the traders of illegal goods and services. Moreover, they are worried about their use in money laundering and tax evasion schemes.
As of November 2018, Bitcoin and other digital currencies are outlawed only in Bangladesh, Bolivia, Ecuador, Kyrgyzstan and Vietnam, with China and Russia being on the verge of banning them as well. Other jurisdictions, however, do not make the usage of cryptocurrencies illegal as of yet, but the laws and regulations can vary drastically depending on the country.
Cryptocurrency Benefits and Drawbacks
Cryptocurrencies hold the promise of making it easier to transfer funds directly between two parties in a transaction, without the need for a trusted third party such as a bank or credit card company; these transfers are facilitated through the use of public keys and private keys for security purposes. In modern cryptocurrency systems, a user’s “wallet,” or account address, has the public key, and the private key is used to sign transactions. Fund transfers are done with minimal processing fees, allowing users to avoid the steep fees charged by most banks and financial institutions for wire transfers.
Central to the appeal and function of Bitcoin is the blockchain technology it uses to store an online ledger of all the transactions that have ever been conducted using bitcoins, providing a data structure for this ledger that is exposed to a limited threat from hackers and can be copied across all computers running Bitcoin software. Every new block generated must be verified by the ledgers of each user on the market, making it almost impossible to forge transaction histories. Many experts see this blockchain as having important uses in technologies such as online voting and crowdfunding, and major financial institutions such as JPMorgan Chase see potential in cryptocurrencies to lower transaction costs by making payment processing more efficient. However, because cryptocurrencies are virtual and do not have a central repository, a digital cryptocurrency balance can be wiped out by a computer crash if a backup copy of the holdings does not exist, or if somebody simply loses their private keys. At the same time, there is no central authority, government, or corporation that has access to your funds or your personal information.
The semi-anonymous nature of cryptocurrency transactions makes them well-suited for a host of nefarious activities, such as money laundering and tax evasion. However, cryptocurrency advocates often value the anonymity highly. Some cryptocurrencies are more private than others. Bitcoin, for instance, is a relatively poor choice for conducting illegal business online, and forensic analysis of bitcoin transactions has led authorities to arrest and prosecute criminals. More privacy-oriented coins do exist, such as Dash, ZCash, or Monero, which are far more difficult to trace.
Since prices are based on supply and demand, the rate at which a cryptocurrency can be exchanged for another currency can fluctuate widely. However, plenty of research has been undertaken to identify the fundamental price drivers of cryptocurrencies. Bitcoin has indeed experienced some rapid surges and collapses in value, reaching as high as $19,000 per bitcoin in December of 2017 before returning to around $7,000 in the following months. Cryptocurrencies are thus considered by some economists to be a short-lived fad or speculative bubble. There is concern especially that the currency units, such as bitcoins, are not rooted in any material goods. Some research has identified that the cost of producing a bitcoin, which takes an increasingly large amount of energy, is directly related to its market price.
Cryptocurrencies’ blockchains are secure, but other aspects of a cryptocurrency ecosystem are not immune to the threat of hacking. In Bitcoin’s almost 10-year history, several online exchanges have been the subject of hacking and theft, sometimes with millions of dollars worth of ‘coins’ stolen. Still, many observers look at cryptocurrencies as hope that a currency can exist that preserves value, facilitates exchange, is more transportable than hard metals, and is outside the influence of central banks and governments.
Future of cryptocurrency
Bill Gates, co-founder of Microsoft, investor and philanthropist:
“Bitcoin is exciting because it shows how cheap it can be. Bitcoin is better than currency in that you don’t have to be physically in the same place and, of course, for large transactions, currency can get pretty inconvenient.” [SOURCE]
Richard Branson, founder of Virgin Galactic and more than 400 other businesses:
“Well, I think it is working. There may be other currencies like it that may be even better. But in the meantime, there’s a big industry around Bitcoin. — People have made fortunes off Bitcoin, some have lost money. It is volatile, but people make money off of volatility too.” [SOURCE]
Al Gore, former Vice President of the United States:
“When Bitcoin currency is converted from currency into cash, that interface has to remain under some regulatory safeguards. I think the fact that within the Bitcoin universe an algorithm replaces the function of the government …[that] is actually pretty cool.” [SOURCE]
Eric Schmidt, executive chairman of Google:
“[Bitcoin] is a remarkable cryptographic achievement… The ability to create something which is not duplicable in the digital world has enormous value…Lot’s of people will build businesses on top of that.” [SOURCE]
Peter Thiel, co-founder of PayPal:
“PayPal had these goals of creating a new currency. We failed at that, and we just created a new payment system. I think Bitcoin has succeeded on the level of a new currency, but the payment system is somewhat lacking. It’s very hard to use, and that’s the big challenge on the Bitcoin side.” [SOURCE]
Do let me know your thoughts in the comments below!
And if you find this post useful, do share it with your friends on Facebook & Twitter!