Education

What is a Cryptocurrency?

what is cryptocurrency

Today cryptocurrencies have become a general phenomenon of which most people are aware. While its technicality is still mysterious to most people, government, banks and many companies are aware of its significance. Currently, you’ll hardly find a big accounting firm, a prominent software company, or a major bank that did not research cryptocurrencies, publish an article about it or start a blockchain project.

Who could have thought that the first instance of payment in Bitcoin was used to pay for a double pizza order for a staggering amount of 10,000 BTC, which is worth around $70 million at time of writing? Who could have anticipated that Ethereum, barely known by investors just several years ago would surge above 5000% in 2017? We all know that by now but few of us grasp what cryptocurrencies actually are.

Cryptocurrencies, or also known as virtual currencies are means of digital exchange. Created by groups of highly skilled technical specialists, cryptocurrencies sparked interest of millions of people worldwide in recent decade.  Cryptocurrencies are not regulated by governments and central banks and therefore are not prone to inflation. They exist completely beyond the framework of state or global monetary policy. Bitcoin emerged as the world’s first cryptocurrency in 2009 and sparked a real boom in the field, with more than 1300 cryptocurrencies existing and more being issued every month. Many of them prove to be short-lived and fail to gain any solid footing among investors while others, like Antshare or Cardano, register solid gains  and even challenge to outperform Bitcoin in the near future.  Optimists believe cryptocurrencies are breaking new ground for much brighter future with no banks as intermediaries of financial operations which could bring financial spectrum to completely new level, free from  manipulative state policies that create inflation and disrupt people’s savings. On the other hand, others are skeptical about cryptocurrencies and believe them to be an over-inflated bubbles bound to collapse in the near future,  with far more devastating consequences for investors than even the most pessimistic forecasts suggest.

Cryptocurrencies are fully decentralized. There is no bank or any government-affiliated party that controls its release. Instead, complex algorithms built within the technology control the supply and value of cryptocurrencies. The main party responsible for smooth and stable operation of the technology are miners, but there is hardly any degree of centralization in their activities. They utilize strong computational power to solve complex cryptographic tasks and keep track of all transactions by adding blocks to the blockchain, a technology which all cryptocurrencies are built upon. In return, they receive new units of cryptocurrency and transaction fees paid by other users in the system.

Importantly, cryptocurrencies are exchangeable for fiat currencies in particular online markets, meaning that each has a variable exchange rate with one of the major world currencies (such as the U.S. dollar, European euro, British pound, and Japanese yen). Exchanges provide user-friendly platforms and act as intermediaries between buyers and sellers of cryptocurrency. Exchanges may be slightly vulnerable to hacking, so choose your broker wisely and do not rush to cryptocurrency investment at the first thought that crosses your mind.

Another good thing about cryptocurrencies is that it’s supply is finite which is implied within their source code. This fully explains why mining is getting harder and harder for miners. For instance, some Bitcoin specialists suggest that at some time in the near future miners will no longer be able to get new units of cryptocurrency, as no computational power will have the capacity to solve new blocks in the chain. Here one can trace some similarities with Gold and Silver, which have limited supply and tend to increase in value over time. This makes them virtually invulnerable to devaluation or any interference from state and banking institutions that implement predatory policies to the detriment of account holders. For example, whereas a government can easily freeze or even seize a bank account that is located in its jurisdiction, such action cannot be taken against the holder of cryptocurrency due to decentralized nature and anonymity of all transactions.

On the other hand, cryptocurrencies have gained a notorious reputation as payment for black market operations and main payment option within the deep and dark web. That is why many people are still treating them with caution. A long debate between opponents and proponents of cryptocurrencies is far from over, but the bare facts of 2017 make it very likely that much more is about to come.

Whether any of the given claims is true remains to be seen, but what remains true is the fact that unprecedented growth of cryptocurrencies in 2017 granted many a status of self-made millionaire.

But besides the press releases and the noise, most people – even scientists, bankers, consultants, and developer have a very little knowledge about cryptocurrencies. They often fail even to understand the basic concepts.

So let‘s go through the full story. What is cryptocurrency?

  • -Where did cryptocurrency originate?
  • How does cryptocurrency work?
  • – Why should you learn about cryptocurrency?
  • what is virtual currency?
  • – What are the things you need to know about cryptocurrency?

How cryptocurrencies began as a side product of digital currency

Not many people know, but cryptocurrencies started out as a side product of a different invention. Satoshi Nakamoto, the mysterious inventor of the first and still most important cryptocurrency, Bitcoin, never meant to create a currency.

Satoshi, in his announcement of Bitcoin in late 2008, said he invented “A Peer-to-Peer Electronic Cash System.”  He aimed at developing something many people failed to create, which is digital cash.

The single most essential part of Satoshi‘s discovery was that he found a way to create a decentralized digital currency system. Decades ago, there have been many attempts to develop digital money, but they all failed. After seeing all the failure of the centralized financial system, Satoshi tried to create a digital cash system without a central authority. Some sort of Peer-to-Peer network for sharing files.

This decision gave birth to cryptocurrency. They are the piece Satoshi discovered in his digital cash concept. The reason why is somewhat technical and complicated, but if you understand it, you‘ll know more about cryptocurrency definition, and the cryptocurrency space generally than most people do. So, we will try to make it as simple as possible:

You need a payment network with accounts, balances, and transaction to realize digital cash. That‘s easy to know. One main problem every payment network has to tackle is to prevent double spending: to make sure that one entity doesn’t spend the same amount twice. This is typically done by a central server which keeps a record of the balances.

However, you don‘t have this server in a decentralized network. So you need every single member of the network to get this done. Each peer in the network needs to have a list of all transactions to check an attempt to double spend, or if future transactions are valid.

But how can these peers maintain a consensus about these records?

If the peers of the network do not agree about only one particular, minor balance, everything is destroyed. They need a unanimous consensus. Usually, you take, a central entity to report the correct state of balances. But how can you accomplish consensus without a central entity?

Nobody knew until Satoshi came out of nowhere. In fact, nobody thought it was even possible. Satoshi Nakamoto proved it was possible. His major achievement was to realize consensus without a central entity. The bitcoin cryptocurrency and other altcoins are a part of this solution, which really made the solution thrilling, captivating and helped it to spread over the world

What are cryptocurrencies?

If you remove all the hype around cryptocurrencies and reduce it to a simple deduction, you will discover it’s just limited entries in a database no one can alter without meeting certain conditions. This may appear ordinary, but, believe it or not: this is precisely how anyone can define a currency.

Let’s take the money on your bank account as an example; it’s merely entries in a database that can only be modified under certain conditions. Even physical coins and notes are limited entries in a public physical database that can only be modified if you meet the requirement that you physically own the coins and notes. Money, in the real sense, is all about a verified entry in some database of accounts, transactions, and balances.

How miners create coins and confirm transactions

Let us take a look at the primary process ruling the cryptocurrency database. Bitcoin and other cryptocurrencies consist of a network of peers. Every peer has a record of the full history of all transactions and therefore of the balance of each account.

A transaction is simply a file that states, “Bob gives Q Bitcoin to Alice” And Bob signed it with his private key. It is nothing but a basic public key cryptography. After approved, a transaction is distributed in the network, sent from one peer to each other peer. Again, this nothing special at all, just a basic p2p-technology.

The whole network is made aware of the transaction almost immediately. But it gets confirmed only after a specific amount of time. Confirmation is a crucial notion in cryptocurrencies. Or better still, cryptocurrencies are all about confirmation.

A transaction remains pending and can be forged as long as it is unconfirmed. But a transaction is set in stone and can never be reversed once it is confirmed. It becomes a part of a permanent record of historical transactions of the so-called blockchain, and it is no longer forgeable.

Miners are the only members of the network that can confirm transactions. This is their primary task in the crypto-network. They confirm transactions are legit and distribute them on the network. After a miner confirms a transaction, each node has to enter it into its database. It has become part of a public ledger known as the blockchain.

For this task, the miners get compensated with an amount of cryptocurrency, for instance with Bitcoins. Since the miner‘s activity is the most critical part of crypto-space we should take a moment and take a more in-depth look at it.

What are miners doing?

Basically, anybody can be a miner. Since a decentralized network has no central entity to assign this task, a cryptocurrency needs some mechanism in place so that no ruling party can abuse it. Imagine someone develops thousands of peers and distributes forged transactions. The system would crumble instantly.

So, Satoshi made a law that the miners must invest some work of their computers to qualify for this responsibility. In fact, they have to find the product of a cryptographic function (a hash) that links the new block with its forerunner. This is referred to as the Proof-of-Work protocol. It is based on the SHA 256 Hash algorithm in Bitcoin.

You don‘t need to know the details of SHA 256. It‘s only necessary you understand that it can be the foundation of a cryptologic problem the miners compete to solve. After getting a solution, a miner can create a block and enter it to the blockchain ledger. As a reward, the miner has the right to add a ‘coinbase’ transaction that gives him a certain amount of Bitcoins. This is the only way valid Bitcoins can be created.

Miners can only create bitcoins if a cryptographic problem is solved. There is only a certain amount of cryptocurrency token that can be created in a given period, as the difficulty of this cryptographic puzzle increases the amount of computer power and electrical energy consumed. No peer in the network can break this is part of the consensus.

Revolutionary properties

If you really think of it, Bitcoin is more of a currency than the numbers you see in your bank account, as it is a decentralized network of peers which keep a consensus about accounts and balances. Besides, those numbers in your bank account are nothing more than a database which can be modified by people you don‘t see and by rules you know nothing about.

Cryptocurrencies are basically records of a token in decentralized consensus-databases. They are referred to as crypto-currencies because strong cryptography secures the process of keeping consensus. Cryptography is the basis of cryptocurrency. They secured by mathematics, and not by people or by trusts. It is more likely that an asteroid drop on your building than that a bitcoin address is jeopardized.

To clearly define the properties of cryptocurrencies we need to set apart the monetary and transactional properties. While most digital currencies share a standard set of features, they are not carved in stone.

Transactional properties:

1.) Irreversible: A transaction can never be reversed after confirmation. By nobody. Not you, not Satoshi, not the US president, not your bank, not even your miner. Nobody. Once you send money, you send. If you sent your funds to a scammer or if a hacker stole them from your computer, no one can help you get them back. There is no safety net here.

2.) Pseudonymous: Transactions and accounts are not traceable to users identities. You only need a randomly looking chain of about 30 characters, known as addresses to get Bitcoins. While analyzing the transaction flow is usually possible, it is not possible to connect users’ real-world identities with those addresses.

3.) Fast and global: Transactions are executed almost instantly in the network and are confirmed in some minutes. Since they take place in a global network of computers, they are utterly indifferent of your geographical location. It doesn‘t matter if I send Bitcoin to my neighbor or someone on the other side of the globe.

4.) Secure: Digital assets are secured in a public key cryptography system. The owner of the private key can only send cryptocurrency. This scheme is impossible to break as a result of the magic of big numbers and strong cryptography. The security of a bitcoin address is higher than that of Fort Knox.

5.) Permissionless: You don‘t need anybody’s permission to use cryptocurrency. It‘s just free software that everybody can download. You can send and receive Bitcoins or other cryptocurrencies after installation. No one can stop you. There is no guard.

Monetary properties:

 1.) Capped supply: The supply of most digital currencies tokens are limited. For instance, in Bitcoin, which is the most popular cryptocurrency, the supply decreases steadily and will reach its final number in 2140. All cryptocurrencies use a schedule written in code to control the supply of the token. This implies the monetary supply of a cryptocurrency in any period in the future can roughly be estimated today.

2.) No debt only beares: Debt creates the Fiat currency on your bank account and the numbers that are written on your ledger stand for nothing but debts. It is some sort of IOU system. However, digital currencies don’t represent debts. They only portray themselves. They are money as tangible as gold coins.

You need to consider both properties in order to understand the revolutionary impact of cryptocurrencies. Bitcoin’s permissionless, pseudonymous, and irreversible nature makes it a threat to the control of governments and banks over the monetary transactions of their citizens. You can‘t prevent someone from using Bitcoin; you can‘t stop someone from accepting payment, you can‘t reverse a transaction.

Cryptocurrencies defile the law of the monetary policy since they are money with a capped supply that is not modifiable by a bank, a government, or any other central entity. They take away the influence central banks have on inflation or deflation by controlling the monetary supply.

Cryptocurrencies: The rise of a new economy

As a result of their revolutionary properties, digital assets have become a breakthrough their creator, Satoshi Nakamoto will find quite startling. While every other effort to develop a digital cash system didn‘t draw a critical mass of users, Bitcoin had something that stirred fascination and enthusiasm. It seems more like religion than technology sometimes.

Cryptocurrencies are pure gold in digital format. Cool cash that is secure from political manipulation. Money that guarantees to preserve and grow its worth over time. Digital currencies are also a fast and easy means of payment with a global scope, and they are anonymous and private enough to serve as a means of payment for black markets and any other illegal economic venture.

Even though cryptocurrencies are more used as means of payment, its use as a medium of speculation and a store of value surpasses the payment parts.

Cryptocurrencies created an astonishingly dynamic, fast-growing market for speculators and investors. Exchange platforms such as Poloniex, Okcoin or Shapeshift facilitates the trade of hundreds of digital currencies. Their daily trade volume overshadows that of major European stock exchanges.

Simultaneously, the praxis of Initial Coin Offering, mostly promoted by Ethereum smart contracts, gave life to amazingly successful crowdfunding schemes, in which often an idea is enough to raise millions of money. In the case of “The DAO,” it has been over $150 million.

You experience incredibly high volatility in this rich ecosystem of coins and tokens.  It‘s natural that a digital currency gains 10 percent today – sometimes 100 percent – just to lose the same tomorrow. If you are fortunate, your coin‘s value surges up to 1000 percent in one week or two.

While Bitcoin still retains its place as the most famous digital currency and most other altcoins have zero non-speculative influence, users and investors should watch out for several other cryptocurrencies.

Below are the current most popular cryptocurrencies.

Bitcoin

Also referred to as the ‘Grandfather of cryptocurrencies,’ bitcoin is the first and most famous of all digital assets. In the whole cryptocurrency industry, Bitcoin serves as a digital gold standard, and it is used as a global means settling debts. It is also the de-facto currency of cyber-crime such as ransomware or darknet markets. Nine years after its inception, Bitcoin‘s price has increased from zero to thousands of dollars, and its transaction volume keeps growing daily. Bitcoin is here to stay, and there is nothing anyone can do about that fact.

Ethereum

The invention of Vitalik Buterin, a young cryptocurrency genius, has mounted to the second place in the cryptocurrency hierarchy. Unlike Bitcoin, the Ethereum blockchain does not only verify some accounts and balances but also of so-called states. This implies that Ethereum can not only execute transactions but multiple programs and contracts.

This flexible nature makes Ethereum an excellent instrument for developing decentralized applications. But it comes with a price. Following the Hack of an Ethereum based smart contract known as the DAO, the developers chose to do a hard fork without consensus, which led to the rise of Ethereum Classic. Apart from this, there are many clones of Ethereum, and Ethereum itself is a host of various Tokens like Augur and DigixDAO. This qualifies Ethereum more as a family of cryptocurrencies than an individual currency.

Ripple

Ripple is somewhat the less popular, or most hated project in the crypto community. While Ripple has a proprietary cryptocurrency known as the XRP, it is more of a network to execute IOUs than the digital currency itself. The currency, XRP, doesn‘t serve as a medium to store value, but more as a token to guard the Ripple network against spam.

The company running the Ripple network, Ripple Labs created every XRP-token and is issued by them on will. Therefore, Ripple is often referred to as pre-mined in the crypto community and tagged as no real digital currency, and the XRP token is not regarded as a reliable store of value.

However, banks seem to like Ripple. At least they adopt the policy at an escalating pace.

Litecoin

Litecoin was one of the first altcoins and was tagged the silver to Bitcoin the digital gold. Litecoin was a sensational innovation, with faster transaction time than Bitcoin, a massive amount of token and a unique mining algorithm. It was perfectly designed to be the smaller sibling of bitcoin. While Litecoin lost its second place after bitcoin as it failed to find a real use case, it is still actively produced and traded and is kept as a backup if Bitcoin busts.

Monero

Monero is the most notable representative of the cryptonite algorithm. The cryptonite algorithm was designed to add the privacy functionality Bitcoin lacks. All bitcoin transactions are recorded in the blockchain, and these transactions can be traced. With the initiation of a notion called ring-signatures, the cryptonite algorithm was able to solve this problem of anonymity.

Bytecoin, the first implementation of cryptonite was heavily pre-mined and was therefore rejected by the crypto community. Monero was the first non-premined bytecoin clone and garnered a lot of recognition. There are many other incarnations of cryptonite with their slight personal improvements, but none of them ever achieve the same fame as Monero.

Monero‘s fame climaxed in summer 2016 when some darknet markets determined to accept it as a currency. This led to a constant increase in the price, while the actual usage of the coin appears to remain disappointingly scanty.

Apart from those, there are hundreds of digital currencies of different families. Most of them are only attempts to reach investors and quickly make money, but some of them serve as an avenue to examine innovations in cryptocurrency technology.

What Lies Ahead For Cryptocurrency?

The cryptocurrency market is fast and wild. New digital currencies appear every day, early adopters get wealthier, and investors lose funds. Every digital asset comes with a big story to transform the world. Some make it through the first months, and most of them are ‘pumped and dumped’ by speculators and continue to exist as zombie coins until the last ‘bagholder’ gives up on seeing any return on his investment.

The fact that markets are dirty doesn‘t change the fact that cryptocurrencies, especially the blockchain technology are here to stay, and here to transform the world. It is happening already. All over the world, people purchase Bitcoin to protect themselves against the devaluation of their national fiat currencies. A vivid market for Bitcoin payment has appeared, mostly in Asia, and darknets using Bitcoin for cybercrime are growing. The first real-world application of blockchain technologies surfaces, as more companies recognize the power of Smart Contracts on the Ethereum network.

The revolution is happening already. Institutional investors start to purchase digital assets. Governments and banks realize that this technology can draw their control away. Cryptocurrencies transform the world. Little by little. It’s up to you to become part of history in the making or stand beside and observe.