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What is Cryptocurrency?

With the rise and massive gains of Bitcoin and alternative coins, such as Ethereum, Cardano, and Matic, over the last few years, cryptocurrencies have rapidly become mainstream and widely discussed, with many seeking to find ways to profit from the new technologies propelling their creation and adoption. Cryptocurrencies are decentralized, encrypted digital currencies that are transferable between peers. Cryptocurrencies and their underlying technologies can offer numerous benefits over current payment methods: The peer-to-peer network aspect has the potential to eliminate third-party financial services and their accompanying fees, transactions are immediately settled upon confirmation by the decentralized network of miners, and cryptocurrencies may bring financial services and stability to underdeveloped areas in the world while maintaining anonymity to prevent the potential for identity theft.

Transactions completed using cryptocurrencies are traditionally maintained in some form of a distributed public ledger via a “mining” process in a proof of work model or through staking in a proof of stake model. Starting with the initial creation of a cryptocurrency coin (e.g., a Bitcoin), each and every transaction is confirmed and stored in the public ledger (a blockchain), which involves identical copies distributed among peers maintaining the public ledger. The public ledger does not include information regarding the real-world identities of owners of the cryptocurrency coin. Rather, it maintains an address, similar to an account number, and a balance (i.e., the amount of cryptocurrency coins associated with that address) for each account. Thus, cryptocurrencies afford a level of pseudo-anonymity uncommon to most financial systems. Using cryptographic techniques, the distributed public ledger offers an unmodifiable history of all cryptocurrency transactions between the various addresses, which enables digital wallets of coin owners to calculate accurate balances and ensure that each transaction uses only coins currently owned by the spender, preventing the possibility of double spending.

The validity of each cryptocurrency’s coins is provided by a blockchain. A blockchain is a continuously growing list of records, called blocks, which are linked and secured in a network using cryptography. Each block contains a hash pointer, a mathematical algorithm that maps data of arbitrary size to a bit array of a fixed size, as a link to a previous block, a timestamp, and transaction data. A timestamp is used to prove the validity of transactions added to the blockchain ledger without the need for a trusted third party. By design blockchains are inherently resistant to modification of the data as it is managed by a pseudonymous  peer to peer network collectively adhering to a protocol for validating new blocks. Once recorded, the data in a block cannot be altered without the alteration of all subsequent blocks, which requires collusion from the network majority. Part of the security of the blockchain is in the fact it is a distributed system that is not stored on a specific server or node, but is instead distributed across innumerable nodes on the web, where every node only keeps a portion of the whole. A node is a computer that connects to a cryptocurrency network. The node supports the relevant cryptocurrency’s network through relaying transactions, validation, or hosting a copy of the blockchain. Each network computer node in relaying transactions has a copy of the blockchain of the cryptocurrency it supports, and when a transaction is made, the node creating the transaction broadcasts details of the transaction using encryption to other nodes throughout the node network so that the transaction, and alls subsequent  transactions, are known. Node owners may be volunteers hosted by the organization responsible for developing a blockchain network or those who host a node to receive rewards from hosting the node network. 

To facilitate a transaction using cryptocurrency, digital wallets use encrypted, electronic signatures that serve as cryptographic proof the transaction originates from the owner of the wallet. Cryptography, in general, refers to protecting data by transforming, or encrypting, it into an unreadable format.  A cryptocurrency wallet stores the public and private keys or seed which may be used to receive or spend the cryptocurrency contained in the wallet. Only those who possess the key(s) to the encryption can decrypt the data into a usable format. One popular cryptography system is a public key system that uses two keys, a public key known to everyone and a private key known only to the individual. Generally, the data encrypted with one key is decrypted with the other and neither key is recreatable from the other. With the private key, it is possible to write in the public ledger, effectively spending or transferring the associated cryptocurrency outbound. With the public key, it is possible for others to send currency into the wallet. 

In order to record the transaction in the public ledger, traditionally “miners” (e.g., decentralized computing systems participating to support the public ledger) approve the transaction by working to solve an increasingly-complex computational problem with the first “miner” that solves the puzzle adding a “block” representing the transaction to the public ledger. These complex computations are always unique to each other such that once an equation is solved, the network knows the transaction is authentic. This is referred to as a Proof of Work model of cryptocurrency, where a transaction is proved through algorithmic work. By representing confirmed transactions as blocks in the distributed public ledger, an individual cannot modify the transaction history of the coin without modifying a majority of the copies of the public ledger maintained by the various peers. Therefore, once a block is mined and added to the ledger, all conforming transactions are essentially permanent and the miner is rewarded with a relatively small transaction fee. This way, mining can serve as a proof-of-work system that gives value to cryptocurrency. While secure, the Proof of Work model comes at high computational costs resulting in high electricity usage in the mining process and limitations on the number of transactions that can be processed at the same time, leading to longer transaction times. Alternatively, some cryptocurrencies offer a Proof of Stake model. The Proof of Stake model offers a consensus mechanism that selects validators in proportion to their quantity of holdings in a particular cryptocurrency. A miner who wants to create a new block must stake an amount of the cryptocurrency they wish to mine- similar to making a refundable deposit. A miner must prove they have a vested interest in the security of the cryptocurrency at stake by proving you own some of it, then staking the cryptocurrency in a locked stake during the mining process. By requiring validators to have some quantity of blockchain tokens, potential attackers would need to acquire a large fraction of tokens on the block chain to carry out an attack.

The first cryptocurrency was developed in 1983 by cryptographer David Chaum who created an anonymous, cryptographic, electronic currency called eCash. Money stored in a digital format was cryptographically signed by a bank and the user could spend the money at any shop that accepted eCash without needing to open an account or transmitting their information. A software program withdrew notes from a bank and designated specific encrypted keys before it could be sent to a recipient which allowed the currency to be untraceable. David Chaum later started the company DigiCash in 1989 to fully implement eCash, which was used as a micropayment system at the Mark Twain Bank in Saint Louis, MO from 1995-1998 before declaring bankruptcy and being sold to eCash Technologies. In 2008 the first decentralized cryptocurrency, Bitcoin, was created by pseudonymous developer Satoshi Nakamoto who released a paper on 31, October entitled Bitcoin: A Peer to Peer Electronic Cash System. This paper detailed methods of using a peer to peer network to generate a system for electronic transactions without relying on trust. On 3 January 2009, the Bitcoin network came into existence with Satoshi Nakamoto mining the genesis block of Bitcoin in which the text: “The Times Jan/08/2009 Chancellor on brink of second bailout for banks” was embedded in the coinbase of the block. The first Bitcoin transaction occurred between Satoshi Nakamoto and Hal Finney, an early adopter,  on 12 January 2009 in Block 170. The first real-world purchase using Bitcoin occurred in 22 May 2010 when Laszlo Hanyecz paid 10,000 BTC to a peer who bought him two large Papa John’s pizzas with fiat. This date is now commemorated in the cryptocurrency communities as “Bitcoin Pizza Day.”

Due to Bitcoin’s history and prominence, broadly tokens, cryptocurrencies, and other types of digital assets that are not bitcoin are commonly known as alternative cryptocurrencies, or “altcoins”. Altcoins often have underlying differences with bitcoin such as different transaction times, the allowance of applications to be run on a blockchain, or various degrees of encryption. Altcoins generally follow the broad market trends of Bitcoin as the total cryptocurrency market cap has historically been dominated by Bitcoin, where altcoins have increased and decreased in market cap value in relation to Bitcoin. 

A blockchain account can also provide for decentralized applications, such as those built on the Ethereum network. Decentralized applications can be built on certain blockchains using smart contracts. Smart contracts are deployed on a blockchain to execute a program through a transaction. Smart contracts are deployed by sending a transaction from a wallet for the blockchain- this transaction includes the compiled code for the smart contract as well as a receiver address. The transaction is then included in a block that is added to the blockchain, at which point the smart contract’s code will execute to establish the initial state of the smart contract. Once a smart contract is deployed it cannot be updated- it is immutable past differences in the variables of the contract. Smart contracts written on Ethereum based networks are written in the Solidity programming language. Smart contracts are used to build applications on these blockchain networks such as creating fungible tokens (tokens) which are smaller units of cryptocurrency than main cryptocurrencies of blockchain networks. For example, a blockchain cryptocurrency may be the Binance Coin (BNB) employed by the Binance Smart Chain while a fungible token on that chain may be the CAKE token, the fungible token utilized by the PancakeSwap decentralized exchange (DEX). Tens of thousands of unique cryptocurrencies on several blockchains- most of these are these smaller fungible tokens. There are also non-fungible tokens deployed on a block chain by smart contracts. These non-fungible tokens (NFTs) are a unique digital asset designed to show ownership of a virtual item. An NFT is a store of data on the blockchain that certifies a digital asset to be unique and thus not interchangeable. A NFT can represent a tangible asset such as a photograph, video, song, or other type of digital file, however access to any copy of the original file is not restricted to the buyer of the NFT. While a copy of the digital item, such as a photograph, may be available for anyone to obtain, NFTs are tracked on the blockchain to provide the owner with a proof of ownership distinct from intellectual property rights. 

Decentralized cryptocurrency is produced by the entire cryptocurrency system collectively at a rate defined when the system is created. This contrasts to traditional centralized banking and economic systems where corporate boards or governments control the supply of currency by printing units of money or adding to digital banking ledgers in an unpredictable manner. Most cryptocurrencies are designed to gradually decrease in production per block, putting a cap on the total amount of currency that will ever be in circulation, thus resulting in a deflationary currency. 

Cryptocurrency presents major strides in economic growth and freedom to individuals from a global perspective, as the crypto market is often easier to access than traditional banks due to fewer regulations and the nature of decentralization. The intrinsic properties of decentralization allow citizens to bypass governments to mine for and trade in cryptocurrency and convert it for common goods. Particularly in countries with high inflation where fiat currency is no longer available to easily utilise, cryptocurrency offers a direct incorruptible path to economic freedom. While the mass adoption of decentralized cryptocurrencies is still a new phenomenon, and one in which both governments and citizens are struggling to understand, it seems apparent given the ease of use and global utility, cryptocurrencies are here to stay. In June 2021, El Salvador became the first country to accept Bitcoin as legal tender, paving the way for broader government adoption of cryptocurrencies through international financial regulatory agreements. The value of all cryptocurrencies in circulation has soared to more than $2.1 trillion USD of which $1.4 trillion USD of that value was added only in the past year. Cryptocurrencies are changing the face of finance and for the first time putting individuals fully at the helm of their financial futures.  

Actualizado el agosto 4, 2021
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*Publicidad pagada. No es asesoramiento financiero. RugDoc no se hace responsable de los proyectos aquí expuestos. DYOR y mantente seguro.