Bitcoin. Litecoin. Ethereum. Ripple. Dash. Before you decide it’s a lot of financial jargon that you don’t get and decide to skip this article, wait. Cryptocurrencies are the hottest things right now. If you exclude A-list models or the word war between Trump and Kim Jong Un mostly. Anyway, coming back to the topic on hand, cryptocurrency is on the brink of revolutionising the world. It is also something that a lot of people don’t get. US Senator Thomas Carper famously, and very rightly said –
“Virtual currencies, perhaps most notably Bitcoin, have captured the imagination of some, struck fear among others, and confused the heck out of the rest of us.”
A prequel to the previous article, Cryptocurrencies 2.0 is supposed to educate and inform the naive reader about the same. Therefore, let us begin without further ado –
How did cryptocurrencies originate?
Cryptocurrencies emerged as a side product of another invention. Satoshi Nakamoto, the inventor of Bitcoin, the first cryptocurrency, never intended to invent a currency. In his announcement of Bitcoin in late 2008, Satoshi said he had developed “A Peer-to-Peer Electronic Cash System. “
“Announcing the first release of Bitcoin, a new electronic cash system that uses a peer-to-peer network to prevent double-spending. It’s completely decentralized with no server or central authority. – Satoshi Nakamoto, 09 January 2009, announcing Bitcoin on SourceForge.
In the 90s, there had been many attempts to create digital money, but they all failed. After seeing all the centralized attempts fail, Satoshi tried to build a digital cash system without a central entity, that is, “a decentralized digital cash system”.
This decision became the birth of cryptocurrency, which helped realize dreams of digital cash.
Why was it difficult to realize digital cash?
To realize digital cash, one needs a payment network with accounts, balances, and transaction. One major problem every payment network has to solve is to prevent double spending, that is, preventing the same person from spending the same amount twice. Usually, this is done by a central server that keeps record about the balances. It is pretty obvious that a decentralized network doesn’t have this server. So, every single entity of the network must do this job. Every peer in the network needs to have a list with all transactions to check if future transactions are valid or an attempt to double spend.
If the peers of the network disagree about even one single, minor balance, everything crashes. They need an absolute consensus. Usually a central authority is needed to declare the correct state of balances. However, using a central figure is contrary to the very idea of decentralization. Nobody believed it was even possible. Until Satoshi proved it was. Satoshi’s major innovation was to achieve consensus without a central authority. Cryptocurrencies are a part of this solution – the part that made it revolutionary.
Finally, what are cryptocurrencies?
A cryptocurrency is a digital or virtual currency designed to work as a medium of exchange. It uses cryptography to secure and verify transactions as well as to control the creation of new units of a particular cryptocurrency. Essentially, cryptocurrencies are limited entries in a database that no one can change unless specific conditions are fulfilled.
How do cryptocurrencies work?
Keeping a central server in payment networks entailed that a third-party authority be basically in control of your funds and with all your personal details on hand.
In a decentralized network like Bitcoin, every single participant needs to do this job. This is done via the Blockchain – a public ledger of all transaction that ever happened within the network, available to everyone. Therefore, everyone in the network can see every account’s balance.
Every transaction is a file that consists of the sender’s and recipient’s public keys (wallet addresses) and the amount of coins transferred. The transaction also needs to be signed off by the sender with their private key. It is basic cryptography. Eventually, the transaction is broadcasted in the network, but it needs to be confirmed first.
Within a cryptocurrency network, only miners can confirm transactions by solving a cryptographic puzzle. They take transactions, mark them as legitimate and spread them across the network. Afterwards, every node of the network adds it to its database. Once the transaction is confirmed it becomes unforgeable and irreversible and a miner receives a reward, plus the transaction fees. Essentially, any cryptocurrency network is based on the absolute consensus of all the participants regarding the legitimacy of balances and transactions. If nodes of the network disagree on a single balance, the system would basically break. However, there are a lot of rules pre-built and programmed into the network that prevent this from happening.
Cryptocurrencies are so called because the consensus-keeping process is ensured with strong cryptography. This, along with aforementioned factors, makes third parties and blind trust as a concept completely redundant.
What are the transactional properties of cryptocurrencies?
Irreversible: After confirmation, a transaction can ‘t be reversed. By nobody. Not you, not your bank, not Satoshi, not your miner. If you send money, you send it. Period. No one can help you, if you sent your funds to a scammer or if a hacker stole them from your computer. There is no safety net.
Pseudonymous: Neither transactions nor accounts are connected to real-world identities. You receive Bitcoins on so-called addresses, which are randomly seeming chains of around 30 characters. While it is usually possible to analyse the transaction flow, it is not necessarily possible to connect the real-world identity of users with those addresses.
Fast and global: Transaction are propagated nearly instantly in the network and are confirmed in a couple of minutes. Since they happen in a global network of computers they are completely indifferent to your physical location.
Secure: Cryptocurrency funds are locked in a public key cryptography system. Only the owner of the private key can send cryptocurrency. Strong cryptography and the big numbers make it impossible to break this scheme.
No Permissions: You don’t have to ask anybody to use cryptocurrency. It’s just a software that everybody can download for free. After you installed it, you can receive and send Bitcoins or other cryptocurrencies.
What can you do with cryptocurrency?
Buy goods – There are a lot of merchants – both online and offline – that accept Bitcoin as the form of payment. They range from massive online retailers like Overstock and Newegg to small local shops, bars and restaurants. Bitcoins can be used to pay for hotels, flights, jewellery, apps, and even a college degree. Other digital currencies like Litecoin, Ripple, Ethereum and so on aren’t accepted as widely just yet. Things are changing for the better though, with Apple having authorized at least 10 different cryptocurrencies as a viable form of payment on App Store. There are Gift Card selling websites like Gift Off, which accepts around 20 different cryptocurrencies. Through gift cards, you can essentially buy anything with a cryptocurrency. Finally, there are marketplaces like Bitify and OpenBazaar that only accept cryptocurrencies.
Invest – cryptocurrencies are the hottest investment opportunity right now. There are many stories of people becoming millionaires through their Bitcoin investments. In November 2017, the price of one Bitcoin exceeded $7,000. Since May 2016, Ethereum’s value increased by at least 2,700 percent. When it comes to all cryptocurrencies combined, their market cap soared by more than 10,000 percent since mid-2013.
However, please note that cryptocurrencies are high-risk investments. Their market value fluctuates like no other asset’s. Moreover, it is partly unregulated, and there is always a risk of them getting outlawed in certain jurisdictions and any cryptocurrency exchange can potentially get hacked.
Mine – Mining is an investment. Essentially, miners are providing a bookkeeping service for their respective communities. They contribute their computing power to solving complicated cryptographic puzzles, which is necessary to confirm a transaction and record it in a distributed public ledger called the Blockchain. Computer geeks, take note!
One of the interesting things about mining is that the difficulty of the puzzles is constantly increasing, correlating with the number of people trying to solve it. So, the more popular a certain cryptocurrency becomes, the more people try to mine it, the more difficult the process becomes.
A lot of people have made fortunes by mining Bitcoins. Once a miner manages to solve the puzzle, they receive a reward as well as a transaction fee. As a cryptocurrency attracts more interest, mining becomes harder and the amount of coins received as a reward decreases. For example, when Bitcoin was first created, the reward for successful mining was 50 BTC. Now, the reward stands at 12.5 Bitcoins. This happened because the Bitcoin network is designed so that there can only be a total of 21 million coins in circulation. As of November 2017, almost 17 million Bitcoins have been mined and distributed. However, as rewards are going to become smaller and smaller, every single Bitcoin mined will become exponentially more and more valuable.
Like everything on this planet, it has its fair share of takers, and critics. Exploring cryptocurrencies is a journey. A fast and wild one. New cryptocurrencies emerge, old die, early adopters get wealthy and investors lose money. It is difficult to say whether they’ll stick on or pass, but they have definitely brought themselves a popularity that nobody could have dreamed of.