What is Cryptocurrency?
Cryptocurrency refers to digital currency, an online cash system which functions as both a decentralised store of wealth and a secure digital payments system that is situated in the digital world.
The first cryptocurrency was Bitcoin, created by ‘Satoshi Nakamoto’ whose vision was initially published in a white paper, distributed to members of The Cryptography Mailing List in 2008. The abstract of this paper starts by outlining what the creator wanted Bitcoin to be:
“A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.”
There is still a lot of mystery around who Satoshi Nakamoto is and even whether they are a group or an individual. There is really no incentive for them to reveal themselves as it is believed that Satoshi Nakamoto has around 1,148,800 Bitcoin stored, which at the time of writing has a value of around $4 billion.
Cryptocurrency users fall into many different categories: you will find investors, users, developers and even governmental bodies. As the global market cap for all cryptocurrencies continues to grow, the Network Effect has lead to increasing interest from governments to regulation and legislation, to the point where countries are viewing cryptocurrencies as potentially legal tender.
Many online retailers accept payments using cryptocurrencies like Litecoin, Bitcoin and Ethereum, and a recent development is the creation of crypto ‘debit cards’ which allow you to store cryptocurrency and then convert it to local fiat currency at the point-of-sale.
Traders and investors see Bitcoin as an investment opportunity with some investors considering it to be a long term store of value, or ‘Digital Gold’. There are ways to diversify investment portfolios into cryptocurrencies like Bitcoin and Litecoin, which are seen to be the most stable in terms of dollar-value.
Alongside long-term investors there are also traders who will speculate against the volatile pricing of cryptocurrencies in comparison to their local fiat currencies.
There are hundreds of different cryptocurrencies for users and traders alike. Often new currencies will have a different or specific use cases, such as faster or more anonymous transactions. New white papers and coins are being published and created on an increasingly regular basis, however they are all connected by one common feature; blockchain technology.
What is the blockchain?
In cryptocurrency the blockchain is a distributed online ledger which stores the details of all transactions and the balances of users ‘wallets’ that have been created since the currency’s chain was first started. The word “blockchain” is used because this ledger consists a chain of standard sized digital blocks upon which new blocks are regularly added, but never taken away. It is here that we get to the underlying technology that makes cryptocurrency viable and secure.
The term ‘crypto’ refers to the cryptographic algorithms that secure a cryptocurrency and its blockchain from being copied, cheated or hacked. The blockchain works by cumulatively storing each transaction made between users and updating the balance of each wallet. Each block on the chain can carry a certain number of transactions and when a block is full then any further transactions need to wait until the next block is created, increasing the chain length and allowing more transactions to be confirmed and completed.
How are these blocks made?
Most cryptocurrencies rely on a ‘proof-of-work’ algorithm. This name refers to the process of discovering and adding a new block to the blockchain and the ‘work’ that is involved.
To create a block, a set of complex equations that must be solved to ensure that the new block fits with the current chain. This uses a lot of processing power and in turn a lot of electricity. The process is known as ‘mining’ and once the solution is found to the equation, the ‘miner’ discovers a new block and can receive a number of a coins as a reward for doing the work.
As well as this block reward, miners are also awarded fees that users pay for the transactions that make up this new block. These transactions are completed once the block is added to the ledger, and will show up on user’s wallets as ‘confirmed’ transactions. At this point the transaction is immutable and stored on the blockchain forever.
The reason that a proof-of-work blockchain is secure is that to copy or recreate the blockchain, the entirety of work done would have to be recreated. To take Bitcoin’s blockchain as an example, an attempt to counterfeit Bitcoin would mean solving every block equation that has been computed since the first block was created in 2008, and then overtaking the current global mining network in block creation speed. The amount of power required to do this task would be phenomenal and with current processing architecture it is not possible.
Why use cryptocurrency?
Part of the original vision in Satoshi Nakamoto’s white paper was to create a form of electronic cash that be entirely administered without a central banking system. The freedom of such an idea has attracted many of the supporters, enthusiasts and users today.
There is no need to trust a central financial institution or exchange, and any funds stored in your wallet are entirely your own. They can never be seized by a government or devalued by a piece of legislation. If you are the owner of 20 Litecoins, they will always be worth twenty Litecoins. They are yours to use in whatever value consensus system you desire and they’re entirely resistant to anything that could occur within the global financial system – if a bank goes under then your savings could be at risk. This would never occur with cryptocurrency is at is built on a decentralised, peer-to-peer system.
With each new user, cryptocurrency gains traction and acceptance as a normal part of life and modern society. The first steps to getting involved are to create a secure wallet to store your cryptocurrency in, funding that wallet with your first coins, and then deciding what to do with your funds. As explained earlier, you can simply use your cryptocurrency as you would your regular cash. Popular online retailers such as Overstock and Expedia accept bitcoin payments, with the former also accepting Litecoin.
You can choose how far you wish to go – you may be interested in mining or running a node, or it may be that you wish to just hold some cryptocurrency for the future and treat your wallet like a savings account.
Whichever you choose, welcome to the club.