A jargon-free introduction to cryptocurrencies
There is still a lot of uncertainty as to what Bitcoin is, what it is designed to do and why it has gained so much attention recently.
Despite its notoriety, however, there is still a lot of uncertainty as to what Bitcoin is, what it is designed to do and why it has gained so much attention recently. It can be difficult to get a handle on the key concepts because the entire cryptocurrency ‘space’ is filled with technical jargon and complex sounding concepts. But the technology that underpins Bitcoin and other cryptocurrencies has the potential to have wide-ranging effects on the way that financial institutions and businesses store and process data.
Ready? Let’s start at the beginning.
What are cryptocurrencies?
Bitcoin is the first cryptocurrency – digital currency that is able to operate without the need for traditional financial intermediaries such as banks. The key here is that cryptocurrencies work in a decentralised way, instead of the centralised system that defines our current system of fiat currency created by central banks.
The idea of cryptocurrencies originated with a mysterious individual called Satoshi Nakamoto, whose identity remains unknown. In 2009 Nakamoto created Bitcoin as a “peer-to-peer electronic cash system” designed to provide an alternative to the bank system, which at the time was being ravaged by the 2008 financial crisis.
Nakamoto’s creation has a number of features that differentiate it from normal forms of currency:
- Instead of being controlled by governments, the supply of Bitcoin is controlled by computer algorithms.
- Whereas fiat currency can be theoretically infinitely created by central banks, there is a finite number of Bitcoins (21 million), which means it remains relatively scarce and valuable.
- The currency and transactions are stored on a distributed, peer-to-peer network instead of a bank and intermediaries such as Visa or PayPal.
What is blockchain?
The distributed networks that Bitcoin and other cryptocurrencies run on are called blockchains. For many people, blockchains are the real revolution behind cryptocurrencies. The essential difference between a blockchain network and traditional computer networks that store data on individual devices and servers, is that the information on a blockchain is stored on every machine in the network.
This is important because it makes the information stored on the blockchain theoretically tamper-proof. To alter transactional information on one machine would cause it to change on every other machine. If everyone else in the network needs to approve every change it becomes very difficult to change transactional information once it has been logged.
The idea of having tamper-proof and public ledgers of transactions is proving to be very popular. Unlike cryptocurrencies, blockchain technology is gaining interest outside of the finance world, with companies trialling the idea in industries as diverse as shipping and real estate. A range of central banks have also launched trials of the technology in the last two years, highlighting its ascent from interesting idea to serious proposition.
Who are some of the main players?
Even though the number of cryptocurrencies has ballooned in the last half decade, there are five that are predominantly viewed as being legitimate rivals to Bitcoin. All of them have their own unique take on the core idea of decentralised exchange.
Here is a rundown of the main players:
Created by Russian prodigy Vitalik Buterin, Ethereum differs pretty substantially from Bitcoin. Whereas the latter’s network focuses on its own currency, Ethereum’s blockchain runs programming code for applications. The network is used by a lot of companies to launch crowd-funding platforms called initial coin offerings (ICOs), as well as other cryptocurrencies.
Unlike Bitcoin, Ethereum’s own digital currency, Ether, is not designed to be used for everyday transactions. Instead, it is mainly used by developers to pay each other for helping to build each other’s applications.
Launched in 2011, Litecoin is very similar to Bitcoin, except that it is worth less. There are 84 million Litecoin compared to 21 million Bitcoin. Litecoin is the easiest way for people to get into cryptocurrencies as it is likely to stay available for longer. The currency is also currently much quicker to transfer from person to person than its more well-known predecessor.
Monero differs from its peers due to a real focus on maintaining the anonymity of its users. Designed to give its users full control over their transactions, Monero lets you select who can and can’t see where your money is going. On top of this, by assigning each transaction a signature based on its place on the Monero blockchain rather than the individual user, it is even more difficult to trace user activity.
Ripple is a cryptocurrency made specifically for banks. If this sounds counter-intuitive, given the stated aim of much of the crypto-community to provide an alternative finance, it is worth thinking about the kind of exchange the technology enables. Blockchain theoretically allows banks to make faster payments of any size at a much lower cost. Traditional cross-border transactions also require banks to go through intermediaries, which add costs and delays to the process. Instead of waiting for each party to verify the transaction, Ripple reduces the process to just minutes by updating each customers ledger at the same time.
Dash sees itself as a replacement for PayPal, speeding up retail transactions. You may have seen merchants starting to accept Dash alongside US dollars, and you can see why. Transactions using Dash don’t take a day or two to charge the payment to the user account. Launched in 2014, the cryptocurrency aims to be the most user-friendly digital currency in the world.
This introduction has only scratched the surface of the constantly evolving world of cryptocurrencies. Always much more than an investment opportunity, the technology represents a fundamental rethinking of the way that we think of, store and exchange currency. Whether or not the technology provides a challenge to the established financial order will depend on whether it can actually improve the lives of consumers around the world.