What is cryptocurrency in simple words

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Put the word “cryptocurrency” in your conversation and you will undoubtedly hear a flurry of different opinions. Some will say that this is the biggest technological breakthrough since the launch of the Internet, others that it is a scam. But how many people are really capable of explaining what it is?

Bitcoin has made it to the most unlikely places, including nursing homes, where it has infiltrated the conversations of grandmothers discussing the morning news.

But here’s what. Despite the fact that bitcoins and cryptocurrencies are rapidly breaking into the news, agendas of board meetings, and billboards, most people still do not have a clear understanding of what this is about.

So, it’s time to get to know this phenomenon better.

Definition of cryptocurrency

In the name alone, you can see two clues that can be easily deciphered: “crypto” and “currency”.

“Crypto” refers to cryptography, the practice of encrypting plain text or data by turning it into an unrecognizable and incomprehensible form. Only if the intended recipient is able to decipher this code with confidential and secure means of exchanging information will he be able to extract the information.

The word “currency” is traditionally associated with the monetary units of a particular state, but in fact, the currency is any system of money used as a medium of exchange.

Bring it together and you have cryptocurrency, a digital form of currency where cryptography regulates the creation of new funds and also enables transactions.

Is cryptocurrency just an encrypted form of digital money?

You can’t go wrong with this answer, but it sounds pretty useless. To understand why the cryptocurrency is so much more than just encrypted money, let’s go back a few years.

Where did cryptocurrency come from?

The point is that cryptocurrencies are not the first form of digital money. Attempts to create digital currencies began in the early 90s, but none of these inventions were able to compete with electronic banking or third-party systems such as PayPal.

David Schaum paved the way for digital currency when he launched DigiCash in 1989. It was an electronic network used to send currency anonymously. Ten years after DigiCash went bankrupt, we saw the likes of E-gold and Liberty Reserve, which also went bankrupt after criminal charges. Soon the idea itself began to seem far-fetched and unrealizable to people.

Why did it all fail? You can just remember the saying that the first pancake is lumpy. But a more plausible explanation is that there was no demand for digital currency since e-commerce had not yet hit the scene, like widespread internet access.

Fast forward to 2008. Then a mysterious figure known as Satoshi Nakamoto gave a new explanation for previous failures: all of these systems were centralized and therefore based on trust. And according to the enigmatic Nakamoto, that was the biggest problem.

A detailed explanation can be found in a document written by Satoshi in 2008: Bitcoin: A Peer-to-Peer Electronic Cash System. In it, Nakamoto highlighted two fundamental problems: the operation of conventional financial systems and the properties of fiat currencies (for example, the US dollar).

What’s the problem with regular money?

You may not have thought about it, but your assets in US dollars, pounds, euros, or any other fiat currency make you dependent on the state. Most of these currencies once represented real tangible assets (like gold), but those days are long gone, and cash has no value other than your belief in it. This is why any government can easily manipulate your funds and thus interfere with your privacy.

And governments do it: they devalue the currency by printing billions of new banknotes to curb inflation or to play with interest rates. The 2008 global financial crisis and its aftermath is an example of how governments can manipulate our money supply and economies.

Banks’ swindle led to a financial crisis, but instead of punishment, the banks received $ 4 trillion in loans. from the US government. The Fed’s magical Quantitative Acceleration program made it possible to do this by buying securities out of the market to lower interest rates. Rather than allowing a natural recovery and recovery in the US economy, the government pumped borrowed money into the very institutions that caused the depression.

Given that fiat currency itself poses problems, what about the centralized systems we use to store and transfer money, that is, banks, trust funds, and online transfer services? They are also, to put it mildly, imperfect.

Some of the problems with centralized systems are:

  • high transaction fees;
  • fraud;
  • an attachment to trust (you trust that the bank or service of your choice will act with integrity, ethics, transparency, and keep your assets safe at all times).

But can we trust an economy controlled by governments and banks? This raised doubts until 2008, and the global financial crisis was the last straw. But what is our alternative?

A decentralized system that does not rely on trust and is not influenced from outside. You guessed it right: it’s a cryptocurrency.

Three key characteristics of the cryptocurrency

1. Cryptocurrencies are not based on trust

Systems that manage cryptocurrencies do not require trust, they do not involve third parties. They replace trust with verification. In a p2p network, assets are fully controlled by each participant and transferred between them directly without the approval and control of the governing body (for example, a bank).

2. Cryptocurrencies are immutable

By its nature, blockchain technology makes cryptocurrency transactions immutable. They cannot be canceled, delayed, duplicated, hidden, or changed. In such a system, it is impossible to cheat in the usual way, and it is protected from human error, which makes cryptocurrency infinitely more transparent than simple electronic money in a bank.

3. Cryptocurrencies are decentralized

For cryptocurrencies, new coins are systematically and transparently created by the system. Take Bitcoin: its infrastructure ensures that only 21 million units will ever exist. Now compare that to the occasional expansion and contraction of the supply of fiat currencies such as the euro at the light hand of governments and central banks.

So how does cryptocurrency work?

In the concept, everything is good and almost understandable, but how does it work in practice, and is it implemented technically? At the heart of cryptocurrencies is a breakthrough technology called the blockchain.

Blockchain is a network of several thousand computers (nodes) that collectively store information. Every time a transaction occurs on the network, most nodes must agree that the transaction is legitimate. In this way, a consensus is reached. Each block then securely seals the communication information with the new block.

As long as 51% of nodes remain legitimate, you have a system that reliably records transactions without bias or fraud. Blockchain networks have a number of ways to incentivize their users to ensure system integrity.

Bitcoin, for example, offers a slice of bitcoin to its miners, who solve computational puzzles to expand the network and validate transactions. This process is known as a proof of work (Proof-of-Work), but the realities are constantly changing, and with the advent of new blockchain developed several alternative mechanisms of consensus. Some other consensus systems in use today are Proof-of-Stake, as well as Byzantine Fault Tolerance (BFT), Directed Acyclic Graph (DAG), and hybrid consensus.

A simplified explanation would be as follows: the blockchain supports a decentralized, immutable, non-trust-based network where transactions cannot be faked and funds cannot be spent twice.

Cryptocurrencies are the means for transactions in decentralized applications that are built on blockchains.

Evolution of cryptocurrencies

Having formulated the essence of the “correct” currency and created the blockchain, Nakamoto became the founding father of the first cryptocurrency – bitcoin. The first block was mined in January 2009, and the following text was encrypted in it, referring to the financial crisis: “The Times 03 / Jan / 2009 Chancellor on brink of second bailout for banks”.

Goodbye banks; hello bitcoin.

As with any innovative technology, the followers were not far behind the discoverer. In less than ten years after the invention of bitcoin, you can observe in circulation over 1,500 cryptocurrencies with a total capitalization close to $ 500 billion (at the time of this writing).

Competition is high, coins are competing to grab a bigger piece. You should remember at least five representatives of this space: BitcoinEthereum, Ripple, Bitcoin Cash, and Litecoin. These five giants have a large market share. For more information, check out the top 50 cryptocurrencies.

The basic idea of ​​bitcoin is quite simple since it is primarily a means of storing and exchanging values. However, this is just the tip of the iceberg, as cryptocurrencies have other functions as well.

Recently, innovators have come up with entirely new uses for cryptocurrencies, many of which Satoshi might not have imagined in his wildest dreams.

Take the second largest cryptocurrency, Ethereum. Vitalik Buterin invented this platform in 2013. Unlike Bitcoin, Ethereum is built to allow the creation of dapps (dapps – decentralized applications) and smart contracts based on it.

Bitcoin itself, in fact, was a dapp designed to fulfill a specific purpose (a decentralized p2p system for exchanging digital currency). Dapps work on blockchains, in the same way that PC programs are created for Windows or other operating systems.

Instead of creating a new blockchain every time someone wants to create their own DApp, you can use the existing Ethereum infrastructure. Compare building your own home in an open field to hiring a team of professionals who thought of everything for you. Ethereum has allowed almost everyone to create their own cryptocurrencies and dapps without too much trouble.

It’s no surprise that there are hundreds of cryptocurrencies built on Ethereum, with individuals, institutions, and startups coming up with all sorts of creative uses for the platform. This is the path of least resistance.

However, many have done the hard work required to create their own blockchains. For example NEM, NEO, Qtum, or Litecoin.

What for? While it is relatively easy to create a cryptocurrency or dapp on an existing platform, you will be limited by the capabilities of that platform and the rules it sets. This is why serious projects often prefer their own blockchains.

How can cryptocurrency be used?

We realized that Bitcoin and Ethereum are revolutionary, but what are the benefits of cryptocurrencies in practice?

What makes cryptocurrencies useful is not so much the goods that you can buy with them, but getting rid of the problems they solve. This is the main value they provide to the end consumer. It is no coincidence that the most valuable cryptocurrencies are innovative.

Take Bitcoin, which revolutionized the way we transact and store valuables by allowing us to send money to anyone, anytime, anywhere, without any permission.

Like any great idea, bitcoin has had several followers at once, eager to improve on what it has achieved. Players such as Litecoin, Dash, IOTA, and Ripple quickly entered the scene, offering faster transactions with lower costs, improved scalability and energy efficiency.

While in some ways these altcoins are struggling to become the most popular payment system of all, nuances have kept them in different markets. For example, Monero is a trace-protected cryptocurrency with anonymous transactions that allows users to keep their transactions private and maintain a balance without fear of being discovered by third parties.

The first and most obvious use of cryptocurrencies is in payments, with the list of companies accepting bitcoin to pay for goods and services is growing, and ATMs with withdrawal functions are located all over the world. The race has begun to create a standard form of payment using cryptocurrency debit cards such as Bitpay, which will allow their owners to pay for purchases through regular terminals in stores.

While all of this is great, blockchain technology is not limited to the financial realm. It can be used to solve many of the problems that exist in today’s digital world. Therefore, now we can see hundreds of new projects with really incredible ideas.

In the wake of Ethereum, dozens of smart contract platforms have been created to offer innovative solutions to problems in agriculture, medicine, IT, logistics, and nearly every other sector.

For example, Sia allows you to rent out unused hard drive space. In exchange for connecting this empty space to the blockchain, you will receive a certain amount of Siacoin, the project’s own cryptocurrency.

The difference between coins and tokens should be noted here. Coins exist exclusively as a form of digital money on their own blockchains. Bitcoin and Litecoin are prime examples of coins.

Tokens occupy a different niche and serve alternative purposes – for example, they represent a digital asset, a share, a fee for using the system, etc. Dragonchain, Waltonchain, and Civic are ERC20 tokens. This means that they exist on the Ethereum blockchain, and they all serve the corresponding utilities provided by the project.

It is important to note that the usefulness of a cryptocurrency is its main characteristic: if a token has practical application and solves an existing problem, it is likely to grow in value.

At the same time, many useless coins ended up getting more than they should have. For example, Dogecoin was originally a prank cryptocurrency with no value or real market use. With a market cap of around $ 600 million (at the time of writing), this is arguably the most profitable joke in the world.

Despite some low-quality projects (or humorous projects), it is fair to say that cryptocurrencies do not exist in a vacuum, but depend on the value of the decentralized application, platform, or blockchain on which they are based.

After reading what you read, you will most likely begin to realize that cryptocurrency is just a great idea. So why has it been ten years and we still don’t buy hamburgers with Bitcoin?

Problems of mass acceptance of cryptocurrency

Despite all its revolutionary properties, the cryptocurrency industry faces a number of challenges that make mass adoption a slow and even somewhat painful process. Let’s take a look at the biggest hurdles that cryptocurrencies must overcome in order to gain massive adoption.

Stability is important in any payment method. The volatility of most cryptocurrencies is frightening at times: they can significantly drop or rise in price in a matter of minutes. This is a good chance for investors, but the average seller or consumer will not resort to cryptocurrencies precisely because of these risks.

Speed ​​and transaction costs are other drawbacks. Few coins can compete with payment systems like Visa. For example, a Bitcoin transaction now takes about an hour on average, and the commission exceeds $ 15. This makes Bitcoin useless for day-to-day transactions. It is hopelessly slow and too expensive for small purchases. Not to mention the scalability issue that prevents networks from processing a large number of transactions in a given period of time.

Then comes the question of security. There have already been millions of dollars worth of crimes in the crypto space, such as the hacking of the Mt. Gox . Plus, users don’t always use cryptocurrency correctly. While cryptocurrencies themselves are incredibly reliable, “security technology” is still evolving. Think of email: It took users decades to learn how to recognize spam, infected, and phishing emails.

The way in which new cryptocurrency projects raise funds has triggered increased scrutiny and led to discussions about regulation. China and South Korea have banned their citizens from participating in ICOs – initial coin offerings – and a number of other countries may well follow suit.

What for? Unfortunately, several scammers have managed to steal from enough people by offering “new coins”. Legitimacy is key to cryptocurrency acceptance, and cowboy-style antics give them a bad reputation and raise skepticism about the technology’s long-term viability.

Even after the ICO issue is settled, the legality of the use of cryptocurrencies will continue to be questioned. The official authorities will not approve of the use of cryptocurrencies by citizens for tax evasion or financing criminal activities.

The future of cryptocurrencies

The list of these problems is impressive, but each of them has more than one solution on the horizon. The smartest people in the world stepped in, filled with enthusiasm.

Technological challenges seem to be the easiest to overcome. Recent additions like IOTA can provide unlimited scalability and near-instant transactions at no cost. The so-called stablecoins solve the volatility problem by using various ingenious methods to keep the value of the cryptocurrency from fluctuating. Security measures are getting stronger and exchanges like NEX are becoming true for knocks of the cryptosphere.

Despite all this rapid progress, the fate of cryptocurrencies depends too much on the authorities. Fortunately, it is clear to many governments that cryptocurrencies have tremendous value, which is difficult to fully grasp at this time. As trillions of dollars flow into the cryptoeconomy, many countries are likely to try to break out into the leaders of the cryptocurrency space.

Where there is money, there will be taxes. As the economy develops, investors, corporations, and users will obey new rules dictated by governments. We will inevitably move away from the insane anarchy of unregulated ICOs. A number of countries are already laying the groundwork for this to happen.

While China and South Korea have opted for bans, Switzerland has released guidelines that build the legal framework for ICOs, aiming to become the most crypto-friendly nation.

Things are getting more interesting. Once bureaucrats give cryptocurrencies the green light, companies of all shapes and sizes will take advantage of it. Naturally, the infrastructure will not lag behind: banks, merchants, and service providers will catch up, and soon your grandmother will start buying Christmas crackers with bitcoins.

The lights are dimmed and you’d better take a seat in the front row. It may take months or even years to gain massive acceptance, but cryptocurrency is the starring actor on a show that definitely deserves attention.