Cryptocurrencies are digital assets generated and protected with cryptographic proof. They’re mediums of exchange permanently recorded and stored in blocks of data on a digital ledger called the blockchain.
More than ten years ago, these digital currencies revolutionized our outdated financial system, proposing a decentralized model based on privacy, autonomy, and transparency. Cryptocurrencies are tailored to the needs and priorities of customers, instead of working for the benefit of intermediaries and banks.
In this guide, we’ll recognize the joint effort by a number of developers that worked on designing forms of digital cash and talk about the technology behind cryptocurrencies. We’ll mention both the advantages and the challenges faced by these coins and introduce you to some household names of the industry.
Let’s get started!
The History of Cryptocurrency
To arrive at the present moment and talk about cryptocurrencies, we must go almost forty years back to where it all began.
The breakthrough moment of the ‘80s was the emergence and widespread adoption of the Internet which announced the birth of the e-market. The first online transactions and credit card purchases took place shortly after, in the early ‘90s.
However, online purchases incurred extremely high fees and had to be made through centralized institutions (banks) that tracked the purchase amount, personal details of both sender and receiver, the purpose of the money transfer, etc.
On the one hand, people felt monitored on their whereabouts, but on the other, they were afraid of cutting the ties with these intermediaries because of the potential thefts, cyber-security threats, and double-spending.
To solve this problem, developers had to find ways to strengthen the level of online privacy, security, and inclusion in the online payment system, and get rid of the nagging presence of centralized service providers at the same time.
First, there was David Chaum with his payment system DigiCash based on blind signatures, a type of digital signatures where the transaction amount and the sender’s identity remained hidden but there was still a central authority (the “signer”) who had to verify the transactions.
In the late ‘90s, Dr. Adam Back launched the anti-spam algorithm HashCash, an early proof of work mechanism where emails were protected with an encoded hashcash stamp. This was a way to filter spam emails.
In 1998, Wei Dai introduced B-Money, another electronic payment system with two types of privacy protocols where senders and receivers both signed the transactions with encrypted public keys. The first protocol is a primary version of Bitcoin’s PoW mining protocol, the second – an early version of the Proof of Stake (PoS) mechanism.
Finally, in 2008, an individual using the pseudonym Satoshi Nakamoto published a white paper where he outlines the first fully-fledged decentralized, peer to peer electronic payment system, Bitcoin.
Nakamoto took notes from developers who worked before him and used their knowledge to help him create a decentralized digital ledger called the blockchain. This ledger permanently records the data into blocks that together form a string or chain, hence the name “blockchain”.
So, how does blockchain solve the double-spending problem?
The model proposed by Nakamoto implements a peer to peer network where users (the nodes) generate computational proof of work to run the transactions through a hashing algorithm and identify them chronologically.
This mechanism is a more advanced version of Dai’s B-Money protocol that relies on the computational power of the nodes to protect the network from double spending and hacker attacks.
PoW is integrated with a timestamp server for whose design Nakamoto gives credit to Adam Back’s HashCash anti-spam algorithm. The server timestamps the hashed transactions so that every upcoming transaction includes the timestamped hash of the previous one in the chain. This way, if someone tries to alter the data, he/she would have to alter the previous transactions too.
Bitcoin’s blockchain was a real technological breakthrough but people would be wrong to assume it’s the only one. From the moment Nakamoto pioneered the technology up until now, it has been used to develop other blockchains and crypto projects and has found multiple use cases beyond the field of finances.
What qualities make cryptocurrencies so desirable?
First of all, decentralization. Cryptocurrencies allow customers to transact without involving third parties and middlemen that make large profits by incurring hefty service fees. Instead, all of the volunteering nodes join their forces to protect the network from data tampering.
Next, cryptos provide anonymity or pseudonymity for their users. When you make a transaction in Bitcoin or any other crypto, the transaction is displayed under an encrypted address known as a public key which can’t be linked to your real identity. This means that no one knows how much money you send or who you send them to.
Pseudonymity and transparency rarely go hand in hand, but cryptocurrencies are an exception to this rule. The blockchain keeps a public record of all the transactions ever processed on the network and this database is at anyone’s disposal.
Another characteristic of cryptocurrencies is portability. Unless you use a credit or debit card that ties you to a centralized authority, you have to carry your fiat currencies in your wallet anywhere you go. Cryptos are intangible currencies which means you only need a digital wallet to store them in and a private key to access them.
The Most Popular Cryptocurrencies
Bitcoin is the world’s first and most popular cryptocurrency with millions of traders around the world. Throughout the years, it has become popular for its investment value that keeps climbing up. Bitcoin has been touted as the best alternative to fiat currencies and we’re yet to see its adoption across various industries.
Litecoin (LTC) is among the first cryptocurrencies, launched two years after Bitcoin by an ex-Google employee, Charles Lee. The currency became known among crypto circles as the silver to Bitcoin’s gold because its purpose was not to compete against the most popular cryptocurrency but for the two to be used side by side.
Lee wanted to design a digital asset that would be suitable for making small transactions and everyday purchases. Litecoin outperforms Bitcoin in this regard because it offers greater scalability thanks to the “scrypt” algorithm and higher transaction throughput.
Ethereum (ETH) is the brainchild of Russian-Canadian developer Vitalik Buterin who began working on this startup in 2013 when he was only 21 years old.
Buterin became interested in Bitcoin and the crypto industry at an early age, and as he was researching the technology, he had a revolutionary idea. Why not use blockchain technology for more than just electronic payment?
Ethereum is both a store of value and a utility token used for the platform’s blockchain-based services such as smart contracts, preprogrammed self-executable contracts, and decentralized applications (dApps).
Pros and Cons
The advantages of using cryptocurrencies:
- You’re the owner of your own money! Decentralization means no one else but yourself has control over your currencies. Your public and private key put you in the place as your own central authority.
- Cryptocurrency transactions are cheaper! Banks and other payment providers need to charge for their services but cryptos incur only tiny transaction fees to incentivize the miners to keep verifying transactions.
- Finally, crypto transactions are faster than regular ones! Sometimes, bank transfers can take up to several days, especially if international financial institutions are involved. In comparison, crypto transfers are completed almost instantaneously.
The disadvantages of using cryptocurrencies:
- Inertia. We’ve been using fiat currencies for so long that people still trust only physical currencies and currencies have been issued by the government. It would take some time before cryptocurrencies gain widespread adoption and become a regular payment method.
- Volatility. It’s no secret that the prices of cryptocurrencies fluctuate on a grand scale because they’re based on speculations. Moreover, it’s normal for new coins to have low liquidity and trading volumes. This also affects price volatility and makes cryptos unstable stores of value.
- Lack of regulation. The newness of the technology makes it challenging to regulate the use and taxation of cryptocurrencies which is a major reason for their misuse in the past.
Cryptocurrency Use Cases
The most important role of cryptocurrencies is that of digital cash in the digitalized financial system of the future. We already talked about the importance of decentralization and pseudonymity, as well as making faster and cheaper local and international transactions. This is exactly what we get using cryptocurrencies.
Moreover, a great many industries would benefit from programmable money. Just imagine the convenience of using smart instead of regular contracts for business partnerships, or keeping digital ledger records in hospitals, tracking supply chains with blockchain technology, and paying a small number of crypto tokens for decentralized social media, renting computer power, or even Internet connection.
We have just one more thing to say about cryptocurrencies – we are yet to hear about the wonderful things these assets can help us with!