Cryptocurrency, explained
The future of money?
The recent buzz regarding cryptocurrency is somewhat reminiscent of the r/wallstreetbets-Gamestop situation: everyone is hearing about it, but nowhere near as many actually understand it. Nothing could be more true than with cryptocurrency.
What exactly is cryptocurrency?
For a currency to be called a called a cryptocurrency, it must fulfill all 5 of the following traits:
Digital: absolutely no physical coins or bills, existing only on computers
Decentralized: this is in contrast to fiat currency, which is controlled by the country’s central bank. Cryptocurrencies don’t have a central computer or server, but instead used decentralized networks of thousands of computers
Peer-to-peer: cryptocurrencies are exchanged directly from person to person without any sort of third-party interference. Unlike fiat currencies, in which users deal with each other through banks or online payment systems such as PayPal
Anonymous: if you want to use or exchange cryptocurrencies, there’s no need for personal information. This feature in particular makes cryptocurrencies an ideal option for sketchy people
Encrypted: going hand-in-hand with anonymity, each cryptocurrency user is assigned a special code so that only they have access to their money and information. Why do you think it’s called crypto-currency? The word “crypto” comes from the Greek word “kruptos” which means hidden or concealed. Think “cryptography” - the study and practice of techniques for secure communication
Who created crypto currencies?
By the early 1990s, a counterculture movement who called themselves cypherpunks felt that personal freedoms were being threatened by governments and corporations violating electronic privacy. According to Eric Hughes, who’s considered the founder of the cypherpunk movement (along with Timothy C. May and John Gilmore) in his A Cypherpunk’s Manifesto:
“Privacy is necessary for an open society in the electronic age...We cannot expect governments, corporations, and other large, faceless organizations to grant us privacy….We must defend our own privacy if we expect to have any….Cypherpunks write code. We know that someone has to write software to defend privacy, and….we’re going to write it.”
So clearly, they wanted to give internet users more control over their money and information. And what better way to do that than by creating digital currencies? The movement came up with CyberCash and DigiCash, both of which had some of the 5 traits listed above, but neither had all 5. By the end of the 90s, they both failed.
Throughout the early 2000s, it seemed like this cryptocurrency idea was a pipe dream. But in 2008, an anonymous programmer by the name of Satoshi Nakamoto published a paper proposing an idea called Bitcoin. Then in January 2009, the first open source Bitcoin software was released, and so the first ever Bitcoin was issued. Nearly a decade later, a single Bitcoin will set you back over $36,000 USD.
But wait a minute - how is it that Bitcoin succeeded whereas other previous attempts at digital currency failed? The answer has to do with what Bitcoin and other modern cryptocurrencies are built upon: blockchain.
Ok so what’s blockchain?
In the context of cryptocurrency, a blockchain is an ever-growing list of transactions that occur via the cryptocurrency. Each group of information is called a block and they’re added to the database one by one. Once the info is added, it can’t be deleted or changed. It stays on the blockchain until the end of time.
This database isn’t centralized - it’s stored on a network of thousands of computers called nodes, with each node having voting power: new information can be added to the blockchain if more than half the nodes agree that it’s valid and correct. This feature, called consensus, is a key difference between cryptocurrency and normal banking.
Let’s say Mark owes $10 to both Jane and Jim, but Mark only has $10 left in his bank account. So he tries double spending by transferring $10 to both Jane and Jim at the same time, but the bank staff catches him and prevents the transaction. But because cryptocurrencies don’t have banks, how would they deal with stuff like this?
Cryptocurrency mining
Miners, in the cryptocurrency universe, are not people with shovels in caves. Rather, they are nodes which perform special tasks that make transactions possible. Let’s look at an example:
Mark owes Jane 10 BTC, so he announces that he is sending Jane 10 BTC to the Bitcoin network
Miners take this information and encrypt it. This is called hashing. To this information, they add other transaction information and hash that too. More and more information is added and hashed until there’s enough to form a block
The miners now race against each other to guess the encrypted code or block hash that will be given to the new block before it’s added to the blockchain. The miner that guesses the right code gets to add the new block to the blockchain
All the other nodes on the network verify the transaction information in the new block. They check the whole blockchain to make sure that the new information matches. If it does, then the new block is valid, and the winning miner can add the new block to the blockchain. This is called confirmation
Jane receives 10 BTC from Mark
Miners are rewarded for the work they do, as cryptocurrency mining uses a lot of computing power. On the Bitcoin network, miners who confirm new blocks of information are rewarded with a certain amount of new Bitcoin. Kinda like actual mining if you think about it - go at it long enough and you’ll be rewarded.
So what’s the big deal with cryptocurrencies?
More and more people are getting turned on by the idea of a decentralized, anonymous currency because it’s seen as a superior alternative to traditional financial systems. Cryptocurrency eliminates the unnecessary costs between traders, thus allowing both parties to benefit even more from their exchanges. With blockchain, which makes everything more transparent, cryptocurrency thereby protects users from corruption. And in the age of digital surveillance, where everything you do is carefully monitored and recorded, cryptocurrency ensures the right to transact privately via encryption.
Lastly and perhaps most importantly, cryptocurrency can’t be “stopped.” How can it? There’s no company to shut down, no currency-printer to unplug, there’s no single entity in charge of everything. You can’t kill something that’s everywhere. Or can you?
88 years ago, Franklin D. Roosevelt signed Executive Order 6102, which forbade the hoarding of gold coin, gold bullion, and gold certificates in the US to remove the constraint on the Federal Reserve which prevented it from increasing the money supply. This was back when the US was still on the gold standard (future article on this coming up). We’re seeing an eerily similar tone today towards Bitcoin by legislators, with Treasury Secretary Janet Yellen arguing that it’s a tool for financing terrorism and President of the European Central Bank Christine Lagarde calling for the global regulation of cryptocurrencies.
The government was able to ban gold nearly a century ago...will Bitcoin be next?