What Is Cryptocurrency?
Content
What is cryptocurrency?
What’s a blockchain?
Why are people saying blockchains could be transformative?
What is bitcoin?
What are Web 3.0 assets?
What are digital payment assets?
What is Ethereum?
What Is Cryptocurrency?
Long shrouded in mystery, cryptocurrencies are today on the cusp of becoming available to mainstream investors. Soon they will take their place alongside traditional assets like equities, fixed income, and commodities as a common part of investors’ portfolios.
All cryptocurrencies—also known as digital assets—share two key qualities:
First, they are built on blockchains, an emerging digital technology with the potential to disrupt virtually every industry and even the internet itself.
Second, they reflect a conviction that digitalization—a trend that has rapidly accelerated alongside the pandemic—is here to stay. In fact, bitcoin, the most well-known cryptocurrency, has attracted interest from major investors, who see it as a kind of “digital gold.”
This is the first in a series of four FAQs exploring the role of cryptocurrencies in a modern portfolio. Let’s start with the basics:
1. What’s a blockchain?
A blockchain is a technological protocol—a ruleset—that combines cryptography and economic incentives to enforce collective agreement on information in computer networks. Each computer in the network maintains a copy of the information, only updating it when new information is collectively agreed upon.
Because broad collective consensus creates security of information, blockchains are particularly useful for transferring value between parties.
2. Why are people saying blockchains could be transformative?
The modern world is built around entities who facilitate trust between parties and who maintain collective information. like records of credits and debits, signatures on contracts, and the enforcement of contracts.
These gatekeepers can be found across all industries, including finance, law, media, communications, insurance, and government. Blockchains represent a different architecture: Because collective information is maintained by default, central entities that maintain information become redundant.
Cryptocurrencies have shown this can be true for money; other industries are in earlier stages of disruption. At their heart, blockchains are powerful because they are the continuation of the “story of the internet” and the march towards digitization: the internet is unparalleled in its ability to connect computers globally in real time.
It had, until the advent of the Bitcoin blockchain in 2009, lacked the ability to exchange value natively between computers. Now, the design space has been blown wide open.
3. What is cryptocurrency?
A cryptocurrency is a form of non-sovereign money built using cryptography rather than trust between institutions. Cryptocurrencies are generated by “miners” who receive income for providing computational power to the network, which helps to maintain an associated blockchain.
Miners of bitcoin and other cryptocurrencies expend computing power to validate and secure transactions recorded on their respective blockchains. As more users join or interact with a given blockchain, demand for that blockchain’s cryptocurrency grows.
Bitcoin was the first widespread application of blockchain technology. Bitcoin was conceived as “peer-to-peer” electronic cash for the internet, meaning that people can exchange it without need for a bank, a government, or another intermediary.
Transactions on the bitcoin ledger are permanent, auditable, encrypted, and distributed. Importantly, the Bitcoin blockchain has never been hacked. Since its inception, the supply of bitcoin has been limited by design, and only 21 million bitcoin will ever be issued. An increase in bitcoin’s value will not affect its supply.
Bitcoin has emerged as one of the only verifiably scarce, immutable, and capped-supply assets in the world, and it is attracting investment as a “store of value” asset, which is why some call it “digital gold.” Like gold, bitcoin is a potential safeguard against macroeconomic trends and sovereign currency fluctuations.
But unlike gold, bitcoin lives on the internet: It can be transferred more quickly, it’s easier to store, and it’s more easily divisible. Bitcoin also has more growth potential than gold; its market cap stands around $200 billion, while gold represents a $12 trillion market.
5. What are Web 3.0 assets?
These assets are primarily meant to support the emerging decentralized internet known as Web 3.0. After bitcoin, the second-most popular cryptocurrency is ether (ETH), the digital currency of the Ethereum blockchain.
Ethereum was the first platform for the building of decentralized applications using “smart contracts”—self-executing code that automatically implements the terms of agreements between parties. These contracts have the potential to streamline processes across the business world.
Developers have built hundreds of decentralized applications on the Ethereum platform in areas including finance, commerce, and social networks. ETH miners provide the computing power for the execution of smart contracts, and demand for these applications indirectly drives demand for ETH. Smart-contract blockchains such as Ethereum may become foundational for the decentralized internet.
6. What are digital payment assets?
The race for digital payments broadly splits into two categories: central bank digital currencies (CBDCs) and “stablecoins” on public blockchains. Bitcoin forced central banks to recognize that cryptographic payment rails are more efficient than legacy payment rails. The announcement of Facebook’s Libra further underscored that point.
Now, more than 80% of central banks globally are studying or developing their own CBDC according to the Bank for International Settlements. CBDCs are blockchain-inspired, but do not need to live on blockchains. According to a European Union task force, CBDCs stand to “provide state-of-the-art payment services”, “increase choice, competition, and accessibility”, and “reduce overall costs and ecological footprint of the monetary and payment systems.”
On the other hand, stablecoins—dollar-pegged cryptocurrencies like USDC, Tether, Dai, Celo, and Libra—live on public open-source blockchains like Ethereum and have grown to more than $20 billion in market size, up 213% from $6.7 billion on January 1, 2020. Stablecoins are cryptocurrencies with reduced price volatility,
making them more suitable for exchange. Celo, a promising startup out of San Francisco, built a blockchain specifically tailored to mobile-first transactions and aims to serve 1.1 billion users who have smartphones but lack access to banking services.
What is Ethereum?
Ethereum is an operating system for Decentralised Applications and smart contracts. The cryptocurrency generated by the Ethereum blockchain is called Ether.
Ethereum is an operating system (world computer) for Decentralised Applications (DApps)
Ether is a decentralised and immutable cryptocurrency running on the Ethereum network
DApps are a tamper-proof and secure way to record contracts called smart contracts
DApps are not controlled by an individual or a central entity
Tokens can be issued via Smart Contracts
Ethereum is a second-generation blockchain. In a way, Ethereum carried forward the ideas and concepts that were introduced by Bitcoin. The goal of Ethereum is to further advance use cases for blockchains and to allow for more than peer-to-peer payments.
Ethereum was conceived by Vitalik Buterin, a co-founder of Bitcoin Magazine and programmer. He set out to create a new platform for decentralised applications after he suggested the implementation of a scripting language in Bitcoin.
Buterin outlined the concepts underlying Ethereum in a whitepaper under the title of “A Next-Generation Smart Contract and Decentralised Application Platform.” Development began in early 2014 and was funded by an ICO which took place from July to August 2014.
During this time, Vitalik Buterin became one of the most prominent figures in the cryptocurrency sphere.
What is the concept behind a “smart contract”?
The idea behind smart contracts was first described by computer scientist and cryptographer Nick Szabo in 1996. He wanted to provide a secure and trustworthy way for contracting between strangers on the Internet. His intention was to make traditional contracts less expensive and more secure at the same time.
Technically speaking, almost all cryptocurrency agreements use smart contract technology. Following Szabo’s vision of secure and decentralised agreements, cryptocurrency systems are based on multilateral agreements of which all wallet-holders are parties.
A smart contract in its original context is a computer protocol that serves to digitally verify, enforce or to facilitate the performance and negotiation of a contract without third parties.
However, computation mechanisms on blockchains such as Ethereum’s and DApps (decentralised applications) running on the Ethereum blockchain are commonly also referred to as “smart contracts”.
Therefore, computers in the decentralised Ethereum network have two functions: to record transactions and to produce smart contracts. For implementing tokens on the Ethereum blockchain, the technical standard used for smart contracts is ERC-20.
