Cryptocurrency

A selection of cryptocurrencies. Source: Adapted from Ankri 2022.
A selection of cryptocurrencies. Source: Adapted from Ankri 2022.

A cryptocurrency is a digital currency that can be used to buy goods and services, but it has other purposes as well. Cryptocurrencies differ on the basis of their technology, purpose, privacy, and performance. Because they're transacted in cyberspace, they're also called virtual or digital currencies. By one estimate (Jan 2022), there are 16,300+ cryptocurrencies.

Cryptocurrencies are created using cryptographic techniques that make them secure. Many of them are based on blockchain technology but there are some that don't use blockchain. This blockchain is distributed across a network of computer systems. No single computer controls the blockchain.

Cryptocurrencies have their challenges. They've been used to conduct illegal activities in an untraceable manner. They can be stolen. Their valuations are volatile, leading to speculative trading. Regulations are not mature or simply non-existent in many countries.

Discussion

  • How are cryptocurrencies different from fiat currencies?
    Comparing gold, fiat currencies and cryptocurrencies. Source: Kelleher 2021.
    Comparing gold, fiat currencies and cryptocurrencies. Source: Kelleher 2021.

    Fiat currencies (dollars, euros, etc.) are issued and backed by governments. Governments also control the supply and this scarcity gives them value. The financial system and transactions are governed by a central bank. Apart from cash transactions, online transactions and cheque payments require intermediaries such as banks. These intermediaries often charge a commission. Transactions can be reversed if necessary.

    Cryptocurrencies are not backed by any government or central bank. Trust in these currencies comes from consensus among participants. Trust is placed in the underlying technology, which is decentralized. No single entity controls the technology. Cryptocurrencies themselves have mechanisms to limit supply. Transactions can happen directly without intermediaries or commissions. Transactions are permanently recorded: they can't be erased or reversed.

    However, both fiat currencies and cryptocurrencies can be used to pay for goods and services, though cryptocurrencies are not widely used for this purpose at the moment. Both store value so long as there's continuing trust.

  • Which are the main cryptocurrencies?

    From the thousands of cryptocurrencies, Bitcoin is the most famous one, followed by Ethereum. Cryptocurrencies other than Bitcoin are generally called altcoins.

    Cryptocurrencies can be categorized as follows:

    • Payments: Bitcoin was created as a currency for fast and cheap cross-border payments.
    • Infrastructure: Ether is the crypto asset of Ethereum. To use applications on Ethereum, ethers are bought and spent. Other cryptocurrencies can build on top of Ethereum. Augur is an example.
    • Services: Created to offer a service. Siacoin provides decentralized cloud storage. MANA can be used to buy virtual land on the Decentraland application. LUNA (from Terra), a DeFi coin, enables decentralized finance. Dentacoin serves the healthcare industry.
    • Stablecoins: Better stores of value since Bitcoin is highly volatile. Tether, USD Coin and Binance USD are examples. They're pegged against the U.S. Dollar.
    • Privacy Coins: Offer greater privacy for transacting parties. They've been popular among hackers distributing ransomware. Eg. Monero, Zcash and Dash.
    • Meme Coins: Created as a joke but have become successful. Eg. Dogecoin, Shiba Inu and Dogelon Mars.
    • Interoperability Coins: Used on platforms that enable different blockchains to interoperate. Examples of these cryptocurrencies (and their platforms) are Dot (Polkadot), Link (Chainlink) and Atom (Cosmos).
  • Are crypto coins the same as crypto tokens?
    Types of crypto coins and tokens. Source: Thoma 2021.
    Types of crypto coins and tokens. Source: Thoma 2021.

    There are two broad categories of cryptocurrencies: coins or tokens. Coins are used for payments but tokens have a variety of uses, often in application-specific ways. Coins can be viewed as digital money whereas tokens as programmable assets. Smart contracts rely on tokens. Such contracts give proof of ownership to real-world assets.

    Tokens are issued through a process called Initial Coin Offering (ICO). Investors get tokens in return for their money. This money is used to develop a product or service to which investors get special access. Tokens themselves can be currency tokens, asset tokens, security tokens, reward tokens, utility tokens, or non-fungible tokens (NFTs).

    Coins are native to their own blockchains but that's not the case with tokens. Bitcoin, Ethereum, Cardano and Polkadot run on their own blockchain platforms. USD Coin, Crypto.com Coin and Wrapped Coin are tokens that run on the Ethereum platform.

    However, the distinction between coins and tokens is not always clear. CryptoSlate website shows coin and token rankings, and some cryptocurrencies appear in both lists.

  • What are the main technical differences among various cryptocurrencies?

    An important difference is how coins are produced and spent, their privacy and transaction speed. Some cryptocurrencies such as Bitcoin, Dash and Monero are created by a process called mining. Miners use powerful computers to solve complicated mathematical problems. Other currencies such as NEM (XEM) don't require mining. Ripple and IOTA are produced by organizations that create them.

    In terms of privacy and performance, transactions in Dash or Monero are faster than those in Bitcoin. Litecoin validates a block in 2.5 minutes whereas Bitcoin requires 10 minutes. Litecoin uses scrypt algorithm for hashing instead of Bitcoin's SHA-256.

    While many cryptocurrencies use blockchain as the underlying technology, IOTA is one that uses tangle instead. More technically, it's based on directed acyclic graphs. IOTA was created to secure data for the Internet of Things (IoT). Even when cryptocurrencies use blockchain there are differences. In a blockchain, participants agree on transactions by consensus. Bitcoin uses Proof of Work (PoW) as the consensus algorithm but Solana use a mix of Proof of Stake and Proof of History.

  • How does a cryptocurrency work?
    How cryptocurrency transactions work. Source: Bonnie 2021
    How cryptocurrency transactions work. Source: Bonnie 2021

    Most cryptocurrencies run on blockchain technology. A blockchain is a digital ledger (or database) of transactions. It's distributed across a network of computer systems but no single computer controls the network. Instead, this decentralized network of computers runs the blockchain and authenticates transactions.

    Each computer is called a node. Each node performs a few main functions: relay transactions to other nodes, process transactions, and maintain the database of transactions. Many transactions are grouped into a block. Blocks are then connected in chronological order in a long, unbroken chain called blockchain.

    Mining itself is the process of validating a transaction to prevent fraud. A node that validates transactions is also called a miner. Validation is simply a miner solving a complex mathematical problem. The cost of the hardware and energy required to solve this problem is very high. The miner that solves the problem first earns the right to post the transaction to the ledger and gets the cryptocurrency as the financial reward.

    Every block is timestamped to indicate when it was validated. Timestamp used is the median of timestamps returned by all nodes of the network.

  • How can cryptocurrencies be bought and sold?
    How to convert from one cryptocurrency to another. Source: Trust Wallet 2020.

    Cryptocurrencies can be bought either via a cryptocurrency exchange or through brokers. Cryptocurrency exchange is a platform where people buy and sell cryptocurrencies. They have relatively lower fees than brokers. Cryptocurrency brokers are the intermediaries that execute transactions on your behalf and charge a fees for it. They also trade through exchanges.

    To buy cryptocurrencies through an exchange, a user creates an account with the exchange. The user needs to verify the account to prevent fraud and meet federal regulatory requirements. The next step is to deposit real-world money into the chosen exchange. Now the user can buy any cryptocurrency out of hundreds of options.

    A cryptocurrency can be exchanged for real-world money. Or it can be converted to any other cryptocurrency using exchange platforms such as Coinbase, Gemini and Trust Wallet.

  • What options do I have to store cryptocurrencies?

    Cryptocurrency exchanges are not backed by banks and they're loosely regulated. So they're at risk of theft or hacking. An investor can lose all his money if he forgets or loses the codes to access his account. Hence, it's very important to have a secure storage.

    Some storage methods include:

    • On the Exchange: Cryptocurrencies are generally stored in a crypto wallet on the exchange. For higher safety, it's better to use a hot or cold wallet.
    • Hot Wallets: These are crypto wallets that are accessible online and run on internet-connected devices, such as tablets, computers or phones. Hot wallets are convenient, but there's still a risk of theft since they operate on the internet.
    • Cold Wallets: Cold crypto wallets aren't connected to the internet. They are stored in external devices, such as USBs or hard drives. Precaution is a must with cold wallets because if the keycode is lost or the device fails or breaks, the cryptocurrency may not be recovered ever.
    • Physical Coins: Bitcoin investors can purchase physical coins corresponding to the amount of bitcoins they purchased, with tamper-proof sticker covering a predetermined amount of Bitcoin.
  • What are the technological limitations of cryptocurrencies?

    The biggest technological limitation is the theft of currency. There have been many incidents when people or organizations have lost it all. In 2014, Fr33 Aid, an anarchist mutual aid organisation had it's Bitcoins stolen from it's online wallet located at Blockchain.info. Approximately 23 bitcoins were stolen, valued at more than 1 million dollars. Similar thefts have occurred at other exchange platforms including Coinbase and MtGox. MtGox went through a $500 million theft that ultimately brought down the exchange.

    Cryptographic private keys can be lost from local storage due to malware, data loss or the destruction of the physical media. This results in the permanent loss of money. Perhaps another limitation is that transactions are irreversible.

    Bitcoin, Ethereum and Dash are examples that require resource-intensive, high-energy-consuming mining. According to Bloomberg, 24 hours of crypto mining from around the world consumes around $150,000 in electricity.

  • What are some criticisms of cryptocurrencies?

    Cryptocurrencies are seen as threatening the establishment, which may result in outright bans or tight regulations. If so, they may not succeed as digital money. High transaction fees charged by exchanges may be an additional discouragement. Due to price volatility, they're not even good as stores of value. Transactions are also not really anonymous unless participants use one of the privacy coins. While built on decentralized technology, it's not really democratic since control is with miners, exchanges and platform owners.

  • How are different countries adapting cryptocurrencies?

    Government of different countries have different stands on the usage of cryptocurrencies. While some developed countries such as US, UK and Canada have allowed them for transactions, Zimbabwe, Kuwait and Bahrain have put an implicit ban on it. China, Bangladesh, Nepal, Qatar and Egypt have put an absolute ban on their use.

    El Salvador is the first country to adopt cryptocurrencies as a legal tender. In Latin America, high inflation and volatility of fiat currencies have made cryptocurrencies a safer alternative. Cryptocurrencies are seen as better store of value. They're also used for sending money home.

    Estonia has strict regulations. Licenses must be obtained, which includes paying a licensing fee, registering a headquarters physically located in Estonia and identifying customers. This resulted in withdrawal of 1,000 activity licenses of virtual currency companies in 2020.

  • Which are the cryptocurrency exchanges out there and what cryptos do they support?

    There are many cryptocurrency exchanges such as Coinbase, Gemini and Binance US. Different exchanges have different interfaces. Following are a few of the many exchanges:

    • Coinbase: According to Forbes, Coinbase is one of the best cryptocurrency exchanges. It offers services in many different cryptocurrencies such as Ethereum Classic, XRP, and Stellar Lumens; but it doesn't support Dogecoin.
    • Crypto.com: It supports access to 180 different cryptocurrencies. It doesn't charge any trading fee.
    • Gemini: It offers a trading platform that's easy to use for beginners, but the fee structure is higher than other exchanges.
    • Etoro: It supports 17 different cryptocurrencies. It offers service in 44 states in the US only.

Milestones

1983
Early history of cryptocurrency. Source: Cohen 2021.
Early history of cryptocurrency. Source: Cohen 2021.

American cryptographer David Chaum develops eCash. The platform allows people to transfer money anonymously over the internet.

1995
DigiCash logo. Source: Cohen 2021.
DigiCash logo. Source: Cohen 2021.

DigiCash, an organization founded by David Chaum based on the eCash concept, gains popularity. It's an early form of cryptographic electronic payments that requires user software for withdrawing or sending payments.

1996

National Security Agency of United States publishes a paper entitled How to Make a Mint: the Cryptography of Anonymous Electronic Cash, describing a cryptocurrency system.

1998

The term cryptocurrency is officially established. DigiCash of David Chaum goes bankrupt. Wei Dai publishes B-money based on a decentralized crypto model.

2009

Pseudonymous developer Satoshi Nakamoto, creates the first decentralized cryptocurrency named Bitcoin.

2013

Billy Markus and Jackson Palmer release a new decentralized cryptocurrency named Dogecoin.

2014

UK commissions a study of cryptocurrencies and the role they could play in the UK economy.

2015

Vitalik Buterin, Gavin Wood, Charles Hoskinson, Anthony Di Iorio and Joseph Lubin release a new decentralized cryptocurrency named Ethereum.

2021

El Salvador becomes the first country to accept Bitcoin as legal tender. Government of China, the largest market of cryptocurrency, declares all cryptocurrency transactions illegal, completing a crackdown on cryptocurrency.

2022

Bitcoin becomes the largest cryptocurrency with a market capitalization of $882 billion, followed by Ethereum at $447 billion. Binance Coin, Tether and Solana follow at $86 billion, $78 billion and $52 billion respectively.

References

  1. Aguirre, Fernando Gonzalez. 2018. "Why are there so many cryptocurrencies?" bobsguide, May 21. Accessed 2022-01-10.
  2. Ankri, Steven. 2022. "Top 100 Cryptocurrency Icons." Sketch App Sources. Accessed 2022-01-10.
  3. Bajpai, Prableen. 2021. "Countries Where Bitcoin Is Legal and Illegal." Investopedia, December 14. Accessed 2022-01-10.
  4. Bit2Me Academy. 2021. "What is Timestamp?" Bit2Me Academy. Accessed 2022-01-08.
  5. Bitpanda. 2022. "What's the difference between a cryptocurrency like Bitcoin and fiat money?" Lesson, Bitpanda. Accessed 2022-01-10.
  6. Boder, Ryan. 2021. "Bitcoin in Latin America: Crypto's Next Big Wave." Entrepreneur, December 23. Accessed 2022-01-08.
  7. Bonnie, Emily. 2021. "Blockchain Simplified: Benefits of Blockchain in Ecommerce." CleverTap, July 06. Accessed 2022-01-08.
  8. Casteele, John. 2021. "Why Serious Investors Should Take a Closer Look at Privacy Coins." The Motley Fool, November 20. Accessed 2022-01-10.
  9. Cohen, Evan. 2021. "A Cryptocurrency Timeline: From eCash to Ethereum." Vincent, July 01. Accessed 2022-01-03.
  10. CoinMarketCap. 2022. "Top Memes Tokens by Market Capitalization." CoinMarketCap. Accessed 2022-01-10.
  11. Conway, Luke. 2021. "What are the Safest Ways to Store Bitcoin?" Investopedia, February 28. Accessed 2022-01-08.
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  13. CryptoSlate. 2022a. "Interoperability Coins." CryptoSlate. Accessed 2022-01-10.
  14. CryptoSlate. 2022b. "Coin Rankings." CryptoSlate. Accessed 2022-01-10.
  15. CryptoSlate. 2022c. "Token Rankings." CryptoSlate. Accessed 2022-01-10.
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  17. Frankenfield, Jake. 2022. "Initial Coin Offering (ICO)." Investopedia, January 3. Accessed 2022-01-10.
  18. FreeManLaw. 2021. "Estonia and Cryptocurrency." FreeManLaw. Accessed 2022-01-10.
  19. Gayomali, Chris. 2015. "Want to make money off Bitcoin mining? Hint: Don't mine." The Week, January 09. Accessed 2022-01-05.
  20. Hayes, Adam. 2021. "10 Important Cryptocurrencies Other Than Bitcoin." Investopedia, December 18. Accessed 2022-01-10.
  21. Hodgson, Fergus. 2020. "Five Ways Cryptocurrency Critics Are Right." Econ Americas, June 22. Accessed 2022-01-11.
  22. Hou, Felicia. 2021. "Stablecoins are taking over the crypto world and they're a hot topic for Congress—here's what they are and the fastest-rising ones to keep an eye on." Fortune, December 9. Accessed 2022-01-10.
  23. Hyatt, John. 2021. "Decoding Crypto: What It Is, How It Works, and How to Get Started." Nasdaq, July 06. Accessed 2022-01-04.
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  29. Outlook. 2021. "Know The Four Types of Cryptocurrencies Based On Their Utility." Outlook, December 13. Accessed 2022-01-10.
  30. Pittis, Don. 2022. "With so many cryptocurrencies, why do any of them have value?" CBC News, January 6. Accessed 2022-01-10.
  31. Royal, James and Kevin Voigt. 2022. "What Is Cryptocurrency? Here's What You Should Know." Nerdwallet, January 03. Accessed 2022-01-04.
  32. Schmidt, John and Kat Tretina. 2021. "How To Buy Cryptocurrency." Forbes, July 12. Updated 2021-07-14. Accessed 2022-01-03.
  33. Schmidt, John and Kat Tretina. 2022. "Top 10 Cryptocurrencies In January 2022." Forbes Advisor, January 03. Accessed 2022-01-08.
  34. Seaton, Jennifer. 2021. "Cryptomining." Techopedia, December 9. Accessed 2022-01-03.
  35. Sheppard, William. 2014. "Keeping Your Cryptocurrency Safe." C4SS, April 01. Accessed 2022-01-05.
  36. SoFi Learn. 2021. "Understanding The Different Types of Cryptocurrency." SoFi Learn, September 17.Accessed 2022-01-10.
  37. Tepper, Taylor and John Schmidt. 2022. "The Best Crypto Exchanges Of January 2022." Forbes, January 04. Accessed 2022-01-08.
  38. Thoma, Martin. 2021. "The 7 Types of Cryptocurrencies You Must Know." GitConnected, on Medium, April 22. Accessed 2022-01-11.
  39. Trust Wallet. 2020. "How to Swap one Crypto for Another." Trust Wallet, on YouTube, November 12. Accessed 2022-01-08.
  40. Voigt, Kevin. 2022. "10 Best Crypto Exchanges and Platforms of January 2022." NerdWallet, January 04. Accessed 2022-01-08.
  41. Wikipedia. 2022. "Cryptocurrency." Wikipedia, January 4. Accessed 2022-01-04.
  42. Wikipedia. 2022b. "Litecoin." Wikipedia, January 11. Accessed 2022-01-11.
  43. Wikipedia. 2022c. "Ethereum." Wikipedia, January 8. Accessed 2022-01-08.
  44. Wikipedia. 2022d. "Dogecoin." Wikipedia, January 4. Accessed 2022-01-08.

Further Reading

  1. Boder, Ryan. 2021. "Bitcoin in Latin America: Crypto's Next Big Wave." Entrepreneur, December 23. Accessed 2022-01-08.
  2. Hyatt, John. 2021. "Decoding Crypto: What It Is, How It Works, and How to Get Started." Nasdaq, July 06. Accessed 2022-01-04.
  3. Wikipedia. 2022. "Cryptocurrency." Wikipedia, January 4. Accessed 2022-01-04.
  4. Royal, James and Kevin Voigt. 2022. "What Is Cryptocurrency? Here's What You Should Know." Nerdwallet, January 03. Accessed 2022-01-04.

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Devopedia. 2022. "Cryptocurrency." Version 13, January 11. Accessed 2022-01-18. https://devopedia.org/cryptocurrency
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Last updated on
2022-01-11 11:51:06