Cryptocurrency 101 - Intro to Cryptocurrency
- Nov 8, 2021
- 5 min read
"I think the Internet is going to be one of the major forces for reducing the role of government. The one thing that's missing but that will soon be developed, is a reliable e-cash". - Milton Friedman
The Internet is one of the greatest technologies that has ever been developed. There have been vast improvements to technology year after year and we the people get to benefit from the value it brings. From communication, entertainment, and education, the Internet has made our lives better. Technologies like FaceTime or Facebook Messenger gives us the luxury to video chat in real time with friends, family, and colleagues all around the world. I have fond memories of browsing through movies at Blockbuster and CD’s at Tower Records on Friday nights, but being able to stream movies and music from anywhere in the world is another example of technology innovation. One of the most important innovations to technology (in my opinion) is being able to provide free education to anyone in the world. People can simply browse through YouTube, Udemy, etc. and learn from people all around the world. All that is needed is an Internet connection. As we continue to innovate, technology will only get better and improve our lives. In this article, we will take a look at a high-level view of Cryptocurrencies and dive into why we think it is one of the greatest innovations to technology in a long time.
What are Cryptocurrencies?
Cryptocurrency is defined as a digital or virtual version of money where transactions are done online. Cryptocurrency is secured through cryptography and runs on a decentralized network based on blockchain technology (see below). You may have heard of Bitcoin (we will cover Bitcoin in another article) which is the first ever and one of the most popular types of cryptocurrency today. However, as this new asset class continued to mature, other cryptocurrencies such as Ethereum, Cardano, XRP, etc. were created and some served different purposes other than money.
Centralized vs Decentralized
Unlike fiat currencies (which is centralized), cryptocurrencies are not backed by the government or any other governing body. They are “decentralized”, meaning there is no central party that controls the monetary policy of the underlying cryptocurrency. Centralized platforms have a core central authority that dictates the truth to the other participants in the network. Only privileged users or institutions can access the history of transactions or confirm new transactions. Decentralized systems have no core or central authority to dictate the truth to other participants in the network. Every participant in the network can access the history of transactions or confirm new transactions.
The following is a table comparison (Figure 1) of a centralized monetary system, similar to our fiat currency and cryptocurrencies that is decentralized.
Figure 1 - Centralized vs Decentralized
While digital money may sound weird, it really isn't. There have been several "weird and crazy" money ideas that people thought would not be successful. For example, after years of carrying around fiat paper currency and clad coins (nickel, copper, zinc metals pressed together), plastic credit cards evolved. There was no need to carry paper currency around as we could swipe our plastic card and pay for any goods and services anywhere these cards were accepted. The idea of currency in a plastic card was seen as crazy at first but has well been adopted and improved over the years. Electronic banking and paying bills directly from your online bank account, transferring money over the Internet, etc. can be done from the comfort of your own home. Then came the ability to pay using technology such as Apple Pay and Google Pay directly from your phone to eventually pay with a smart watch. This all seemed like strange ideas at first, but they eventually were adopted by the public. When the Internet was first created, there were mixed reviews and critics did not think it would evolve to be useful to mankind. Digital money (cryptocurrency) is no different. We can use cryptocurrencies like Bitcoin to pay for goods and services, remit money to families across the world faster, cheaper, and without any middleman standing in our way. All of this is possible because the Internet and technology has evolved over time.
Going back to our centralized monetary policy, while many people do not know what happens when they swipe their credit card or use Apple Pay to pay for a good or service, they feel comfortable knowing that somehow currency is being transferred from one account to another to settle the transaction. The networks used in these platforms are centralized and require a middleman, financial institutions, or a government body to monitor the platform. They can inflate the platform (print more currency), change interest rates, etc. and are overseen by the government. Cryptocurrencies, on the other hand, are built on a decentralized peer-to-peer network that is powered by its peers (other computers or nodes).
Blockchain (Distributed Ledger)
In the beginning of the article we mentioned that the cryptocurrency’s decentralized network is based on blockchain technology. Blockchain is a network system of recording data in a way that makes it difficult or impossible to modify, hack, or manipulate. It is a digital ledger of transactions that is replicated and distributed across the entire de-centralized network of computer systems on the blockchain.
Each block within the blockchain contains a number of transactions, and every time a new transaction occurs on the blockchain, a record of that transaction is added to every computer system’s ledger. The blockchain is secured through cryptography, which basically means securing communications from outside observers. The transactions are recorded with a hash function that is tamper resistant to maintain the transaction’s integrity. There is a consensus for agreement if one block in one chain was modified, it would be evident that it was tampered with. If hackers wanted to corrupt a blockchain system, they would need to change every block in the blockchain and across all of the distributed versions of the chain. The security of the blockchain improves as more blocks are added to the blockchain.
The following are characteristics of a distributed ledger:
Distributed: all network nodes have a copy of the ledger for complete transparency.
Immutable: validated records cannot be reversed or modified.
Time-stamped: all transactions are time stamped and recorded in each block.
No central authority: the network protocol is the only thing that determines the state of the system.
Programmable: contracts can be written and executed on the blockchain.
Secure: All transactions are encrypted and secured.
Anonymous: The identity of participants is anonymous or pseudonymous (fictitious)
Public: All transactions and records are public.
Why Care About Cryptocurrencies?
The only way to protect your wealth is to invest in assets, and as investors we want to invest in real things that add value and change lives. Cryptocurrencies have been around for over a decade and while it is starting to become mainstream, this is still a developing market. Similar to the Internet bubble, cryptocurrency projects today may not be around in the next year, five years, ten years, etc. Cryptocurrency projects like Bitcoin and Ethereum have been adopted by the public and institutions and we believe it will continue to see more adoption into the cryptocurrency asset space.
When the Internet was first created, there were mixed reviews and critics didn’t think it would evolve to be useful to mankind. Cryptocurrency (digital money) is no different. All of this is possible because the Internet and technology evolved over time.
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