Eleven years ago, the word “cryptocurrency” sounded alien to many. Today, the word is thrown around so often, yet, many people still do not truly know what it means. It is a word commonly associated with the flagship digital currency, bitcoin; however, what are cryptocurrencies?
Most people have a vague idea of what cryptocurrencies entail; to some, it is a word associated with scams and other financial illegalities. To others it’s just another buzzword people make money with.
Cryptocurrencies can be understood simply. Understanding the maths behind them will take a while, a very long while at that.However, having a grasp of the framework that makes them valuable is all that is required to use them.
What are cryptocurrencies?
A cryptocurrency is a digital or virtual currency that can be used as a medium of exchange. It can be seen as regular money, but one that doesn’t have a physical version. To gain a better grasp of the concept, see it as regular fiat– Nigerian Naira, Ghanaian Cedi, American dollar, Kenyan shilling or the South African Rand. Cryptocurrencies are like any of these currencies, but with a significant difference – cryptocurrencies are virtual.
Unlike regular fiat, cryptocurrencies are not owned by any geographical entity. They can, therefore, be used by anyone, anywhere (although, legality is still a little fuzzy in some countries).
What makes them secure?
Cryptocurrencies are secured with cryptography. Cryptography is simply a way of securing messages on the internet. In an age where a lot of business and transactions have gone digital, cryptography plays a formidable role in securing the pieces of information flying all around the interwebs. Cryptography encrypts information or messages in a way that it is only meant for the intended party. Interestingly, cryptography did not start on the internet. It is a practice that is dated as far back as 1900 BC.
How does cryptography work with cryptocurrencies?
The most important cryptographical tool to cryptocurrencies is the concept of digital signatures. A signature is often used to show authenticity in the offline world, and the same thing goes for digital signatures in the digital world. A signature should tell you who the owner of a document is, it should not be forgeable, and once a document is signed, the signature cannot be removed. These are the same things digital signatures do.
However, while signatures are a great way of proving authenticity, they can still be forged. To bypass this problem, cryptography goes a step further by adding keys to this digital signature. These keys lock the document, in order to ensure that prying eyes would be unable to see the signature.
There are more mathematical complexities to cryptography that help ensure the safety of cryptocurrencies, thereby, making them usable.
A little history of Bitcoin and cryptocurrency
Flooz, Beenz and Digi cash are some of the first few attempts at cryptocurrencies during the 90s tech boom. Unfortunately, they all failed.
Consequently, the failures of the first attempts at a digital currency, made the idea lost cause and no known attempts were recorded since.
Then came Satoshi in 2009. An anonymous programmer under the pseudonym; Satoshi Nakamoto, came up with bitcoin. He described it as a completely decentralized peer-to-peer currency that did not require any third party. Sending the currency was as simple as sending a file from one phone to another.
The decentralized nature of cryptocurrency is one of its most remarkable features. Like any payment network, it had to solve the problem of double spending. Double spending is the fraudulent practice of spending the same amount twice. The normal way to solve this problem would be to create a central server that would keep records of every transaction and record balances. This method, however, requires a third party that will have relevant information about each user. Satoshi’s bitcoin does need a server to keep records. It uses a distributed ledger technology known as blockchain. This eliminates the need for a central server recording transactions. Blockchain is a ledger with which everyone has a copy. Any changes made to the ledger immediately reflects in everyone’s copy, thereby making it impossible for a single person to make alterations to every ledger.
Within a cryptocurrency network like bitcoin, miners confirm transactions. Miners do this by solving complex cryptographic puzzles.
So, what can we use cryptocurrencies for?
Like normal currencies, cryptocurrencies can be used to pay for goods and services. On the 22nd of May 2010. A man named Lazlo Hanyecz paid for his pizza with 10,000 bitcoins. This was the first time a digital currency was used as a means of exchange. The day is now known as the “bitcoin pizza day”. Today, Lazlo would have paid $231,000 for that pizza.
There are more merchants that would readily accept cryptocurrencies as payment today. On the Apple app store, cryptocurrencies have been authorised as a mode of payment. In most parts of Africa such as Nigeria, it is a great way to facilitate cross border payments.
Besides being used as a medium of exchange, cryptocurrencies are widely used as a form of investment. A person who invested in 1 bitcoin in 2010, a time when bitcoin was less than a dollar would have earned over $18,000 today.
Although bitcoin might be the most valuable asset of the decade it is important to note that cryptocurrencies are notoriously volatile,thereby, making them a very risky investment.
Bitcoin, the most dominant cryptocurrency had an epic fall in 2017. Its value rose to $20,000 and crashed down to $3000. However, the currency has now surpassed its former all time high (ATH). it is now valued at $23,000 at the time of writing this.
Proof of work (PoW) deals with mining
Cryptocurrencies can also be mined. Mining is a very important part of cryptocurrencies, especially those that use the Pow (proof of work) consensus mechanism. Miners confirm transactions so it can be added to the distributed ledger. In a way, they provide bookkeeping services. Miners solve cryptographic puzzles. These puzzles have become more complex over the years for popular currencies. Nowadays, industrial computational hardware is required to be a successful miner. For every puzzle solved, miners are rewarded with bitcoins.
Mining is the way more coins gets into circulation. Over the years the reward miners get has been reduced to decrease the number of cryptocurrencies in circulation. This is partly why the value of bitcoin increases. Miners were rewarded 50 bitcoins when the currency first launched, now the reward is 6.25 bitcoins. The reward will, however, be reduced again as the amount of bitcoin in circulation is close to the amount intended. Only 2 million bitcoins are left to be mined. Mining them will bring the total amount of bitcoins in circulation to 21 million.
Proof of stake requires validators to stake certain amount.
Unlike mining, some currencies use staking as a consensus mechanism. As bitcoin requires miners to confirm transactions, other crypto currencies do not. An example is the new Ethereum 2.0. The currency with most market capitalization after bitcoin. Ethereum requires validators to validate transactions that occur on the ethereum network. These validators are required to stake at least 32 ethers in order to be given the right to validate.
Validating does not require immense computing power like mining. A strong personal computer can validate.
Staking, however, isn’t running on the ethereum network yet. It is a new upgrade to the network that will be implemented in 2021.
Learning about cryptocurrencies is a process that often starts by owning them. Reading enthusiasts’ views and comments on social media will propagate more understanding. Follow relevant accounts on social media, and follow news updates to make informed decisions on cryptocurrency.