Are you interested in cryptocurrencies, but never seriously delved into this topic? No worries, we will explain all the necessary basics that will help you understand cryptocurrencies.
We will begin with the basic question about what are cryptocurrencies, and then we will split the topic into more digestible pieces of information. For a better understanding, we must clarify concepts such as digital currencies, blockchain, decentralization, cryptography.
TABLE OF CONTENTS
- What are cryptocurrencies?
- How to use and store cryptocurrencies
- A brief history of cryptocurrencies
- (-2008) Years before Bitcoin
- (2008) Satoshi Nakamoto and Bitcoin
- (2009) The beginning of mining
- (2010) The first successful transactions
- (2011) New cryptocurrencies appear
- (2013) The first major bubble
- (2014) Mt. Gox and turbulent times
- (2015) Ethereum and the boom of altcoins
- (2016) Flourishing ICO projects
- (2017) Bitcoin reaches 20,000 USD
- (2018) Back to reality
What are cryptocurrencies?
First of all, let’s answer this fundamental question with a more general explanation.
Cryptocurrencies are digital (or virtual) currencies that use cryptography — a technique for secure (encrypted) communication. Because of this security feature, most cryptocurrencies are practically impossible to forge, though their security is also dependant on several other factors.
Most cryptocurrencies are decentralized systems that are based on blockchain technology. This is a public ledger of transactions, which is maintained and updated by thousands of people (miners) all over the world. All transactions are anonymous but are publicly available.
In the paragraph above, we have listed quite a few terms that you may not know yet, so we will explain them in more detail in the following chapters.
Cryptocurrencies: What is virtual currency?
Cryptocurrencies are digital currencies. They exist only on computers, as there are no tangible banknotes or coins in the system.
Virtual money can either be centralized, where there is a central point of control over the money supply, or decentralized, where the control over the money supply can come from various sources. Cryptocurrencies belong to the second category.
Cryptocurrencies: What is cryptography?
Cryptocurrencies are used to convert transaction data. One of the most famous devices for cryptographic communication is Enigma, which was used during the Second World War.
But Enigma had a flaw, which is why the Allies managed to find a solution for decoding Enigma’s messages, while cryptography used in cryptocurrencies is still uncrackable. At least for now, although it is expected that it will remain so for a long time, unless an unforeseen jump in computational power occurs. Quantum computers are often cited as one of the possible candidates that could disrupt modern-day cryptography, but they are still highly experimental.
It could also be called cryptography of public and private keys. This technology allows for the identification of a pair of cryptographic keys: a private key and public key.
Cryptocurrencies: What is decentralization?
Cryptocurrencies are decentralized because the systems operate without a central bank or a single administrator. The value and supply of this digital currency are governed by the users themselves. In a sense, it is a currency that truly belongs to the people.
In order to understand how Bitcoin works, it is essential to understand what a decentralized network is. The concept of decentralization has already been described above, but we can look at it from another point of view. When you visit your web browser and enter “www.google.com,” your computer starts a conversation with Google servers. The browser then shows you various search results. If Google’s servers were not available for whatever reason, you would not be able to see those results. This is because the data is stored in a centralized network.
In a decentralized network, we can avoid such problems.
The basic characteristic of cryptocurrencies is that it is not issued by any central authority, which makes them theoretically immune to the interference or manipulation of the government.
Cryptocurrencies: What is blockchain?
A blockchain is a form of distributed ledger technology which is both transparent and immutable. It is a ledger which publicly records all transaction data. For a transaction to be recorded, the majority of the network must reach consensus. In doing so, the network is agreeing that a transaction is valid.
Let’s explain it with an example. Did you ever send a digital file (say a picture from a trip) to your friend or family via email? If you did, then you invariably created a digital copy of the file. You can probably imagine that it wouldn’t be great if you could do the same with digital money.
The very nature of digital files is such that it is not difficult to duplicate them indefinitely. Filmmakers and musicians have been facing this issue ever since the advent of the internet and peer-to-peer technology.
In the financial world, this issue of duplication is called a Double-spending problem. How do you eliminate the possibility of creating new money out of nothing?
This is where blockchain technology comes into play because it enables distribution instead of duplication.
We have discussed this in more detail in our article on blockchain technology.
The blockchain is, therefore, a solution to the double spending problem. Transactions cannot be duplicated, which prevents the creation of new coins out of nothing.
Cryptocurrencies: What is Mining?
Mining is a distributed consensus system. When someone wants to make a transaction, everyone in the decentralized network receives a copy of this transaction. All members of the network must confirm this transaction, thereby reducing or even eliminating the possibility of fraud.
A lot of people around the world are involved in maintaining the network. Mining is a term used to validate transactions that are waiting to be included into the blockchain.
This is how a chronological order of transactions is achieved in the blockchain. In order to be confirmed, the transaction has to be packaged in a block, which must be in compliance with stringent encryption rules that are verified and validated by the miners on the network. No centralized governmental authority is involved in the process. This is how the neutrality of the Bitcoin network is protected.
Let’s make a quick comparison with the traditional electronic money system. When you make a credit card payment, the issuer (like MasterCard) must verify and record the transaction.
The process of creating new cryptocurrencies is called mining, as it has many parallels with the mining of gold. In both cases, it involves investing a large amount of work and energy to produce a valuable product.
In essence, the Bitcoin miners actually create new Bitcoins as a reward for investing large amounts of computing power to maintain and protect the network!
How to use and store cryptocurrencies
Cryptocurrencies exist only in digital form, so you might think that paying with them is done in a similar way to paying with credit or debit cards. At first glance, it might look like it, but things work quite differently in the background.
Cryptocurrencies exist only on the blockchain, and users access their coins with the so-called public and private keys. Cryptocurrencies aren’t stored in one location in the form of a file (in the section “what’s blockchain” we identified a shortage of digital files).
You can imagine that cryptocurrencies work a lot like email. To receive an email from someone, you must first share your email address with them. It is the same for cryptocurrencies, but you must share your public key (wallet address).
You have to know your password if you want to access your email messages. It is the same for cryptocurrencies, but you have to know your private key.
The crypto wallet always consists of two parts. The first part is the public address of the wallet, which you can share with others without worrying. The second part is a private key that you must never reveal.
A private key is used to encrypt transactions while the public key is used to decrypt them. As a result, it is critical that the private key always remains secure, and why we say that anyone who has access to a private key is also the owner of the wallet. The public key is intended to be shared sharing with third parties and it announces that you are the owner of the address.
You can, therefore, share public keys with others while your private key must remain safely in your possession.
A brief history of cryptocurrencies
Let’s look at a short history of cryptocurrencies. It is closely related to the development of Bitcoin because it was the first true global cryptocurrency.
(-2008) Years before Bitcoin
In the years prior to the creation of Bitcoin, there were quite a few prototypical examples of online digital currencies, but none succeeded in establishing themselves more seriously. Two examples of such currencies are B-Money and Bit Gold, which were designed but never fully got out of the development stage.
(2008) Satoshi Nakamoto and Bitcoin
In August 2008, the Internet domain bitcoin.org was registered and it remains the homepage of the most famous cryptocurrency. On 31 October of the same year, a person or organization under the pseudonym of Satoshi Nakamoto published a scientific paper titled Bitcoin: A Peer-to-Peer Electronic Cash System.
The paper presented the concept of blockchain technology, and Bitcoin is described as a digital resource and an open source system. This means that nobody owns it, and everyone can participate in its use and development.
To this day, no one knows who Satoshi Nakamoto is, so his identity has grown a lot of myths and theories of the plot. The high probability is that his identity will always remain unknown.
(2009) The emergence of crypto mining
In early 2009 the Bitcoin software became available to the public for the first time, and Satoshi Nakamoto mined the first 50 Bitcoins, thus beginning the story of crypto mining. It was a time when only a small team of programmers and enthusiasts participated in the development for what few of them anticipated to be a groundbreaking technology.
(2010) First successful transactions
In the first year of its existence, it was difficult to attribute any real value to Bitcoin as it wasn’t being traded on any larger scale. Developer Gavin Andresen, for example, bought 10,000 Bitcoins for $50 and created a website called Bitcoin Faucet, where he was literally donating Bitcoin for fun.
The most famous case from this era comes from Laszlo Hanyecz, a developer who bought two pizzas for 10,000 Bitcoins. It is considered to be the very first cryptocurrency transaction. At Bitcoin’s peak price, those two pizzas would be worth well in excess of 100 million dollars. But Laszlo never regretted his decision as he believes it was a crucial step in helping the growth of the crypto ecosystem.
In December 2010, Satoshi Nakamoto posted his last public message to the popular online forum called bitcointalk. He wrote about some minor details about the latest version of the software. Afterwards, he remained in touch with some programmers via email, but there is no trace of him after April of 2011. It is very likely that his identity will remain a mystery forever.
(2011) Arrival of new cryptocurrencies
On the basis of Bitcoin’s revolutionary technology and on the wings of its relative success, the idea of decentralized currencies slowly started to gain traction. As a result, the first alternative cryptocurrencies began to appear. We call them altcoins.
Most of them try to improve on the original Bitcoin protocol with features like greater speed, anonymity etc. Litecoin was among the first altcoins, which is why it was dubbed the silver to Bitcoin’s gold. At present time, there are thousands of cryptocurrencies.
(2013) The first major bubble
In January 2013, Bitcoin’s price exceeded $1,000 for the very first time. It was an important milestone in its history, even if the price dropped quickly afterward and then stagnated for about two years before it managed to climb back up to the all-time high.
Some people suffered great losses during this time and it caused a lot of negative press for Bitcoin. Even so, all publicity is good publicity, and cryptocurrencies appeared on the radar of major media outlets and the general public.
Cryptocurrencies started to grow out of their infancy, but it still wasn’t clear whether they would survive. A lot of them didn’t.
(2014) Mt. Gox and turbulent times
In January 2014, the largest Bitcoin exchange Mt. Gox was hacked. It succumbed to theft of around 850,000 Bitcoins! It still isn’t clear who was responsible for what remains the largest theft in Bitcoin’s history.
Cryptocurrencies are based on anonymity and decentralization, so it isn’t surprising that they are very attractive for criminals, and those who are technically gifted can easily conceal their tracks.
In November 2014, the world of the cryptocurrencies was plagued by more bad news as Ross Ulbricht, the founder of the Silk Road website, was sentenced to life imprisonment. Drugs accounted for about 70% of all products sold via his website, and transactions were possible with Bitcoin. A lot of people believe that Ulbricht was falsely accused because some of the evidence used against him is very controversial, but there is little to no possibility that he will ever be released.
(2015) Ethereum and the boom of altcoins
The Ethereum project was launched in 2015, and it is often cited as the first truly useful implementation of the system built on the idea of Bitcoin’s blockchain. Ethereum introduced smart contracts, an interesting concept that makes it possible to conduct publicly transparent contracts where transactions are carried out under precisely set conditions. The philosophy of smart contracts spawned countless new tokens which were built on the ERC20 standard and residing on the Ethereum blockchain.
(2016) Flourishing ICO projects
Ethereum’s popularity was marked by the emergence of projects that acquired start-up funds via crowdfunding. This type of funding in the crypto sphere is called an Initial Coin Offering (ICO). People were buying these coins and tokens on the basis of faith in the project and the belief that virtual tokens will acquire value when the planned project is realized.
Some countries (like China and some US states) banned such projects, or at least warned that in some cases they may be frauds or Ponzi schemes that are concealed as legitimate investments.
(2017) Bitcoin reaches 20,000 USD
The number of publicly available trading platforms and exchanges gradually increased, making it much easier to buy and sell cryptocurrencies. In addition, the ICO projects were entering their golden period.
All of this contributed to the rapid growth of the ecosystem. This young technology promised huge profits, and the total market capitalization of cryptocurrencies exceeded 800 billion dollars at the start of 2018. Practically all cryptocurrencies were selling like hotcakes.
(2018) Back to reality
This growth was unsustainable, so it was rather unsurprising that the bubble popped and the prices started to decline. Many projects collapsed as they were too ambitious for this infant technology. But keep in mind that volatile cycles are normal for such a young market.
The world is increasingly digital and interconnected, and the cryptocurrencies play a very interesting role in all of this. Bitcoin and other cryptocurrencies represent one possible future of money, with some people predicting that it will radically change the global financial system.
Cryptocurrencies definitely have the potential to change our lives and help us regain control of our funds, especially for people in the third-world countries who don’t have the same access to the banking system. There are many types of cryptocurrency, and each one of them promises unique solutions to different problems.
Write down your thoughts or questions in the comments below!