What is cryptocurrency?
In a world where everything’s gone digital, cash and money in general have been left behind. Even considering the widespread use of credit cards and online transfers, we still expect physical money to exist somewhere – whether that’s a bank or a wallet. Cryptocurrencies aim to change these antiquated notions of third parties and physical cash by not existing anywhere but in a digital database called a “blockchain”.
In its simplest form, a cryptocurrency allows users to transfer money almost instantly, with cheap transaction fees and no third parties involved. Over the years, many cryptocurrencies have moved beyond this core component and built platforms that allow users to transfer anything from money to real-life assets such as cars and real estate, all using the blockchain technology introduced by bitcoin.
The crypto part in the name “cryptocurrency” comes from the fact that transactions – the act of transferring assets such as currency and digital or real-life assets between a sender and a recipient – are encrypted for security, a process known as “cryptography”. Cryptography is used for three reasons:
- To protect transactions from being tampered with
- To protect the identity of parties acting in a transaction
- To enable the creation of new coins via the mining process
A brief history of cryptocurrency
The road to cryptocurrencies starts in the 1980s. In an effort to protect the cash of small shops and gas stations, banks began investigating and pushing the idea of points of sale, where a customer can use a credit card instead of cash to pay for products.
Later, in the 90s, came a web-based payment system still used today: PayPal. This gave merchants the power to accept credit card payments online and it introduced the idea of transferring fiat currencies directly between end users entirely online. With PayPal proving that the web is a viable medium for transferring currency, similar services were created, such as WebMoney (a Russian PayPal alternative) and e-Gold, an American corporation that let users buy gold online – gold that it would then hold for them.
In the 2000s, after the FBI shut down e-Gold, cryptocurrencies began popping up in the cryptography community and mailing lists. Known as the Cypherpunks, people like Julian Assange, the founder of WikiLeaks, and Jacob Appelbaum, the developer of Tor, were members.
Unfortunately, none of these cryptocurrencies could gather the necessary momentum to push them into the public’s consciousness until, in 2008, Satoshi Nakamoto published a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System”.
In the years to come, bitcoin grew to become not only the number one cryptocurrency available on the market, but a household name amongst even those who have no interest in cryptocurrencies.
Bitcoin eventually gave rise to hundreds of cryptocurrencies, known collectively as altcoins. Some of these altcoins are little more than copies of bitcoin, but others are attempting to do things with the underlying blockchain technology that not only disrupt the financial sector but also our understanding of apps and website services, all in an attempt to fix today’s problem of centralisation.
The problem with centralisation
Read any literature relating to bitcoin and cryptocurrencies and you’ll eventually stumble upon the concept of decentralisation. To understand decentralisation, you first need to understand the problem with centralisation.
If we take a close look at the world we inhabit today, a world of information and data about who we are, what we do and what we like, we realise that our information is held by a few large organisations: private and public corporations and the government. The dataset representing you (financial records, emails, Facebook messages and likes etc) is held on servers that exist in a central location. For example, your financial records, every transaction you’ve ever been a part of, your current balance and all your loans, exist on your bank’s servers. Your bank might have multiple servers for backup and audit purposes, but it still all exists in virtually one location: your bank.
So let’s say a cracker – a malicious hacker – attacks your bank’s servers and tampers with your account reducing your balance to $0. How can you prove that you didn’t just withdraw all your money? How can your bank verify your claim that you were hacked?
The Cypherpunks, the community from which cryptocurrencies first arose, understood this bleak scenario and aimed to fix it. Cryptocurrencies are said to be decentralised systems because every user of a cryptocurrency keeps a copy of everyone’s transaction history. The moment you join a blockchain you receive the entire history of that cryptocurrency, including all transactions ever made. If a user disagrees with a transaction (say a cracker changes their wallet value from 1 BTC to 1,000 BTC), a consensus must be reached by at least 51% of the users of that cryptocurrency. That 51% then decides what the correct amount should be.
This automatic consensus is the beauty behind cryptocurrencies and decentralisation. There is no one server that crackers can attack. They would need to convince 51% of all users because every user keeps a copy of the blockchain.