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Cryptocurrency

cryptocurrency

General introduction

‘Cryptocurrency’ is a term commonly used to refer to bitcoin-like digital currencies. At present, over forty different ‘cryptocurrencies’ exist 1, with the significant majority being ‘forks’ of Bitcoin (meaning they are modified copies of Bitcoin’s code).

When speaking of ‘cryptocurrencies’, people mean the novel medium of exchange that was pioneered by bitcoin, which is a digital technology for issuing, exchanging and administering currency units. The application of this technology is currently restricted to the currencies that are today shared under the ‘cryptocurrency’ denominator (with names like Litecoin, Feathercoin, and Namecoin), but may in the future also be applied in different currency models.

Background

The fundamental purpose of the cryptocurrency technology has been to offer privacy and independence from the traditional financial services and banking sector to the user community. The inventor, Satoshi Nakamoto, pursued a peer-to-peer version of electronic cash (which he named ‘bitcoin’) that would allow payments to be sent directly from one party to another without going through a financial institution. Instead, the transaction is broadcasted over the network of ‘peers’ (private computers running dedicated software) that verify the validity of the transaction. This feature has ensured that the ‘cryptocurrency’ functions as a means of settling payments in a secure and irreversible manner, provided that people can be encouraged to accept the currencies as a means of payment.

Technology

Cryptocurrencies accounts are maintained and cleared through a process called ‘mining’ with the execution of specific tasks required to keep the network running and secure. These are performed by a distributed network of computers (nodes). New currency is often issued during this process at a specific rate, and issued to the most active participants of the network (miners).

Another key feature of cryptocurrencies is their reliance on a ‘block chain’, which is a transaction database shared by all nodes participating in a system. A full copy of a currency’s block chain contains every transaction ever executed in the currency. With this information, one can find out how much value belonged to each address at any point in history. This way, wallets can calculate their available balance and perform transactions which can be verified to ensure that the user is spending coins that they actually own. The integrity and the chronological order of the block chain are enforced through cryptography, hence the name. The large number of nodes working on the block chain protects the neutrality of the network, and allows independent computers to verify the validity of the system.

This technology is not necessarily limited to transactions of cryptocurrencies but could also be employed for transactions of conventional currencies. Thus it is always important to differentiate these technologies into payment system innovations and the currency innovations. With Bitcoin, convention now has it that the currency or units itself are referred to with a small b, the technology and network idea itself are written with a big B.

Examples of ‘cryptocurrencies’

The principal and best-known example is bitcoin but there are many other examples of cryptocurrencies that have emerged since 2010.

Still a long way behind Bitcoin in terms of user base, Litecoin is currently the second largest cryptocurrency. Litecoin differs from Bitcoin (only) in that the block chain is extended four times more rapidly and thus will eventually produce four times more coins than Bitcoin, and it uses a different encryption algorithm 2.

Other variants and ‘improvements’ of Bitcoin include attempts to make ‘mining’ accessible to domestic computer users (e.g. Litecoin), improving the security of transactions (e.g. Feathercoin 3),  improve issuance technology (e.g. Peercoin 4), implement innovative currency mechanics like demurrage (e.g. Freicoin 5) or tether it to non-speculatve value like the generation of solar power in Solarqoin.

Most cryptocurrency can be converted to and from fiat currencies and other cryptocurrencies, mostly on online exchanges, which mostly function like auctioning platforms like stock-exhanges or ebay.

Further reading

A video (20 min) plus transcription explaining the workings of Bitcoin

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