What is it?
Cryptocurrencies are decentralized digital currencies, which use encryption techniques to verify transactions and regulate the available supply of digital coins. These electronic coins consist of chains of digital signatures that change hands when the owner signs away the coin to the next owner. The main idea behind these digital currencies is that transactions are completed on a peer-to-peer basis without the need for a centralized regulatory authority.
In our current financial system, the government issues currency, and banks or electronic cash systems such as PayPal oversee electronic transactions to make sure they are legitimate. Cryptocurrency removes these authorities. A decentralized cash system would appear to be impossible without any type of authorities verifying transactions. What would stop someone from sending the same electronic coin to two people, since digital information can be readily reproduced?
The solution to this problem was proposed in the paper “Bitcoin: A Peer-to-Peer Electronic Cash System”, which was published in 2009 by an un-identified individual under the alias Satoshi Nakamoto. The paper cleverly proposed a way to combine existing technologies to create a secure electronic cash system that does not rely on trust [1]. The system allows transactions to go from one party to another without a financial institution acting as an intermediary.
Contained within the first 50 Bitcoin blocks was the message “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”. This message would imply that Nakamoto was motivated by the repercussions of the 2008 financial crisis, and that cryptocurrencies were created in order to start a major shift away from banks that were involved in the crisis [2].
The genius of cryptocurrencies, and one of the main benefits of a decentralized coin, is that you own it. The design is such that there is no single entity that can seize or freeze funds, make changes to the inflation rate, or implement new policies. Furthermore, there is a greater level of anonymity, identity theft is next to impossible, and transactions are generally quicker and processed with little or no fees. Since the start of Bitcoin hundreds of “altcoins” (alternative Bitcoins) have been created, each hoping to grow in popularity enough to one day become the world’s primary form of online currency [3].
How It works
If you are thinking about starting to use cryptocurrencies, it is a good idea to understand what you are investing in. To start off, let’s look at digital signatures and how they are used to verify information. To be able to perform a transaction the first thing you need is a private and public key. Cryptocurrency exchanges monitor and keep track of the public keys to make it easier for you to engage in digital currency exchange. The private and public keys are generated together and are mathematically related. A private key, also known as a secret key, is a long list of random numbers that must be kept secret to protect your digital wallet, and the public key is publicly known because it is necessary in order to have currency sent to your wallet.
A digital signature depends on both your private key and the contents of the message you are sending. In the message, the party sending cryptocurrency to another party specifies the instructions for that particular exchange: the address it is being sent to and the fee amount being sent. Before the other party receives the message, and thus payment, the signature, is verified by the cryptocurrency system by inputting the public key, signature, and message into a verification function. The verification function confirms that only the owner of the private key could have generated the signature. This makes sure that the sender of the cryptocurrency is actually who they say they are. The cryptocurrency system also verifies that there is enough cryptocurrency to complete the transfer. These verifications stop overspending and prevent identity theft.
If the slightest change was made to the contents of the message, such as the receiving party setting the amount higher in the message, or just copying the message to receive the payment twice, a different signature would be created. Since it is generated based on the secret key and the unique message, any message that was changed or just copied would not pass after being inputted into the verification function; the result would be a failed transaction. For this reason, the signature could never be plagiarized and the contents of the message cannot be modified unless someone were to gain access to the private key. The cryptocurrency signature is actually a lot more secure than an ink signature, because the digital signature changes with every message and relies on your private key. The private key is next to impossible to guess and any fraudulent transaction would fail to be verified without it.
Each cryptocurrency is set up a little differently, but what all current cryptocurrencies have in common is the use of Blockchain technology. A Blockchain is basically a comprehensive ledger consisting of every transaction that has been made since the creation of that cryptocurrency’s unique coin. It is publicly available and anyone can look through it. Each block in the Blockchain is linked to the one before it, so that any change would alter the entire chain from then on. That way the chain is resistant to modification, as everyone has a copy of the ledger and any chain that differs from the majority will be rejected.
This devalues fraudulent entries into a ledger. Fraudulent entries would not be confirmed and would not result in a change to the Blockchain. This is evident to everyone else, as there would be no change to the Blockchain detailed on their ledger, only on the ledger of the person who added an entry to their ledger about a supposed transaction. This also means that the ledger doesn't have to be hosted anywhere, as everyone has their own individual copies; this provides more autonomy. A block consists of all transactions which have occurred within a pre-determined amount of time, and in Bitcoin’s case, each block contains every transaction which was made in the last 10 minutes. Remember that each individual transaction included in this block needs to be verified by inputting the public key, message, and signature into a verification function.
A block is only considered valid and added to the chain if it has a corresponding proof of work. This proof of work is computationally expensive to find, meaning it would take a LOT of computer power to find by anyone trying to submit a modified block to the block chain. There is much more to be said about the inner workings of cryptocurrencies and if you would like a more in depth view of this information it’s source is this YouTube video on Bitcoin and other cryptocurrencies:
Bitcoin
Bitcoin was the first cryptocurrency, and is, without a doubt, the most widely known and recognized digital coin. With a market cap of 42 billion dollars, at the time this article was written, it makes up half of the entire crypto market. As mentioned previously in this article, there are hundreds of other “altcoins” which have since been created. Why is Bitcoin so much bigger than the rest then? The main reason is that Bitcoin is established, secure, and becoming increasingly adopted as an official form of payment. Over the years, companies such as Microsoft, Dell, Subway, Expedia.ca and many other have all started to accept Bitcoin as payment.
It isn’t just companies that are adopting Bitcoin. As of April 2017 Japan announced a new law making Bitcoin a legal method of payment [4]. All cryptocurrencies are only as valuable as the value that people assign to them. You could make your own cryptocurrency but no one would buy it if they can’t do anything with it. The easier it is for a coin to be exchanged for real life products or cash, the more useful and hence more valuable it becomes. Prices for coin have increased over 300% since the start of the year leaving many people wondering how high the ceiling really is.
The Future of cryptocurrencies
It is impossible to say for sure what will happen with cryptocurrencies in the future, but what we can look at is the potential the technology has. Cryptocurrencies and Blockchain technology have the potential to revolutionize many industries by providing a platform to confidently share information that is incorruptible, transparent, and robust [5]. Many altcoins which are now in circulation are powering ambitious projects which take advantage of Blockchain technology. Golem is a good example of such a project that, like many others, is pushing towards decentralized computing. If successful, Golem would revolutionize current off-site data storage by allowing users to store fragmented data across all participating computers on the network. People would no longer have to feel uncomfortable surrendering their information to an off-site data storage company under the terms of their privacy agreements. Your files could never get stolen and you would truly be the only person that could ever access your property. Many of these projects are in very early alpha stages however, the possibilities and freedom that this technology allows is truly exciting and very real.
References
[1] Nakamoto, S. (2009). Bitcoin: A Peer-to-Peer Electronic Cash System. Bitcoin. Retrieved from https://bitcoin.org/bitcoin.pdf.
[2] Bustillos, M. (2013, April 1). The Bitcoin Boom. The New Yorker. Retrieved from http://www.newyorker.com/tech/elements/the-bitcoin-boom.
[3] Rosic, A. (2016, June 28). 5 Benefits of Cryptocurrency: A New Economy For the Future. Ameerrosic. Retrieved from http://www.ameerrosic.com/5-benefits-of-cryptocurrency/.
[4] Gautham. (2017, April 2). Japan Officially Recognises Bitcoin as Currency Starting April 2017. NewsBTC. Retrieved from http://www.newsbtc.com/2017/04/02/japan-officially-recognises-bitcoin-currency-starting-april-2017/.
[5] What is Blockchain Technology? A Step-by-Step Guide for Beginners. (n.d.). Blockgeeks. Retrieved from https://blockgeeks.com/guides/what-is-blockchain-technology/.
