Cryptocurrency: what is it?

The term cryptocurrency, or virtual money, was first prominently mentioned in 2011 by the business magazine Forbes, which used it to refer to Bitcoin, the first cryptocurrency created in 2009. The term refers to an electronic means of exchange or payment (essentially a mathematical equation) where cryptography is used for transaction security and control over the issue of new units. A principal difference between cryptocurrency and traditional means of payment is that it is initially issued in digital format only.

In the classical example, cryptocurrencies are decentralised — unlike central electronic money systems, they do not have a specific issuing hub or an institution that monitors all transactions centrally. Cryptocurrency is generally issued based on some specific algorithms. Another feature of cryptocurrencies is that all transactions are recorded in a public log called a ledger, which relies on blockchain technology. Transactions with cryptocurrency take place based on the same principle as digital payments, with the exception of some specific cases — one of them is a cryptocurrency exchange, which allows cryptocurrency to be monetised, i.e converted into regular money or various other cryptocurrencies, which currently number in the thousands.

Advantages and drawbacks

The meteoric rise in the popularity of cryptocurrencies is the result of several factors. First and foremost, in an age of ubiquitous information technology, universal and secure means of payment are in demand — this would allow settlement in the electronic space without being tied to any individual country’s national currency. Further advantages of cryptocurrency include anonymity and, certainly, very low to zero commission fees — there are no intermediaries processing a payment (i.e. banks, electronic payment systems and others). One other advantage that is frequently mentioned is the speed with which settlement takes place, although this is only partly true — decentralised cryptocurrency systems are generally slower than classical electronic payment systems by orders of magnitude; for instance, Bitcoin is only capable of processing seven transactions per second, whereas major international settlement systems such as Visa and MasterCard process tens of thousands of individual transactions every second. At the same time, a transfer of funds from a bank in one country to another bank in a different country will often take a day or more — the worst-case scenario with cryptocurrency payments is several minutes. If we consider electronic payment systems like PayPal, they are faster than cryptocurrencies but require hefty fees, which can add up to a large amount over multiple transactions.

Finally, cryptocurrencies are more than just a virtual payment method, they are an asset being traded on specialised exchanges. Cryptocurrencies, particularly at their early stages following creation, can be acquired by nearly anyone interested in so-called mining — the generation of new entries for the blockchain. Sure, as an asset cryptocurrencies are a high-risk holding because no country in the world has seriously considered insuring an investment in transactions of this kind.

Cryptocurrencies have several other drawbacks, too. For instance, loss of virtual keys means the loss of all savings in a given cryptocurrency. If, in the case of losing a bank card, you can always contact your bank and have the card reissued for you, there is no bank for cryptocurrencies, and nobody can restore lost keys to a virtual cryptocurrency wallet. Some estimates indicate that up to one-fifth of Bitcoin generated so far may already have been lost for this reason. The coins continue to exist virtually, but transactions with any of them are highly unlikely to occur at any time in the future.

Cryptocurrencies and tokens

One kind of cryptocurrency is referred to as tokens. Some tokens, like the well-known Ether, are cryptocurrencies in their own right — they can be used in a wide variety of transactions, and they are assets; technologically, the procedure for using all tokens is the same as with cryptocurrencies, although classical cryptocurrencies were initially created as alternatives to money, and created from scratch (one might say, from the internet); tokens, on the other hand, are a unit of digitally accounting for parcels of a certain asset. Numerous kinds of tokens exist, the main ones being equity tokens — shares of company stock; utility tokens — valuable to online business platforms, these include cookies, reputation points, points for specific actions within the framework of a business model, play money and a lot of other things; and last but not least asset backed tokens — these are bound to real goods or services and embody the issuer’s obligation to deliver certain goods or provide specific services to the holders of such tokens.

Unlike classical cryptocurrencies, tokens do not require dedicated blockchains; the vast majority of tokens are created on the basis of existing blockchain platforms (such as Ethereum) and the solutions they offer — so called smart contracts. Another difference is that tokens may be issued in a centralised (controlled by a specific organisation) or decentralised way (based on certain algorithms). Transaction processing may also be either centralised or decentralised. Notably, if the value of classical cryptocurrencies only depends on supply and demand, the value of tokens is affected territory several other aspects — the actual price of assets by which the tokens are backed, the extra requirements or obligations tied to an issue of tokens etc.

Overall, tokenisation, which is what the linking of digital assets to actual value is being called, using blockchain allows to make many processes, particularly trading, much faster and cheaper. At the same time, the sale of tokens and initial coin offerings (ICOs), somewhat analogous to crowdfunding, is becoming an ever more popular way of attracting financing, especially among start-up companies.

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