What (tf) is cryptocurrency and blockchain?
Are cryptocurrencies a new modern way of investing? A new version of money? Or maybe just a bubble? Are all of them same? If not what are the differences?
For most, it’s very hard to understand this topic even if one is a professional in finance subject — understanding the topic requires some technical background.
Regardless of personal stance in regards to cryptocurrencies, the creation of the Bitcoin as a first cryptocurrency resulted in unseen interest in cryptocurrencies both economically and scientifically. (1) While some are seeing the situation as a big bubble that is soon about to burst, leaving the investors ashamed and without their assets (2) the others see it as an innovation similar to the email or internet in the early 90s. Just as those technologies had been followed with scepticism and disapproval reasoning that businesses would never change their processes in order to send their documentation electronically instead of physically many see cryptocurrencies to be the same level of innovation that would eventually become a new standard.
Either way, middle of the January 2018 saw estimated Market Cap for all cryptocurrencies to around 720 billion USD.(3) This makes impossible to ignore this phenomenon, especially for big financial institutions and banks. Some of them created or invested in the development of cryptocurrencies that mostly align with their policies. (4)
Names like Barclays, Credit Suisse, Canadian Imperial Bank of Commerce, HSBC, MUFG and State Street are in the newspaper articles that describe their take on cryptocurrency world (5)
What is cryptocurrency?
Cryptocurrency is a medium of exchange, or way of making transactions.(6) (7) (8) To better understand this, imagine any other currency bill, a 10$ bill for example. Imagine John is paying to Mary 10$. The value that a 10$ bill represents is exchanged between two parties (John and Mary) simply by John handing over the bill to Mary.
Downside of this approach is that John and Mary have to be physically close for exchange to happen.
It would be possible for John to mail 10$ to Mary but that method is insecure and lacks trust element. To explain it, let’s expand our example. Let’s say John is paying Mary 10$ for translation service. John could say to Mary that he sent money to her via post mail, that she will receive it eventually and that he expects translation in return. How can Mary trust John? John might lie that he sent money. Also, a lot of things can happen to mail, it can get lost or returned back. Because of that, she might say to John that she will give him the translation after she receives the money. But how can John trust that Mary will give him a translation after she receives the money? Maybe she will say that she never received the money and that might be true if mail got lost or she might be lying.
In the modern world, it is possible to securely send a 10$ bill to someone remote we don’t trust by using financial institution (a bank) as an intermediary. In that case:
- John would give 10$ bill to a bank
- the bank would credit John’s account
- John would request the transaction in amount of 10$ to Mary
- Bank would credit Mary’s account and remove credit from John’s account
- Mary would have a proof that John sent the money
- Mary would go to bank and bank would hand over a 10$ bill
- John would have a proof that Mary took the money
Downside of this method is as we all know transactions made using a bank as an intermediary are very costly and are not fast. In this example, John would have to give the bank some money for the transaction to happen, for example, 11$ and Mary would need to wait until she receives her money, maybe even after few days.
Cryptocurrency is an attempt to resolve above-mentioned problems. Just as any other currency it transfers value from one entity to another by simply handing over the bill. Since cryptocurrency is a digital asset “handing over the bill” means transfer it digitally.
To prove transaction happened, a computer system is using something called cryptography (hence the name — cryptocurrency) and something called blockchain. (9) Please see following sections for explanations on both cryptography and blockchain.
Downsides of each cryptocurrency are different and result in so many different cryptocurrencies existing. Each new cryptocurrency is created with the intention to resolve problems of already existing cryptocurrencies. (10)
What is cryptography?
Simply put it is a way to make a message hidden or cryptic for everyone else but the author of the message and its intended recipients. (11)
In cryptocurrency subject, a cryptography is an approach to use computing and mathematical algorithms to digitally sign transactions. Only the author of the transaction can produce a digital signature, no other user can do it, but every intended user that needs to check the validity of transaction can verify that a digital signature is valid and the transaction is really made by the author.
In simple words:
Since on internet anyone can claim anyone's identity, cryptocurrencies use cryptography to digitally prove transaction was really created by its author.
What is blockchain?
The blockchain is a way to keep the record of transactions permanent in a network of decentralised nodes. (12) Transactions are put together into groups called blocks. Each group/block is verified, timestamped (13) and chained with a special algorithm to the previous block. The algorithm works in such way that if anyone changes any transaction in any of the blocks, all blocks are changed and other participants know that change was not legitimate. (14)
In simple words:
Since in use of cryptocurrency there is no central authority (like a bank, for example), blockchain is a computational method to prove anytime that transactions haven't been altered by anyone.
Cryptocurrency is a method of digitally exchanging valuable assets between parties that don’t trust each other. It uses cryptography to prove the origin of the transaction and uses blockchain to prove that transactions haven’t been altered by anyone.
How to achieve correctness in a decentralized environment?medium.com
- “Blockchain, Bitcoin, Cryptocurrency And ICOs — All You Need To Know In 10 Minutes” September 15, 2017. Forbes. Author: Bernard Marr — https://www.facebook.com/BernardWMarr/ — https://twitter.com/@bernardmarr
- “Bitcoin biggest bubble in history, says economist who predicted 2008 crash “ February 2, 2018. The Guardian. Guardian News and Media Limited. Author: Angela Monaghan
- “Cryptocurrency Market In The Green, Total Market Cap Bounces Back” January 12, 2018. Coin Telegraph. Author: Molly Jane Zuckerman
- “Blockchain: understanding the potential” July 2015. Barclays Corporate Banking Portal. Author: Simon Taylor, Blockchain and Distributed Ledger Subject Matter Expert
- “Six global banks join forces to create digital currency” August 31, 2017. Financial Times. Author: Martin Arnold, Banking Editor
- “Crypto Currency” April 20, 2011. Forbes.com. Author: Andy Greenberg
- “Cryptocurrencies: A Brief Thematic Review” December 25, 2017. Economics of Networks Journal. Social Science Research Network (SSRN). Author: Usman Chohan
- “The Concise Fintech Compendium” September 9, 2015. Fribourg: School of Management Fribourg/Switzerland. Author: Schuettel, Patrick
- “What is Cryptocurrency: Everything You Need To Know” February 24, 2017. Blockgeeks Inc. Author: Ameer Rosic, https://ameerrosic.com
- “Five reasons 2018 could be the best year yet for cryptocurrencies” February 23, 2018. CNBC LLC. NBCUniversal. Author: Julian Hosp, TenX
- “Cryptography” 1990. Handbook of Theoretical Computer Science. Author: Rivest, Ronald L.
- “The Truth About Blockchain” January 18, 2017. Harvard Business Review. Harvard University. Authors: Iansiti Marco, Lakhani Karim R.
- “Blockchain” March 23, 2016. Investopedia.
- “What Is a Decentralized Application?”. “Decentralized Applications: Harnessing Bitcoin’s Blockchain Technology” July 18, 2016. O’Reilly Media, Inc. pp. 1–2. ISBN 978–1–4919–2452–5. OCLC 968277125. Author: Siraj Raval