Bitcoin and Cryptocurrencies: What’s all the hype about?
The current story of cryptocurrencies is one of serendipity! Prior to the creation of Bitcoin, multiple attempts at creating a digital currency system had been made, with Digicash being the most notable, and all the attempts resulting in failures. After realizing that all prior attempts shared a common approach of using a centralized authority to monitor and confirm transactions, Satoshi Nakamoto, a Japanese pseudonym for an unknown computer scientist and cryptographer, came up with the crazy idea (not so crazy anymore) to resort instead to a peer-to-peer network of computers, like a peer-to-peer file sharing system, to help create a trustworthy electronic cash system. In 2008, Satoshi Nakamoto took the web by storm, and announced the successful creation of the first ever electronic currency system with no central server or authority to monitor transactions but powered instead by a peer-to-peer network that verifies transactions, confirms and records them in an immutable way, therefore solving the double-spending problem of digital currency systems. Nakamoto started a cryptocurrency revolution unintentionally!
Why do I say unintentionally? Well, although his initial intention was to create a decentralized cash system that could support a payment network with accounts and also track and record their balances and the transactions they engage in, Nakamoto gifted the world with something more than just digital money, he created and demonstrated for the first time, how a decentralized peer-to-peer network of computers can be used to create digital tools to help track different types of assets and the changes associated with them! By choosing a peer-to-peer network over a central authority to create this electronic cash system, which most thought was impossible, Nakamoto introduced for the first time not only digital cash, but also the blockchain, or the concept of using a shared ledger of transactions and create a distributed database that records and keeps track of any changes to the state of the asset, and ownership of the asset.
How do cryptocurrencies like Bitcoin do this? Regular money on a bank account at bank X represents simple entries in a database of accounts ledgers, balances and transactions of bank X, that can’t be changed until a certain set conditions are met and approved by a central computer. Cryptocurrencies use the same principle, but in a slightly different way. In the case of regular money for instance, those conditions would be when you have the right debit card and its pin number, or when you sign a receipt of a transaction at the coffee shop. In Bitcoin’s case, the entries are not verified and created by a central computer, but instead the transactions are sent to multiple computers on the network for verification, and the first computer to successfully validate the transaction can create the entry. Cryptocurrencies can serve this purpose by providing a medium of exchange for verifying transactions, encrypting and storing the correct entries in the distributed database called the blockchain. Once created and added to the blockchain, an entry can’t be modified, and is stored by every single person on the network, making it further impossible to mess with, and giving the process layers of fidelity and security. The network of people who verify transactions are known as miners, and are rewarded with small fees for sorting and confirming transactions. In my opinion, cryptocurrencies that will find better and scalable ways to mine, attract and retain miners, for faster transactions, will be poised to dominate a large share of the digital money space.
Although Bitcoin introduced us to the blockchain, the technology has evolved quite a great deal from 2008, the first time we heard of the blockchain and its applications. The blockchain technology’s applications have increased, from creating decentralized digital money to other decentralized assets tracking and trading systems. As of today, the cryptocurrency space registers upwards of one thousand different cryptocurrencies, with a large number running on the first and second generation of the blockchain technology, and a select few running on the most recent third blockchain generation, all with different applications and features.
The second and third generations of cryptocurrencies take the shared ledger of the blockchain technology to another level, by allowing the development of more and better decentralized applications of the blockchain through reusing parts of other blockchain applications for better and complex applications. In some of those cryptocurrencies that run on the most recent blockchain generations for instance, the blockchain can be used to create self-executing smart contracts, and tokens (digital representation of assets). Companies can raise money by creating and issuing different kinds of “tokens” that can receive dividends and/or grant voting rights to the respective owners. The tokens can then be used to redeem assets in the real world, and the complete transactions would be registered in a distributed single ledger.
From shipments and cargo tracking to identity verification, the potential B2B and B2C applications of the blockchain technology are by implication multiple. One of the biggest promise of blockchain technology, is to help businesses and individuals save valuable resources (time and money), mostly by eliminating the unnecessary middle-men whenever possible. Recently, MoneyGram and Western Union, some of the biggest names in the international money transfer industry along with a few big names in international banking have partnered with Ripple, and are testing one of these blockchain-based applications, XRapid and the its digital token XRP, a product developed by Ripple and promises to solve the liquidity problem of banks, by speeding-up up and reducing costs of payments and financial transactions among large businesses. The cryptocurrency space is growing daily, with new different cryptocurrencies, and various applications. Different teams are working to address challenges that are still in hindering the trust and adoption of cryptocurrencies by the public, such as scalability, trust and more. Whether cryptocurrencies will prove viable and help revolutionize the way we trade is still up for proving. What I know for sure is that 2018 promises to be an interesting year, where we’ll see the first pretenders in the cryptocurrency space fall, and the top dogs truly rise up the challenge.
In my next piece on the topic of cryptocurrencies and the blockchain, I will discuss whether there are any opportunities for regular folks like you and me in the cryptocurrency space, and share a few of my own moves that I have made in the past and how they have played out so far.