Understanding the different types of cryptocurrencies
I get this question often “Why are some called tokens and others called coins? Is it just marketing?” Our idea of a cryptocurrency is pretty much limited to the “currencies” that are built on a blockchain or crypto platform. However, the term encompasses much more than just the coins that we “mine” or speculate on. In fact, what we should be talking about are the crypto assets. Crypto assets refer to any kind of assets that are built on a blockchain platform and which have an intrinsic value.
Cryptocurrencies are a virtual currency based on cryptographic techniques that can be used as an alternative to FIAT currencies. Unlike the fiat currencies that derive value from a centralized authority such as central banks, cryptocurrencies are fully decentralized and do not fall under the control or jurisdiction of any governments. Each cryptocurrency has its own value and a different exchange rate. The whole cryptocurrency system is based on a blockchain technology that was conceived in 2008 by someone under the assumed name Satoshi Nakamoto.
At the core level, there are three main types of cryptocurrencies. These are:
Bitcoin
Bitcoin is a fully decentralized virtual currency that was founded in 2009 by someone using the assumed name Satoshi Nakamoto. It’s the most popular and most valuable cryptocurrency with a market capitalization of more than $100 billion. At its peak in December 2017, the value of Bitcoin hit $20,000 though it has since plummeted to $3,669 as at the time of writing.
A Bitcoin is simply a digital token that is powered by a technology called blockchain. Unlike FIAT currencies, Bitcoins have no physical backing or government backing via central banks. As a currency, Bitcoin can be used to transfer value from one user to another without the involvement of a third party intermediary. Users only need a Bitcoin wallet and a computer to transfer value to another user or purchase items in online shop-fronts that accept the cryptocurrency.
A single Bitcoin can be subdivided out up to eight decimal places so the smallest Bitcoin unit is 0.00000001 Bitcoins which is equivalent to $0.000036 as at the time of writing. This is the smallest Bitcoin unit, the “penny” in Bitcoin and it is called a Satoshi.
Bitcoin is quite different from other traditional payment platforms in that it is not centralized but is based on a distributed and encrypted ledger called blockchain that keeps the records of all the Bitcoin transactions. The platform is not run by a single person or organization but by multiple users in a very democratic peer-to-peer network. Instead of transactions getting verified by a central intermediary such as a bank or third party payment gateway or broker, the transactions on a Bitcoin blockchain platform are recorded and simultaneously verified by everyone on the network before they are validated. By 2017, there were just over 9500 computers on the Bitcoin blockchain network and the number is growing. It is these computers that help in maintaining the database of all Bitcoin transactions in a fully decentralized model.
Users from around the world that are hooked to the blockchain will compete to validate the transaction by solving complex cryptographic puzzles using powerful computers called mining rigs. Validated transactions are then time-stamped and added to the blockchain ledger in chronological order. This peer-to-peer approach makes it almost impossible to manipulate or duplicate the transaction records on the Bitcoin blockchain network.
Apart from the unhackability, the transactions are also fully transparent and users on the blockchain are not limited by operational hours. Bitcoin has all the qualities of fiat currencies such as fungibility, divisibility, scarcity, portability and it is also impossible to counterfeit. It operates just like cash and the prices are determined through an open market bidding. These qualities have led to widespread acceptance of Bitcoin by many financial players and ordinary users so it is expected to have enduring value.
Altcoins
The second categories of cryptocurrencies are called altcoins. These are the Bitcoin competitors. The runaway success of Bitcoin spawned more than 1800 new cryptocurrencies that fancy themselves as alternatives and better versions of Bitcoin. The term Altcoin is used to describe any Bitcoin alternative.
Many altcoins work just like Bitcoin and are based on blockchain technology with minor modifications. However, it is important to keep in mind that not all altcoins are Bitcoin alternatives. Some are built with significant deviations from the peer-to-peer proof-of-work based cryptographic algorithm that powers Bitcoin blockchain. Some are not cryptocurrencies in the classical sense and have been built to serve a different purpose.
Some altcoins don’t even use the proof-of-work Bitcoin algorithm. Instead, they might deploy a proof-of-stake methodology or smart contracts in verifying and validating token events and achieving the desired objective.
Good examples of Altcoins that are radically different from Bitcoin include Ethereum and NEO which allow users to build blockchain-based applications on their platforms using smart contracts.
Smart contracts in cryptocurrencies such as Ethereum are self-executing contracts where the terms of reference between buyers and sellers have been coded directly into the blockchain ledger. The code and agreements in the smart contracts exist within the decentralized and distributed blockchain network and can automatically execute instructions when certain conditions are met. Due to this, they can lend themselves to diverse real-life applications as they make it possible to tokenize real items such as electricity or land registry records and then insert them into blockchain. The drawback with altcoins is that they don’t enjoy the wide acceptability that Bitcoin has.
Tokens or dApps
Lastly, there are the tokens or the decentralized applications, usually shortened as dApps. They are growing quite popular and issuing hundreds of initial coin offerings (ICOs) every year because innovators are finding more powerful use-cases with these platforms. They literally allow you to decentralize everything using Smart Contracts.
A dApp or a decentralized application refers to a server-less peer-to-peer application that does not run on any single system. A dApp can run on a blockchain network or on the traditional peer-to-peer platforms that have been in existence over the past few decades such as BitTorrent. Herein lies their advantage. They are platform-independent so they are capable of taking the power out of the platform authorities and opening up limitless opportunities for application in various blockchain endeavors. Once the standards have been set in decentralized applications or dApps, they are easily implemented with the use of smart contracts.
The dApps do not have their own blockchain networks like the other cryptocurrencies listed above but are built to use Smart Contracts in executing commands and retrieving information from various blockchain systems.
At its most basic, a dApp is simply a decentralized application with a backend, a user interface and Smart Contracts at the core of the application which it uses to connect to and perform various functions on the blockchain.
To reward their users, dApp developers are issuing native tokens on their platforms that can easily be traded for real money. Not only does this shine spotlight on these tokens and help the platforms gain more popularity with crypto community, but they provide value and relevance to the platform users. Examples of DAPPS include Civic (CVC), WePower (WPR) and BitDegree (BDG).
I believe that this is just the start and that we will see many more types of cryptocurrencies terms to describe them in the future. Will this impact the way we spend them or interact with them? I don’t believe that it will, people care about about what a product lets them do. Take the iPhone for example, no one cares about the tech that makes it run as much as they care about the value it delivers.
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