What Are Cryptocurrencies?
In our last article, we touched on how to get started in the world of blockchain. Assuming that you took our advice, you’re now ready to dive into the deep end. However, before you start aimlessly wandering the thousands of cryptocurrencies currently in existence, it’s important to first understand what they really are and what makes them unique.
In this article, we’ll be breaking down some of the distinguishing characteristics between different cryptocurrencies and what separates one from another.
Thousand Foot View
In essence, cryptocurrencies can be thought of as digital currencies for various blockchain economies. Whereas a country like the United States uses the US Dollar, or Japan uses the Japanese Yen, different blockchains also have unique currencies. For example, Ethereum uses a currency called Ether (ETH) and Binance uses Binance Coin (BNB) to fuel the greater ecosystems.
Cryptocurrencies are borderless, meaning that they can easily be exchanged for fractions of a dollar between any two individuals anywhere on the globe so long as they have an internet connection. In a world where wire transfers often cost anywhere from $10–50 nationally and upwards of $250 internationally, being able to send thousands of dollars in under a minute for less than $1 is pretty innovative.
Lastly, cryptocurrencies are largely decentralized, meaning that while they may have been created by a traditional company or small team, their long-term success is entirely dependent on the support of a distributed community, all playing key roles in the currency’s underlying value (more on this below).
It’s important to note that in the past year, we’ve seen new projects like Libra or China’s proposed digital currency challenge the notion that cryptocurrencies need to be decentralized. With this in mind, the existing community strongly value decentralization as a core tenant of what makes any given cryptocurrency unique.
Why Is This Novel?
What makes cryptocurrencies different from fiat currencies is that their issuance (or creation) is often programmatically coded, meaning that, generally speaking, no one company or entity is able to drastically alter the total supply at any given time. Whereas the Federal Reserve is able to print an unlimited amount of US Dollars at their discretion, cryptocurrencies like Bitcoin have a predefined total supply, with a programmatic issuance rate that only changes after a certain amount of blocks (or batch of transactions) have been created.
On a more granular level, you can think of cryptocurrencies as a means to create a unique currency for any given business or company. Unlike traditional shares that are entirely focused on accruing value through investment characteristics, cryptocurrencies can be designed to include consumer-friendly use-cases including discounts, rewards, and benefits relative to time and amount held.
Best of all, cryptocurrencies can also incorporate investment characteristics along with consumer use-cases, meaning that it’s entirely possible for a cryptocurrency to not only give you a discounted membership but also to grant you a quarterly dividend based on the issuer’s revenue from the past quarter. Finally, cryptocurrencies are naturally fungible, meaning that they can easily be traded among individuals on the free market.
How Does this Differ from Points or Gift Cards?
For those of you who are convinced that cryptocurrencies are no different from gift cards or credit card points, let’s take a look at how cryptocurrencies work under the hood. As we mentioned in our introductory paragraph, the large majority of cryptocurrencies are decentralized, meaning that validating transactions and transfers occur on a globally distributed scale.
Unlike gift cards or points whose sole purpose is to be spent or redeemed for products or services, cryptocurrencies act as the glue that holds together an immutable (or permanent) database of information. Permissionless blockchains such as Ethereum need a currency like ether to incentivize people to help process and store the information that occurs on the network.
Whereas a company like Starbucks stores all of its data on AWS, a blockchain like Ethereum stores all of its data across thousands of nodes all around the world. This allows Ethereum to maintain a historical record of every transaction that has ever occurred on the network while spreading it to enough unique hard drives that the information can never be lost.
Tying this back to the original point, cryptocurrencies not only work as digital rewards. They also serve as a form of compensation to the individuals sacrificing energy, computation and hardware costs to ensure the data from a given blockchain is both legitimate and final.
Taking A Step Back
Getting too complex too fast? Let’s take a small step back. For those of you who are new to the space, it’s important to distinguish a few different types of cryptocurrencies which are fundamentally important to recognize the value proposition of any given token.
First and foremost, there are protocol tokens such as Bitcoin and ether which are used as a currency to transfer tokens from one wallet to another. Said another way, in order to send Bitcoin from one wallet to another, you need to pay a small amount of Bitcoin as a transaction fee. These fees are used to compensate miners who verify that your request is legitimate (by checking your digital signature) and plausible (by ensuring there’s enough of currency in your wallet for the transaction to occur). In doing so, these miners update a ledger to keep track of every amount of Bitcoin in every wallet that has ever been created.
Next, we have secondary tokens, otherwise known as tokens that are created on top of a protocol like Ethereum. Thanks to the advent of smart contracts, individuals are able to create a cryptocurrency that uses Ethereum’s underlying structure without having to create a new blockchain. This is useful as it allows for unique use-cases and applications without having to worry about incentivizing validators (because ether already does this). As it relates to you, it’s important to note that Ethereum’s ERC20 token standard has quickly become the most common secondary token on the market.
Without going too deep into the topic in this article, it’s worth recognizing that secondary tokens drastically outnumber the number of protocol tokens. This means that for every native blockchain protocol token, there are about 50 -100 secondary tokens created on top of it.
The biggest takeaway here is that secondary tokens are only compatible with the wallet(s) from the protocol they’re built on. This means that ERC tokens on Ethereum can only be stored on Ethereum-based wallets. For those who have ever traded on an exchange like Binance, you’ll note that they support dozens of assets, all by maintaining a vast array of different protocol wallets.
Virtually all exchanges will be sure to let you know about this before having you withdraw any given asset to ensure you aren’t sending Bitcoin to an Ethereum wallet. For a list of the largest ERC20 tokens by asset cap, please reference this list.
Tying this all together, let’s consider the question of why someone would make a cryptocurrency in the first place. Unfortunately for the industry in recent years, cryptocurrencies posed an interesting opportunity for companies to fundraise without selling equity. Seeing as these assets were highly liquid on a multitude of secondary exchanges, it became very easy for investors to speculate on the future value of a cryptocurrency based on a proposed business model in the form of a whitepaper.
Today, we’re seeing a lot of those propositions play out live and unfortunately, many of them are severely missing the mark. Most notably, many cryptocurrencies today actually raised higher barriers to entry for the very users they were looking to target. Due to the fact that average users such as yourself had to navigate to numerous exchanges to acquire an obscure ERC token, many of the business models that required a token to function properly obviously saw little to no adoption.
So, let’s instead change the question to why would someone use a cryptocurrency. As we’ve discussed throughout the article, cryptocurrencies can provide a number of benefits to your business. In particular, strong token economic models can allow for your early adopters to capture more upside in the event that your business really starts to take off. Whereas today the upside on giant tech players are largely only realized by venture capitalists and investment bankers, cryptocurrencies poise a new scenario for the average joe who was there on Day 1 to enjoy similar monetary rewards to the VC who provided you with a $100,000 check.
Secondly, cryptocurrencies can serve as a one-stop-shop for your entire digital experience. Whereas today purchasing anything online involves an endless number of credit or debit cards, cryptocurrency wallets look to change this by making your assets entirely digital. This means that instead of having to input a long string of numbers with an expiration date and security code, in the future you’ll be able to pay for things using one click from one wallet.
Lastly, cryptocurrencies have the power to unlock economies of scale. Whereas today we see labor rates varying relative to the country a given business is located in, with cryptocurrencies, the internet offers a much more stable playing field. Someone who owns a Bitcoin in India owns the exact same relative value as someone who owns a Bitcoin in the United States. When we apply this concept to the creation of global ecosystems, we can start to create businesses that no longer favor those that come from affluent backgrounds.
In this article, we took a look at what a cryptocurrency is, what makes them unique and how they differ from one another. It’s important to note that we did not distinguish what makes a cryptocurrency valuable. This was intentional as the value of any given currency (including the US dollar) is entirely subjective relative to the support network and the number of individuals that deem it valuable. Stated another way, the biggest cryptocurrencies today have become “valuable” because a large number of individuals believe in them enough to trade their hard-earned cash for a digital asset.
Before you get upset that we didn’t give you the secret to finding the next gem, please recognize that designed cryptocurrency ecosystems to capture value is our specialty here at Fitzner Blockchain. In our future articles, we’ll be diving into this concept by introducing concepts such as staking, burning, and governance.
In conclusion, we do not believe that every company should have its own cryptocurrency. In fact, we often encourage many of our clients to use an established cryptocurrency rather than creating their own from scratch. Furthermore, we believe that offering a unique cryptocurrency as a supplement rather than a requirement is an innovative way to capture the upside of this industry without dooming your business from the start.
If you or your company are curious to explore how a cryptocurrency may make its way into your business, please feel free to give us a call! We pride ourselves on having successfully served dozens of clients through thick and thin and look forward to doing all we can to answer any questions you might have.