Why Cryptocurrencies Matter?
#9 — What are cryptocurrencies and what make them so special
We keep hearing about bitcoin and cryptocurrencies. Maybe you have already bought some cryptocurrencies, or maybe you are totally against and started hating them. We will see in this article what is special about them, what are their foundations, and some of the existing use cases 🙂.
Let start with the definition of “Cryptocurrency” from Cambridge dictionary.
“A digital currency produced by a public network, rather than any government, that uses cryptography to make sure payments are sent and received safely”
There are some many interesting keywords such as “public network”, “cryptography” and “safely” now let’s see what are they referring to.
This article is part of my Learning challenge where I learn about one topic each month. As you can imagine, this month, I was learning about blockchain & cryptocurrencies. I based this studies on a Coursera MOOC, a few articles, some whitepapers and the building of my own Proof of Stake Cryptocurrency and Coin Generator. Click here, if you want to know more about my methodology.
How did this start
Before talking about the specificities of cryptocurrencies, let’s have a brief history recap. Bitcoin was the first Cryptocurrency built in 2008 by someone under the pseudonym of Satoshi Nakamoto. His goal was to build a secure and decentralized p2p cash 💰.
If you want to know why he built it read the article below.
Decentralization & distribution
The main strength of cryptocurrencies is the decentralization and distribution. I’ll try to explain it in the simplest way possible.
How does decentralization work?
Most of the cryptocurrencies use a blockchain. To put it simply, a blockchain is a database that stores all the currency transactions made by the users. Once a transaction is written you can hardly remove it or change it because this database is synced with a lot of computers and servers in a peer-to-peer network.
By checking the list of transactions sent and received from a user you can know what is his balance at any time. Since this database (blockchain) is in every computer running the software of the cryptocurrency, it is decentralized.
Also, when you make a transaction, all the computers of the peer-to-peer network will get notified and will record the transaction in the database after checking if the transaction itself is valid (which means that you have a positive balance). All the computers will check its validity and in case you are trying to double spend your coins, it will be refused.
The more computers will run a node, the more decentralized the cryptocurrency will be, and the more secure it will be.
This explanation is simplified to make it easy to understand, in reality, the process is much more complex 😅. You can have a more detailed explanation of how it works in this other article I wrote.
Why would someone run a node?
This depends on the policy of the cryptocurrency but most of them give rewards.
Who should I trust?
With your fiat currency, such as euro or dollar for example, when you give money to a bank, you need to trust them. If the bank is having a bankruptcy, your money disappears with it. You don’t really own the money, the bank keeps it for you. They are responsible for it and you gave them your money because you trust them!
In the case of cryptocurrencies, you owe the secret key of your account. But no one owns the money except you. The money is there because millions of nodes are keeping the database (blockchain) safe, and ensure that no one cheats.
Indeed you have to be responsible for saving the private key of your account the same way you keep the key of your house safe. You have to trust yourself!
Does decentralization matter?
Yes and no…. I know, it’s the best answer ever 😬😬.
The Non-coiners (people who are against cryptocurrency) will say the decentralization is useless. Euro or dollar or yen or yuan or ruble or rupee (or any other fiat currencies) is the best, it’s stable. It’s true, but these fiat currencies are centralized. Which means the central bank of the currency can decide at any time to devaluate the money by issuing new bills whenever they want. You will say it’s not a big deal compared to the bitcoin volatility, it’s also true. But what about other countries like Zimbabwe? 1 USD was worth 1780 ZWL (Zimbabwe dollar) in August 2008 and 669 billion ZWL in September 2008! My example is voluntary extreme just to show the power that you have when you can print bills. Not all the currencies are as stable as Euro or Dollar.
In case of cryptocurrencies, the rate of issuing money is predetermined and cannot be changed after its launch.
Also, another problem with fiat coins are the fees when you make a transaction with your credit / debit card. The company billing pays fees — fixed and variables — to the company managing the transaction such as Visa or Mastercard. Even though you don’t feel it when you buy some goods. It’s usually included in the price. Or even worst, and very typical in Paris, you cannot use your card unless you pay an amount above a threshold. Sometimes it’s 5 €, most of the times 10 €, and I even know some restaurants that asks a minimum of 25 € 😡😡 !!
But centralization is more than just issuing money. Let’s see it through the following example.
In my opinion centralization is more than just issuing currencies. Central banks controls your life, your vacations, your jobs because they have the control of the money, and money is all you need to cover your basic needs.
That brings us to another strength of cryptocurrencies that goes along with decentralization, the distribution of wealth. Since cryptocurrencies are not owned by anyone why not distributing them equally to everyone in order to create the Universal Basic Income. I recommend reading the following article that talks more about distribution.
Limitation of decentralization
Actually, most of the cryptocurrencies are not fully decentralized. Even though everyone can run a node to validate transactions. There is a main limitation: the software updates. Every cryptocurrency lives through a software that should run in a different computer to make it decentralized. Most of the cryptocurrencies have an open source software. Thanks to that anyone can improve the software but only the team of the cryptocurrency can approve it, so the governance of the cryptocurrency is centralized. On the other hand there are some cryptocurrencies such as Decred with a voting system to make the decision decentralized.
Security & transparency
Key pair & signatures
Cryptocurrency uses cryptographic signatures to ensure the security. That’s where its name comes from.
Every user of a cryptocurrency receives a pair of keys:
- Private Key
- Public Key
The private key, that should be kept secret, is used to digitally sign a transaction through a cryptographic process. The validity of the signature can be verified using the paired public key.
The public key is used also as an id or an address.
Let’s say Amy has a Public Key = “Pk_amy”, and a Private Key = “Secret_amy”. Amy wants to make a transaction of 1 Coin to Jerry’s Public Key. She will have to create the transaction, then to sign it using “Secret_amy”. Once sent, the nodes will check if she has a balance of at least 1 Coin, and check if the signature is matching her Public Key, “Pk_amy”. If so, it’s valid and the transaction will be added to the blockchain. It works through quite complex cryptography. See more details in this Wipedia article about the ECDSA.
This is how a transaction look like in bitcoin:
https://blockchain.info/tx/db985304b8215ead8a1606711c4121d96ed3e2cee9f08845721133e2cde2b93b
Every node before validating transaction ensures that they are valid, and not double spent. Therefore it’s fully secured.
Here is how a Private Key and Public key actually looks like for bitcoin! I just created an empty paper wallet as an example, never share your private key!
You can see above :
- on the left, the public key “1BeN7s454ofQMyioBrK2VEdxAqzFBPtvh9”
- on the right, the private key “5K3Lzh3CEL75YMh84kuK8PVfFnHniRU1QB9CW7m1FDuFuRKCxBv”
Again: Never share the private key as I did it only for the example! Also don’t send your bitcoin to this public address otherwise anyone can take it since I shared also the private key 😬.
Transparency
Not all the cryptocurrencies are transparent, but bitcoin is.
Every transaction recorded into the blockchain is visible to everyone. So you can see the time, the amount, the sender address and receiver address of every transaction.
Open sourced
As said before most of the cryptocurrencies are open source, so you can check what the code is doing. Also, the source code contains the rules of coin issuing. For example, in bitcoin every 10 minutes 12.5 coins (in 2018) are created and given to the node that discovers the block. In bitcoin this reward is halved every 4 years.
Immutability
As I said before every transaction which is written stays forever in the blockchain. It’s almost not possible to erase it or to edit them.
Account security
Concerning the account’s security, it’s up to every user. I recommend you to read this article if you own cryptocurrencies.
Privacy
Regarding privacy, once again, it depends on the cryptocurrency.
Actually, most of them are pseudonymous. Which means that you don’t have to reveal your real identity, you are hidden behind your address or your addresses if you have multiple ones. It’s basically like in an online video game, you will have a nickname and no one knows who you are except if you talk about your real identity somewhere.
For example, let’s say I owe the address “BeN7s454ofQMyioBrK2VEdxAqzFBPtvh9”, then I create an account in Coinbase with my name. I send 1 BTC from my address to Coinbase. They will know that “BeN7s454ofQMyioBrK2VEdxAqzFBPtvh9” is very likely to be mine.
So it’s often possible to track people, and since every transaction is transparent anyone can know the balance of any address, check for example here, you can see all the transactions made by the account “3Lyxavu5w2AHDhgpancUsn8hjfQyZ8WKXU” and therefore its balance:
https://blockchain.info/address/3Lyxavu5w2AHDhgpancUsn8hjfQyZ8WKXU
Nevertheless, there are some mixing services to try to hide your transaction mixing it with other transactions. For example, CoinMixer, I have never tried it so do your own research in advance and use it with cautious.
Otherwise, you have some cryptocurrencies such as Zcash, Monero or PIVX made specially for anonymity. They use other algorithms and processes to not disclose the amount of transactions.
Use cases
Some people say that blockchain and bitcoin are useless, that there are no real use cases, and that decentralization is useless. It’s not true.
There are already a few proven use cases:
- Store of value, digital gold (bitcoin)
- Money laundering and black market
- Decentralized computer, eternal apps (Ethereum)
- Fundraising through ICO (Initial Coin Offering) or TGE (Token Generation Events)
- Helping Syrian refugees with the World Food Program to feed people
I also hope to see in the future:
- A universal basic income
- More local currencies for your cities, most of them are currently using paper bills, what a pity in a digitalized era!
- A digital worldwide currency
I probably miss some good use cases, so feel free to add them in comments!
Do you think Cryptocurrency are solving real problems? Share your opinion with comments.
What’s next?
This article is part of my Learning Challenge about Blockchain & Cryptocurrencies. Like this one, I made 5 others article related to the topic.
- How Cryptocurrencies Work (Technical Guide)
https://medium.com/learning-lab/how-cryptocurrencies-work-technical-guide-95950c002b8f - Proof of What? Understand the Distributed Consensuses in Blockchain
https://medium.com/learning-lab/proof-of-what-understand-the-distributed-consensuses-in-blockchain-1d9304ae4afe - How to Make Money with Cryptocurrencies?
https://medium.com/learning-lab/how-to-make-money-with-cryptocurrencies-9a6d4a08e976 - How I Integrated Blockchain to My Existing Product (Kanbanote)
https://medium.com/learning-lab/how-i-integrated-blockchain-to-my-existing-product-kanbanote-c97c74dafb6c - How to Build Your Own Cryptocurrency (PoS) in Just a Few Minutes
https://medium.com/learning-lab/how-to-build-your-own-cryptocurrency-proof-of-stake-in-just-a-few-minutes-6d526bca4a91
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