How Bitcoin Relates To Blockchain, Cryptocurrencies & Digital Securities
What is the first word that most people will shout out if you say the word blockchain? Bitcoin of course. What if you mention cryptocurrencies, digital securities or tokens? Usually the same — Bitcoin. It is true that Bitcoin fits into the conversation but blockchain, cryptocurrencies and digital securities are each distinct technologies or applications of technology that stand on their own.
Let’s wrap our heads around blockchain first since it is at the core of the emerging world of digital finance.
Blockchain is a new, underlying technology that enables cryptocurrencies and digital securities as well as many other types of applications. As the name suggests, it is a sequence of blocks or groups of transactions that are chained together and distributed among the users. The blockchain allows users to create a secure system for recording any kind of transaction or information. There is no need for a centralized authority such as a government or bank. Every user relies on the technology itself, following predefined rules to achieve consensus and ensure the authenticity of the data.
The first component of a blockchain is a hash. A hash is a cryptographic function that transforms any input of data, such as a financial transaction, into a fixed-length string of numbers.
This data becomes part of an incorruptible ledger. Every block of the chain contains a hash plus the previous hash. It is not possible to modify any block without changing the entire chain.
The blockchain data is distributed among all the user computers. Every user has its own copy of the transactions and hashed blocks, and they spread the information of any new transaction to the entire network. This way, it is not possible for anyone to alter the information in the chain since it is not stored by an individual entity but is spread among an entire network of users.
Every time a user adds a new block, all users have to validate the correctness of the new block by using a common protocol for acceptance.
This is where Bitcoin fits in. Cryptocurrencies are a new form of digital money that has been made possible by the advent of blockchain technology. There are a number of cryptocurrencies in circulation such as Ethereum, Litecoin and Ripple, but Bitcoin is by far the most well-known.
It is true that you can already transfer funds and transact digitally using traditional currencies, such as the U.S. dollar, but cryptocurrencies work differently. Bitcoin or Ethereum are virtual currencies which are not controlled or regulated by a central authority such as a government. Financial transactions can occur securely and directly between individuals or entities without the intervention of third parties — banks, brokers, credit card companies, etc. — that add significant complication and expense to what should otherwise be a straightforward transaction.
Cryptocurrencies by their very nature are not subject to the exchange rates or transaction charges imposed by a specific country. Transactions across international borders are essentially seamless.
Several years ago, a number of companies began applying blockchain technology to offer equity, the promise of goods or services, or ownership of some sort of tangible goods in the form of custom digital tokens or coins. These offerings were known as ICOs or Initial Coin Offerings. The problem with ICOs is that they skirted established securities laws which brought regulatory scrutiny. As a result, the launch of new ICOs began to peter out in 2018. In its place, we saw the rise of digital securities.
A digital security is a digital representation of an asset in the form of a security, often an investment agreement, for which ownership is verified and recorded on a blockchain. A digital security is governed by traditional securities laws, and is often referred to as a security token. It could represent a share in a corporation, a note or other debt security, or a fractionalized interest in an underlying asset such as a work of art. A digital security can be purchased using traditional currencies (FIAT) or cryptocurrencies such as Bitcoin or Ethereum.
So now the next time someone mistakenly conflates the meaning of Bitcoin with Blockchain, Cryptocurrencies or Digital Securities, you stand ready to impress them with your deep knowledge of cutting-edge financial concepts.