Cryptocurrency
New Material
This article contains material not explicitly covered by the book. The question often arises what is the difference between cryptocurrency, digital currency, and electronic money.
Cryptocurrency
Cryptocurrency is privately issued "money" or a token of value, that comes into existence generally using the science of cryptography and generally the solution to a mathematical problem.
Let's take the "genesis block" of Bitcoin, for example. Prior to the creation of this block, no bitcoins were in existence. The question: how did Bitcoins come into existence? The answer: Nakamoto following the rules of a protocol that "he/she/they/it" created, solved a mathematical problem using a processor, electricity, and time. When the correct solution was produced, by trial and error, a bitcoin came into existence.
The first block, the genesis block, produced 50 bitcoins. The mathematical problem is called the "nonce", that is, the number to be guessed; the use of computers, electricity and time is called "proof of work". The latter is a cost that "miners" incur in an attempt to receive a reward: primarily bitcoin and, secondarily, fees to process transactions.
The next question: why does this thing created out of nothing but protocol, mathematics, and energy, have any value. The market gives it value. The other important aspect is that Bitcoin is electronically recorded on a decentralised ledger. What does this mean? Decentralised ledger technology simply means that we have a network of computers linked together for the purpose of managing the currency called Bitcoin. It is decentralised because no participant in the network is in control of the system. Rather, the participants follow protocols or what usually is called a "consensus system" to verify and validate transactions that take place between owners of Bitcoin.
This ledger organises transactions into "blocks" thereby giving the name blockchain. Individual blocks are chained by cryptographic hashes. A hash consists of an input and, subject to a hash function, a deterministic output. What do I mean? Hash functions are algorithms. For example, take the input "I like to read books". If I hash this input, using SHA-256, I will get a string of letters and numbers comprising 256 exact characters. The slightest change to the input changes the output. Let's say I misspell the word like and enter "lik", the output is entirely different. An observer then knows something is wrong: the input has been altered. The concept is simple: make it easy to create an input and make it hard, virtually impossible, to take the output and trace it back to the input. These hashes are the "chains" in the blockchain system. Every block contains its own hash and the hash of the previous block.
Now, we have many different types of consensus systems, as proof of work is deemed detrimental to the environment. In addition, this POW takes time, so that transactions cannot be cleared instantaneously. So, cryptocurrencies like Ethereum [ETH] will move to what is called "proof of stake". But these are details. The main point is that they are privately issued not government-issued money. Now there are thousands of coins. The question to be asked in evaluation: what is behind this digital asset. In the bitcoin case, it is the finite amount 21 million BTC and no more, expected to be mined by 2040. Therefore BTC is considered to be digital gold, a scarce resource, and of course, it has been accepted by the market as a non-tangible asset of value.
The volatility comes from the way people treat BTC, like an investment opportunity, not a currency to be used to pay for goods, services and debt. This may change in the future.
Now to the distinction between cryptocurrency and digital currency. This is where governments come into the picture. Some nation-states are considering the introduction of Central Bank Digital Currency. Of course, this currency will be issued by a government and does not need to rely upon the science of cryptography and certainly will be recorded on a centralised permissioned ledger. Since the term "cryptocurrency" may imply illegality, nation-states prefer the term digital currency. The same perspective may be projected upon the entire market for non-tangible money because there is no consensus on vocabulary.
There is no taxonomy accepted across the literature regarding distinctions among the terms cryptocurrency, digital currency, and electronic money, In one sense, we can isolate the term "cryptocurrency" since it is based on the science of cryptography. But, the distinction between "digital" and "electronic" is unsettled. Both are forms of electronic money since neither is paper-based.
Having said this, the next question arises: if I am an investor, what to do? I can only say that Bitcoin and ETH dominate the market, probably 70% or more. You must look under the hood, so to speak. What is this thing? Is it logical? Who is behind it and why? For example, based on my minuscule knowledge, I like XRP because it is the reserve currency of Ripple, a cross-border payment system that operates in real-time. It trades for $1.20, but a year ago it was probably $0.20. But when I look at it, I see that there is something real and valuable behind this coin. Not that I am saying buy it. Who knows?
This article contains material not explicitly covered by the book. The question often arises what is the difference between cryptocurrency, digital currency, and electronic money.
Cryptocurrency
Cryptocurrency is privately issued "money" or a token of value, that comes into existence generally using the science of cryptography and generally the solution to a mathematical problem.
Let's take the "genesis block" of Bitcoin, for example. Prior to the creation of this block, no bitcoins were in existence. The question: how did Bitcoins come into existence? The answer: Nakamoto following the rules of a protocol that "he/she/they/it" created, solved a mathematical problem using a processor, electricity, and time. When the correct solution was produced, by trial and error, a bitcoin came into existence.
The first block, the genesis block, produced 50 bitcoins. The mathematical problem is called the "nonce", that is, the number to be guessed; the use of computers, electricity and time is called "proof of work". The latter is a cost that "miners" incur in an attempt to receive a reward: primarily bitcoin and, secondarily, fees to process transactions.
The next question: why does this thing created out of nothing but protocol, mathematics, and energy, have any value. The market gives it value. The other important aspect is that Bitcoin is electronically recorded on a decentralised ledger. What does this mean? Decentralised ledger technology simply means that we have a network of computers linked together for the purpose of managing the currency called Bitcoin. It is decentralised because no participant in the network is in control of the system. Rather, the participants follow protocols or what usually is called a "consensus system" to verify and validate transactions that take place between owners of Bitcoin.
This ledger organises transactions into "blocks" thereby giving the name blockchain. Individual blocks are chained by cryptographic hashes. A hash consists of an input and, subject to a hash function, a deterministic output. What do I mean? Hash functions are algorithms. For example, take the input "I like to read books". If I hash this input, using SHA-256, I will get a string of letters and numbers comprising 256 exact characters. The slightest change to the input changes the output. Let's say I misspell the word like and enter "lik", the output is entirely different. An observer then knows something is wrong: the input has been altered. The concept is simple: make it easy to create an input and make it hard, virtually impossible, to take the output and trace it back to the input. These hashes are the "chains" in the blockchain system. Every block contains its own hash and the hash of the previous block.
Now, we have many different types of consensus systems, as proof of work is deemed detrimental to the environment. In addition, this POW takes time, so that transactions cannot be cleared instantaneously. So, cryptocurrencies like Ethereum [ETH] will move to what is called "proof of stake". But these are details. The main point is that they are privately issued not government-issued money. Now there are thousands of coins. The question to be asked in evaluation: what is behind this digital asset. In the bitcoin case, it is the finite amount 21 million BTC and no more, expected to be mined by 2040. Therefore BTC is considered to be digital gold, a scarce resource, and of course, it has been accepted by the market as a non-tangible asset of value.
The volatility comes from the way people treat BTC, like an investment opportunity, not a currency to be used to pay for goods, services and debt. This may change in the future.
Now to the distinction between cryptocurrency and digital currency. This is where governments come into the picture. Some nation-states are considering the introduction of Central Bank Digital Currency. Of course, this currency will be issued by a government and does not need to rely upon the science of cryptography and certainly will be recorded on a centralised permissioned ledger. Since the term "cryptocurrency" may imply illegality, nation-states prefer the term digital currency. The same perspective may be projected upon the entire market for non-tangible money because there is no consensus on vocabulary.
There is no taxonomy accepted across the literature regarding distinctions among the terms cryptocurrency, digital currency, and electronic money, In one sense, we can isolate the term "cryptocurrency" since it is based on the science of cryptography. But, the distinction between "digital" and "electronic" is unsettled. Both are forms of electronic money since neither is paper-based.
Having said this, the next question arises: if I am an investor, what to do? I can only say that Bitcoin and ETH dominate the market, probably 70% or more. You must look under the hood, so to speak. What is this thing? Is it logical? Who is behind it and why? For example, based on my minuscule knowledge, I like XRP because it is the reserve currency of Ripple, a cross-border payment system that operates in real-time. It trades for $1.20, but a year ago it was probably $0.20. But when I look at it, I see that there is something real and valuable behind this coin. Not that I am saying buy it. Who knows?
