Cryptocurrencies and Bitcoin
What is cryptocurrency?
Cryptocurrency is a digital currency which is secured by cryptography and built using decentralized blockchain technology. Computer code and technology are used to create an entirely virtual currency that enables people to transact with one another and store wealth.
In order for cryptocurrencies to fulfill the role of traditional currencies as medium of exchange and a store of value, they need to share the fundamental properties of a currency.
- Transportability: the currency must be easily transferrable
- Durability: the value can’t erode with time
- Divisibility: the currency must be divisible into smaller units to accurately reflect the value of every good and service.
- Verifiability: should be easy to verify and identify
- Fungibility: the currency units must be interchangeable
- Scarcity: the supply in circulation must be reasonably limited
What are the differences between cryptocurrency and traditional currency?
- Today’s traditional currencies, also known as fiat currencies, are issued and controlled by governments and central banks. Crypto is not issued or governed by a central authority or government, but instead managed digitally by the distributed network participants.
- Fiat currencies like USD are government backed legal tender whereas cryptocurrencies are not (yet) government declared legal tender.
- Crypto transactions only need to involve the two parties on either side of the transaction, whereas in the traditional setting an intermediary, such as a bank or government, is involved.
- Crypto transactions are public but anonymous
- Crypto transactions can theoretically be quicker because the involvement of an intermediary in fiat transactions delays the process
What is Bitcoin?
Bitcoin is the original cryptocurrency that was launched in 2009 and invented by a person (or group of people) using the alias Satoshi Nakamoto, the true identity of whom is still unknown. Bitcoin was the first electronic cash system which aims to bring greater transparency to financial transactions worldwide and a less centralized system of authority.
This purely digital currency (there are no physical coins) eliminates the need for trusted third parties, such as banks and governments, to facilitate financial transactions. Instead, the members or nodes of the peer-to-peer (P2P) network which power the cryptocurrency manage it collectively. This P2P network is public meaning that anyone is free to participate. As there is no single institution controlling the network, but instead all members are involved in managing the system, the governance is distributed and the network is said to be ‘decentralized’.
Although Bitcoin cryptocurrency, traded as BTC, is not considered legal tender, it is increasingly being held as a store of value. Bitcoin has inspired the creation of many other cryptocurrencies and blockchain projects, however it remains popular and is the biggest cryptocurrency by market cap. Bitcoin is still being issued to the market, however the total supply has been set at 21 million coins, with currently roughly 2.5 million yet to be released into circulation. Transactions can take place with smaller units, the smallest being the ‘satoshi’ which is one hundred millionth of a bitcoin (0.00000001).
How does Bitcoin work?
The Bitcoin P2P network is made up of a collection of nodes (also known as members or miners) which all run and store Bitcoin’s code. The bitcoin network originated when the first piece of the Bitcoin code was created and shared across the network, or in other words when the first ‘block’ of the chain, the genesis block, was mined. Subsequent ‘blocks’ are added to the genesis block in chronological order of creation making a ‘chain’ of blocks, and creating a permanent record of each transaction, which in essence forms the Bitcoin blockchain network.
Each block stores code representing Bitcoin payment transactions which are fully transparent to everyone. The transactions and balances are kept on a distributed ledger that are stored on the node computers all around the world. When a new transaction is added to the ledger, it is propagated to all of the ledgers in the network, and when all the networks agree that they have recorded the correct data the transaction is permanently committed. Since the transactions are transparent and irreversible, it is very hard for them to be tampered with.
What are the main benefits of using Bitcoin and Cryptocurrency?
Anonymous transactions: Identities aren’t directly shared on the Bitcoin network and names don’t appear in transactions, instead only public keys similar to a bank account number are shared. Even between parties within the same transaction, anonymity can be retained.
Security: The public and transparent nature of the bitcoin network as well as the distributed encrypted and permanent data storage makes it very difficult and expensive to hack the system and fraudulently alter the records.
Removes the need for a trusted centralized authority: An intermediary is not required because the design of the system ensures that verification of transactional data is automatically carried out and shared amongst all nodes. As the system doesn’t rely on trust this is often called a ‘trustless’ system.