What is Cryptocurrency?
What is Cryptocurrency?
An introduction to cryptocurrency, also known as crypto, its applications, and the underlying blockchain technology.
Cryptocurrency vs. Blockchain
It is important to distinguish between cryptocurrencies and blockchain technology. Not all cryptocurrencies operate on a blockchain, and not all blockchains utilize cryptocurrencies as part of their design.
A cryptocurrency is a form of digital currency that is created, maintained, and secured with strong cryptography. This makes its transactions extremely difficult to hack or manipulate. Unlike other forms of digital assets—like the gold traded on exchanges, money used in online games, or unique virtual assets like company-managed loyalty points—a cryptocurrency is typically censorship-resistant because it is not controlled by a central authority. This inverts the old currency paradigm, whereby currency was created and issued by government monetary authorities and controlled by central banks, such as the United States Federal Reserve.
Cryptocurrency vs. Traditional Currency
Traditional forms of currency are known as fiat currency, because they are supported solely by the authority of its issuing government as opposed to commodity currency which is backed by physical assets, such as gold.
Governments that issue currency without the backing of any physical asset do so by fiat, and if they are unable to support their national currency by military or economic might, those currencies can lose much or all of their intrinsic value.
For example, Zimbabwe attempted to fight internal economic problems in the early part of the 20th century by printing more of its national fiat currency. However, since the country lacked the power to enforce its currency values internally or on the international stage, the printed notes quickly became all but worthless. Zimbabwe was eventually forced to abandon its currency and has effectively lost the ability to issue or control the value of its own banknotes. Its citizens now use several foreign currencies, including the U.S. dollar and the Chinese yuan, as legal tender.
Historically, most governments have tied the value of their issued currencies to a certain amount of gold, which was known as the gold standard. The gold standard fell out of practice during the Great Depression as countries found themselves hamstrung in their efforts to combat economic decline by the amount of gold in their reserves. The gold standard was abandoned worldwide in the 1970s after U.S. President Richard Nixon ended a policy that allowed other countries to convert their supplies of U.S. dollars to gold.
Cryptocurrencies and Bitcoin
Bitcoin is generally considered the first modern cryptocurrency because it was the first digital currency designed to operate in a fully decentralized manner without the need for a central authority. Earlier attempts at creating cryptocurrencies failed due to lack of public trust and inadequate technology to ensure proper operation. It was simply not possible to create an effective and functional distributed cryptocurrency with the technology and connection speeds of the 1990s. Bitcoin’s creation also produced the world’s first functional blockchain.
The Value of Cryptocurrencies
Modern cryptocurrencies are often broadly exchangeable for fiat currencies, particularly if the cryptocurrency enjoys widespread recognition and can be bought or sold on a cryptocurrency exchange. They may have free-floating values that are calculated, similarly to share prices on the stock market, as a function of their relative supply and demand at any given time. Some cryptocurrencies attempt to “peg,” or link, their values to the value of something else, like Bitcoin or the U.S. dollar.
Use Cases and Applications for Cryptocurrencies
A cryptocurrency may serve as a store of value that people choose to save in anticipation of higher prices or better exchange rates in the future. Some cryptocurrencies may even be used as payment to acquire goods and services, which makes them a medium of exchange. Like fiat currencies, some cryptocurrencies are much more effective in these roles than other cryptocurrencies.
Store of Value (SoV)
Anything can be a store of value. For millennia, gold was (and still is) considered a good store of value because individuals and governments believe that it will continue to remain valuable in the future. Today, global reserve currencies, such as the U.S. dollar and British pound have become relatively good stores of value. A store of value doesn’t need to necessarily stay the same price, but it cannot fluctuate drastically and must maintain the global perception that it will continue to grow in value over time. Bitcoin, Ether (the Ethereum platform’s native token), and other cryptocurrencies are slowly becoming recognized by global institutions and national governments as potential long-term stores of value because they aren’t controlled by a single country and have programmed levels of inflation.
Today, cash and credit cards are common mediums of exchange, meaning they are universally accepted for the exchange of goods and services. Over the past couple of decades, more modern payment processes have formed, such as Paypal, Venmo, WeChat, and other forms of mobile/electronic payments. However, all of these payment forms are primarily denominated in U.S. dollars or another major currency. Bitcoin, ether, and other cryptocurrencies have slowly integrated into the world and can be used to pay for ordinary goods and services, further cementing their ability to be used as a medium of exchange. The UnionBank of the Philippines in partnership with ConsenSys Solutions, Kaleido, Amazon AWS, ConsenSys Diligence, Microsoft Azure, and seven rural Philippine banks recently piloted Project i2i, an inter-rural bank payment platform built on Enterprise Ethereum. A new class of cryptocurrencies, termed stablecoins, have also started to gain traction as a medium of exchange because they are generally pegged to the U.S dollar or the unit of one.
A token is a digital representation of a unit of value. This unit of value can be assigned to anything deemed valuable by society, be it virtual assets or digital representations of real-world assets. Tokens are created using smart contract platforms, such as Ethereum and each token can be programmed with various features.
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Many cryptocurrencies also serve as the foundation of crypto-economic systems, in which participants are incentivized to behave in a self-interested way that simultaneously benefits and advances the system as a whole. The crypto-economic system behind many cryptocurrencies bears a strong resemblance to the unfettered free market envisioned by pioneering economist Adam Smith, whose principle of the “invisible hand” dictates that self-interested participants in a free market economy will automatically reach a state of equilibrium between buyers and sellers of any assets. The degree to which the ecosystems of these cryptocurrencies resemble unregulated free markets does depend in large part on the degree to which its creators exert control over cryptocurrency issuance and development.
These are some of the broad applications of cryptocurrencies. As cryptocurrencies undergo further development and experimentation, they gain new use cases and potential applications. While it’s impossible to say for certain how cryptocurrencies will be used in the future, the existing use cases and applications certainly guarantee that they will be a disruptive technology. Blockchain technology itself, which powers cryptocurrencies, also has a wide array of use cases and potential benefits for various industries.