What is Cryptocurrency?
Money is a social institution that serves as a unit of account, medium of exchange and store of value. With the emergence of decentralised accounting technology (DLT), cryptocurrencies represent a new form of money: they are issued privately in digital form and allow peer-to-peer transactions.
Historically, currencies fulfil their main functions when their value is stable and their user network is sufficiently large. So far, cryptocurrencies fail to meet these criteria because they have high volatility, a young market and are used by a niche of users. Precisely these aspects, which make them a type of currency that is unlikely to replace fiat currency in the short term, have created the conditions for them to establish themselves as a speculative medium and long-term investment.
History of Cryptocurrency
David Chaum, an American cryptographer, was the first in 1983 to conceive the idea of electronic money based on cryptography and anonymity-oriented, to which he gave the name ecash. The idea was taken up during the 1990s by developers like Wei Dai, who came up with a similar concept and called it “b-money”. Soon after, another well-known personality in the crypto scene to this day, Nick Szabo, formulated his theory on how what he called bit gold would work. Szabo introduced concepts with regard to blockchain technology that are still innovative to this day.
The historic year is the birth of the first true cryptocurrency, bitcoin in 2009. Its anonymous developer hides behind the pseudonym Satoshi Nakamoto. Satoshi created the first decentralised cryptocurrency exchange system.
The second cryptocurrency, Litecoin was born from a fork of the Bitcoin blockchain in 2011. Since then there have been thousands of cryptocurrencies offering different solutions and projects.
Cryptocurrency: What are Altcoins?
Over the years, computer scientists and developers have worked hard to understand and improve blockchain technology by creating all the cryptocurrencies we know today. All these cryptocurrencies that are not bitcoins are called “alternative coins”, aka “altcoins“.
The value of cryptocurrencies on the market is determined by the law of supply and demand. Some cryptocurrencies derive their value, in terms of convenience, also from advantages or characteristics that distinguish them individually.
There are about 18,000 cryptocurrencies, but most of the transactions involve the top two market leaders, Bitcoin and Ethereum. In March 2022, cryptocurrencies represent about $1.7 trillion in terms of market capitalisation, where Bitcoin and Ethereum account for 60%. Market capitalisation (Market Cap) is the amount of units in circulation multiplied by the price of a cryptocurrency at a given time. For comparison, the notes and coins issued by the Fed represent about $ 1.6 trillion, while those issued by the European Central Bank represent € 1.2 trillion (2018 data).
The Classification of Money: Where do Cryptocurrencies fit?
To understand how cryptocurrencies fit into the financial system, it is necessary to describe them according to the three criteria by which fiat currencies are classified:
- the issuer: government or private
- the form: physical or digital
- how transactions are settled: with a centralised or decentralised system
Cryptocurrency would, therefore, represent a form of money already theorised in the financial taxonomy, but born only in 2009 with bitcoin.
In particular, cryptocurrencies are:
1) Privately issued
Currency issued privately by independent individuals is nothing new. For example, bank deposits are such. Unlike these, cryptocurrencies are not a liability and cannot be refunded. Private issuance is not decided by a political institution but by an algorithm, which avoids discretionary decisions that can lead to excessive inflation. They even have an advantage against deflation, being divisible into several decimal places. Bitcoin, for example, has 8 decimals, while ether has 18. Mathematical control over their issuance is a prerequisite for their transparency and the predictability of their monetary policy.
Similar to electronic money issued by central and commercial banks, cryptocurrencies are also fiduciary (they have no intrinsic value).
As digital currencies, cryptocurrencies are not tangible, they cannot be withdrawn from ATMs. For this reason, they are exchanged in a different way compared to traditional money.
Fiat currencies are used both in physical and digital form, so when they are digitized they can be confused with cryptocurrencies, which are exclusively digital currencies. It is normal to keep fiat money in your wallet or in your bank account, but it is impossible to keep cryptocurrencies in a physical wallet.
Confusion can arise about the balance visible on some payment apps or your home banking, but this money has nothing to do with cryptocurrencies. It is simply fiat money in digital form.
Cryptocurrency can be sent directly between two users thanks to crypto wallets. These transfers have minimal transaction costs, allowing users to avoid the high fees required by traditional financial institutions.
The absence of a connection to a particular jurisdiction, country or intermediary allows cryptocurrencies to be a truly global and easily accessible currency, which could facilitate global trade and the integration of the 1.7 billion people who do not have access to financial services. Cryptocurrency can, therefore, bring benefits in countries where there is a major economic crisis or in developing countries.
In summary, cryptocurrencies have advantages over fiat currencies in that:
- They don’t need intermediaries
- They circulate safely thanks to cryptography
- They are independent of governments and borders
- They’re anti-inflationary
- They are an alternative asset for investment diversification.
How do cryptocurrencies work?
The prefix “crypto” suggests the answer: “cryptography”. The application of cryptography protects ownership and verifies cryptocurrency transactions through complex algorithmic calculations. Because it is based on mathematical functions, the cryptocurrency system is more secure than systems based on human control. In particular, encryption ensures that:
- a user does not spend twice the same amount of cryptocurrency (double spending)
- a user can exchange cryptocurrency without compromising his privacy
- keeps the entire ecosystem safe
To access the network, a user must have a pair of keys called private key and public key. The first works as a kind of password that gives access to the blockchain, with the essential difference that it can not be changed or recovered if lost.
From the private key, the system can generate a public key and a public address. These are used to receive cryptocurrency, as if they were a bank account and an IBAN respectively. From a public key or public address, it is impossible to determine the private key that generated them. This system, called public-key cryptography, is what makes cryptocurrency ownership secure and virtually inviolable by third parties. No one can block your crypto account or stop you from moving them. In addition, it is very easy to prove to the network of nodes that it has to verify your cryptocurrency transaction and your right to spend it.
Cryptocurrencies are digital currencies used for the exchange of goods and services, based on cryptography and peer-to-peer technologies.
Cryptocurrencies such as Bitcoin seem to have exposed an issue in the global banking system. A system that only works 8 hours a day, 5 days a week in the Internet age does not seem very practical. To date, Bitcoin has about 14,000 nodes. Turning it off is practically impossible. What is possible is for governments to find a way to regulate Bitcoin and other cryptocurrencies.
Cryptocurrency, in general, is based on open-source software that can be implemented by anyone directly from home. As long as there is an Internet connection, new cryptocurrency projects can be created. This is the real issue for any government: the spread of unregulated currencies. The faster the technology on which cryptocurrencies are based, i. e. the blockchain, the higher the chance for new and improved cryptos to be adopted.
In the short term, cryptocurrencies could evolve into legitimate private means of payment, rather than defying the role of official currencies. Ultimately, as a potential competitor of fiat currencies, cryptocurrency could even have a positive effect by acting as a disciplinary device that pushes central banks (especially in countries with lax monetary policy histories) to take their price stability mandates seriously.