It’s been called the cash of the future and a threat to the modern banking establishment, but what exactly is cryptocurrency? Is it the same as Bitcoin? Are there different kinds? And how is blockchain involved? If all these questions have your head spinning, you’re not alone. We’re pulling back the curtain on the complex world of digital currency to help you understand the ever-expanding modern currency.
What Is Bitcoin?
Bitcoin creator Satoshi Nakamoto introduced the first digital currency to the world in 2009 in a white paper called “Bitcoin: A Peer-to-Peer Electronic Cash System.” In the paper, Nakamoto, a still unknown person or group, explained Bitcoin as “a purely peer-to-peer version of electronic cash [that] would allow online payments to be sent directly from one party to another without going through a financial institution.”
The white paper went on to explain the Bitcoin and blockchain intricacies and detailed the complex mathematical equations that would be used to regulate and track transactions.
Nakamoto released the open-source code and domains at the core of Bitcoin to others in the community in 2011 and disappeared.
What Is the Blockchain?
Blockchain is the technology that holds Bitcoin and many other cryptocurrencies together. It’s the building-block foundation that records and organizes transactions into “blocks.” As explained by the Financial Industry Regulatory Authority (FINRA), “Each block in a chain is comprised of a series of records secured by cryptography that describe preceding and current transaction data.” When new blocks are added, the chain grows.
The reason blockchain technology is preferred to a centralized banking method is that there is no government authority or financial institution that controls it. Additionally, a blockchain holds an entire history of transactions, and theoretically, anyone who wants to verify a transaction can do so — while maintaining privacy on both ends — as long as they’re already a participant in the chain. And since records on the blockchain are nearly impossible to alter, they’re extremely accurate.
Not surprisingly, the idea of blockchains is appealing to other industries outside of cryptocurrency. Archiving health records, streamlining supply chain and shipping practices, and creating one-of-a-kind collectibles known as non-fungible tokens, or NFTs, are all being done using blockchain technology today.
According to the market and consumer data company Statista, an estimated $6.6 billion was funneled into blockchain solutions in 2021, with global investment in the technology expected to approach $19 billion by 2024.
How Is Cryptocurrency Generated and Valued?
While crypto, like cash, doesn’t grow on trees, it is in a way pulled from thin air.
As outlined in Nakamoto’s white paper, Bitcoin miners connect to the Bitcoin blockchain and engage in complex mathematical problems to verify and store new transactional data on the blockchain, a process known as proof of work. When an equation is solved, new Bitcoin is created, and given to the miner as a reward. Anyone can be a Bitcoin miner with the proper equipment such as a graphics processing unit (GPU) or an application-specific integrated circuit machine (ASIC).
However, unlike cash, there is a finite amount of Bitcoins that can be mined and created — ever. Nakamoto capped the number of Bitcoins at 21 million. In December 2021, it was reported that 90% of that total had been mined, with the full 21 million expected to reach the open market around the year 2140.
As the amount of Bitcoins continues to grow, that doesn’t necessarily mean that its value does, as well. The model of how much Bitcoin is worth resembles traditional markets, like the stock and real estate markets. The more people want to buy than sell Bitcoin, the higher the value. If there are more sellers than buyers, prices will likely fall.
What Are Some Other Cryptocurrencies?
Bitcoin may be the largest cryptocurrency right now, but there are thousands of others competing for consumer investment. Some of the better-known “altcoins” (alternatives to Bitcoin) include Ether, the currency of the decentralized software platform Ethereum; Litecoin, which offers faster transaction confirmation times than Bitcoin; and Dogecoin, which famously earned the endorsem*nt of Elon Musk.
Investors can buy and sell these assets through dedicated marketplaces like the one hosted by Coinbase, which in April 2021 became the first publicly traded cryptocurrency company. Brokerage platforms such as eToro and Robinhood also sell crypto and offer services to manage portfolios.
Banks, while originally meant to be bypassed in the peer-to-peer digital transaction world, are also trying to find ways to get involved in the crypto business. Some of their tactics include issuing stablecoins — a digital currency “pegged” to a reserve asset like the U.S. dollar — and assisting crypto trading on behalf of their customers.
What Are Some of the Problems Associated With Crypto?
For all the steps taken to bring digital currency out of the shadows and into the mainstream, it remains a risk for investors. The North American Securities Administrators Association (NASAA) warns of the dangers of purchasing little-known currencies and engaging in minimally regulated exchanges. Furthermore, the technology remains susceptible to hackers performing unauthorized withdrawals and is also problematic for those who get locked out of their accounts due to passwords that are lost or forgotten.
There are also environmental concerns tied to the use of supercomputers to verify transactions and create more money. According to a September 2021 report in The New York Times, the process of mining Bitcoin eats up approximately 91 terawatt-hours of electricity on an annual basis, more than the amount used by the 5.5 million residents of Finland.
Some crypto companies, like Etherium, have addressed this issue by transitioning from a proof of work to a proof of stake model, in which users “stake” their coins as collateral in exchange for the opportunity to validate transactions.
Crypto Continues To Inspire Confidence and Scare Away Traditionalist
While many people invest in digital currencies solely for the potential of seeing their assets rise in value, other consumers and companies are using crypto just like you would cash to purchase goods and services. Will it replace the traditional banking infrastructure? Only time will tell, but it’s definitely making waves in financial circles and beyond.
