On the 22nd of May, 2010, a Florida developer named Laszlo Hanyecz got his name into history books when he ordered two pepperoni pizzas. There wasn’t anything really special about the pizzas. The transaction got into the books of history because of the mode of payment Laszlo used to pay for the meal. Laszlo paid 10,000 Bitcoins for the two pizzas, making this the first transaction where a cryptocurrency was used to pay for a real-world commodity. Back then, cryptocurrencies were virtually unknown. One Bitcoin was worth just a few cents at the time. Had Laszlo chosen to keep his Bitcoins and forego the pizzas, his Bitcoins would have been worth over 576 million dollars today!
Eleven years since Laszlo’s historical transaction, cryptocurrencies have become a global phenomenon. While most people do not understand the technical aspects of cryptocurrencies, everyone is talking about them. This article will take you into the geeky world of cryptocurrencies and help you understand how they work and how you can make money with them. However, we first need to answer the following question, ‘What is a cryptocurrency?’
The term cryptocurrency refers to any digital medium of exchange that is based on cryptography and encryption. Cryptocurrencies rely on the rules of mathematics to regulate the production of new units, ensure security, and prevent fraud. The term cryptocurrency is a mash-up of the words cryptography and currency. To break it down further, a cryptocurrency is simply a set of entries in a digital database that can only be changed once specific conditions are fulfilled. Each unit of a given cryptocurrency is referred to as a token or a coin.
Since cryptocurrencies are digital in nature, they cannot be printed by the government as is the case with ordinary currency. So, where do they come from? Before we get to how they are produced, we first need to take a deeper look into how they work. Cryptocurrencies rely on the rules of mathematics. Before any cryptocurrency transaction can be completed, it has to be verified by a network of computers. These computers verify the transaction by solving complex mathematical equations in a process known as mining. By verifying transactions, this network of computers keeps the whole system running. In return, the system creates and awards new coins to the computers in the network after a predetermined number of transactions.
One thing that totally sets cryptocurrencies apart from ordinary currencies is that they are not backed or regulated by any bank, government, or central authority. To ensure accountability, cryptocurrencies rely on a non-trust-based public system known as the blockchain, to record and verify transactions.
History of Cryptocurrencies
To most people, cryptocurrencies are a fairly recent phenomenon. Before the advent of Bitcoin in 2009, cryptocurrencies were virtually unheard of. However, attempts at creating a digital payment system started long ago. The seemingly new phenomenon we are seeing today is actually a result of decades of painstaking mathematical research and strong-gut attempts by progressive thinking mathematicians and developers.
The first recorded attempt at storing value in something other than cash happened in the 1980s and came as a result of necessity. Noticing the huge amount of money in the oil industry, bandits started raiding petrol stations in remote areas of the Netherlands for cash. Unfortunately, the petrol stations could not close at night since trucks needed to refuel. To keep the bandits at bay, someone came up with the idea of putting money into smartcards, giving birth to electronic money. Instead of carrying cash, drivers were issued these smart cards, which they could then use to refuel at petrol stations.
At about the same time, an American cryptographer named David Chaum was investigating different ways of creating electronic cash. One of his major concerns was that electronic cash had to be similar to ordinary cash in that it would allow people to make hand-to-hand transactions safely and privately. Improving the RSA algorithm that had been invented in 1977, Chaum came up with a blinding formula that allowed the secure exchange of unalterable information. Chaum moved to the Netherlands – then a hotbed of mathematics and cryptography research – where he teamed up with other cryptocurrency enthusiasts to create Digicash, the first internet money invention. Like ordinary currency, Chaum’s company controlled the supply and use of this digital cash.
The invention of Chaum’s blinded cash was very innovative, and as a result, it received a lot of press attention. The press attention brought along very exciting deals for Digicash, with Deutsche Bank, Microsoft, and other big corporations interested in partnering with Digicash. However, after making a series of missteps and falling foul with the Netherlands Central Bank, Digicash ended up in bankruptcy in 1998.
Following the hype of Chaum’s Digicash, many other startup companies became interested in digital currencies. In 1996, an amateur economic history scholar named Douglas Jackson came up with E-gold, an online platform that gave people gold credits (e-gold) in exchange for physical gold deposits. E-gold was driven by Jackson’s notion that since his virtual currency was backed by gold, it would be stronger than fiat currencies, which are not backed by any physical asset. E-gold gained a lot of popularity. By 2005, the platform had over 3.5 million users in 165 countries. Unfortunately, E-gold’s popularity attracted a lot of criminals, and as a result, it was shut down by the FBI in 2005.
In 1997, a British cryptographer known as Adam Back came up with the ‘hashcash’ proof of work algorithm that would become the foundation on which modern-day cryptocurrencies are built on. Back’s algorithm inspired the system that modern-day cryptocurrencies use to mine new coins. In 1998, a Computer Science graduate named Wei Dai outlined the working of a virtual currency known as b-money. In his white paper, Wei Dai proposed many of the features associated with modern-day cryptocurrency, including anonymity and decentralization. However, Dai did not implement b-money.
Still searching for a viable form of virtual cash, a software company known as Confinity came up with a system that allowed people to make payments via email. Soon after, they focused their attention on allowing people to pay eBay sellers through email, giving birth to PayPal. PayPal gained massive success and grew to become the largest player in online payments.
In October 2008, a person or group of persons using the pseudonym Satoshi Nakamoto introduced Bitcoin, the first modern-day cryptocurrency. In 2009, Satoshi mined the first block of Bitcoin, giving rise to a digital currency that was both secure and free from regulation by any central authority. Bitcoin was also the first cryptocurrency to apply the concept of the blockchain. Following the success of Bitcoin and blockchain technology, several other programmers and cryptographers started creating their own cryptocurrencies. In April 2011, Vincent Durham created Namecoin, which added some innovative features to Bitcoin’s infrastructure. In 2012, Ripple was created, functioning both as a cryptocurrency and as an electronic platform for financial transactions. Peercoin was also launched in 2012, introducing a new proof of stake security method. Currently, there are over 4000 cryptocurrencies in the world, whose combined market capitalization is over $2.4 trillion.
Attributes of A Cryptocurrency
Cryptocurrencies have certain attributes that set them apart from fiat currencies. These include:
Anonymity: This attribute is one of the reasons behind the popularity of cryptocurrencies. Cryptocurrency wallet addresses are not linked to a person’s name or physical address. This allows cryptocurrency users to make transactions without having to reveal their identities.
Transparency: Cryptocurrencies use a non-trust-based system that relies on transparency. Every single cryptocurrency transaction is recorded in a huge digital ledger. The information within this ledger is publicly accessible to all the computers in the network. This means that anyone can see all the transactions and the number of coins owned by every cryptocurrency address. Despite this transparency, the addresses cannot be used to identify the owner of the coins.
Decentralization: One of the most revolutionary attributes of cryptocurrencies is that they are not regulated or controlled by any central entity. Instead, cryptocurrencies operate on a devolved system where the processing and validation of transactions are done by all the computers within the network. Due to their decentralized nature, no government or financial central authority can influence cryptocurrencies. Their decentralized nature also means that cryptocurrencies are always active. If some of the computers in the network go offline, others simply step in to fill the gap.
Speed: Another attribute that has contributed to the massive uptake of cryptocurrencies is their transaction speed. It only takes a couple of minutes for the computers in the network to verify a cryptocurrency transaction, allowing you to instantly send money to any part of the world. Compare this to banks which need several days to process and confirm transactions.
Ease of setting up: Getting started with cryptocurrencies is a breeze. There are no checks. Simply set up a cryptocurrency wallet in a few minutes and you are good to go. Compare this to banks, which require you to go through a number of checks before you can create a bank account.
Irreversibility: Unlike regular money transactions, cryptocurrencies do not have chargebacks. Once the transaction has done, it can’t be reversed.
Advantages of Cryptocurrency
The massive uptake and popularity of cryptocurrencies in recent years have been driven by the distinct advantages offered by cryptocurrencies. Some of these advantages include:
Instant Funds Transfer
One of the inconveniences of banks and regular payment processing systems is that it usually takes several days to process and confirm payments. Cryptocurrencies get rid of this inconvenience by allowing you to transfer funds anywhere in the world within a matter of minutes. The same case applies to credit card payments. If your business accepts credit card payments, you are forced to wait for several days before the money gets to your bank account. With cryptocurrency payments, the funds are accessible and ready to be used immediately once the transaction is completed.
Fraud Protection
One of the major challenges faced by online businesses is the risk of fraud. Many credit card fraudsters buy items online and then later on claim chargebacks, which leads to losses for online businesses. With cryptocurrency payments, businesses are protected from such fraudsters since cryptocurrency transactions are irreversible. Cryptocurrency transactions have to be validated by the entire network before the transaction is completed, thereby eliminating the risk of counterfeit payments. By paying for goods using cryptocurrency, customers also keep their financial information safe from hackers who usually target small businesses.
Privacy
One of the attributes of a cryptocurrency is that it has to offer anonymity. By not linking personally identifiable information to your cryptocurrency wallet, you are able to exchange money with other people without revealing your identity. This is important when you want to keep your transactions away from prying eyes.
Global Access
A huge part of the population in remote areas of the world does not have access to banks and financial institutions. However, most of the population in these areas have access to internet-linked mobile devices. The number of mobile phone users is set to exceed 4.7 billion in early 2018. A large chunk of this population depends on mobile devices for their financial transactions. Cryptocurrency gives this population the opportunity to save their money and make financial transactions on their own terms.
Total Control Over Your Funds
One of the disadvantages of a payment system that is controlled by a central authority is that you are never in full control of your account and funds. The bank or company has the final say over your account and funds. For instance, you have no control over your PayPal account. If PayPal feels that you are not acting in compliance with their terms and conditions, they have the power to freeze your funds without even consulting you. With cryptocurrency, no one wields such power over your funds. You have total ownership and control over your funds. No one has access to your wallet’s private key, which means that no one can mess around with your money.
Low Transaction Fees
Another disadvantage of banks and conventional payment processing companies is that every transaction is accompanied by processing fees. With cryptocurrency, there are no third parties, which means that you can make transactions at absolutely no fee. However, due to the technical nature of cryptocurrency, many users rely on third parties to maintain their wallets. These third parties will definitely charge a fee for their fees, though their fees are nowhere near as high as what banks will charge you.
Are Cryptocurrencies Real Money?
Ever since Bitcoin was first introduced to the world, there has been a raging debate as to whether cryptocurrencies qualify to be referred to as money. The back and forth argument has attracted support from big players in the cryptocurrency and financial industries. Just recently, the CEO and Chairman of JPMorgan Chase referred to Bitcoin as a fraud. But is this really true? Are cryptocurrencies really money? To answer this question, we need to understand what money is. Money is defined by the following properties:
Uniformity: For something to be termed as money, each unit of measure should have a similar purchasing unit to another equal unit of measure. For example, one dollar has a similar purchasing power to another dollar.
Portability: For something to be used as money, it should be easy to carry and transfer to others. For instance, you cannot use a sack of potatoes or a goat as money because you cannot easily carry them.
Divisibility: Money should be able to be divided into smaller units without loss of value. For instance, using the example above, you cannot divide the goat into smaller units without loss of value.
Durability: Money should be capable of withstanding repeated use – repeated exchange between people, storage in pockets and wallets, wear and tear, etc.
Acceptability: Something can only function as money if it widely accepted as a means of exchange.
Fungibility: This means that a unit of money should be essentially interchangeable with another similar unit without profit or loss. This means that one unit of money should not be superior to a similar unit. For instance, a ten-dollar bill can be exchanged with another ten-dollar bill without gain or loss.
Based on the above properties of money, we can now deduce whether cryptocurrencies meet the requirements of money. Cryptocurrencies are uniform since each unit of cryptocurrency has a similar purchasing power to another equal unit of the same cryptocurrency. Since cryptocurrencies exist digitally, they are extremely portable. They have no weight and size restrictions. You can store them online, on your computer, or on your smartphone. Transferring them to others is easy and frictionless. Compare this to paper money, which is cumbersome and dangerous to carry around in large quantities.
Cryptocurrencies have high divisibility, with most being capable of division up to 8 decimal places. Despite not having the same level of acceptance as fiat money, it is steadily growing. Currently, there are over 64 million active cryptocurrency wallets. Hundreds of thousands of businesses also accept cryptocurrency payments. Considering that cryptocurrency is still in its infancy stage, its acceptance will only keep growing.
Cryptocurrencies are digital entries that do not exist physically. This means that they don’t face the risk of physical degradation. Cryptocurrencies cannot be destroyed as happens with paper money. So as long as you have your wallet password and you keep it safe, you cannot lose your cryptocurrencies. Finally, cryptocurrencies are highly fungible. You can interchange a unit of cryptocurrency for another similar unit without gain or loss. Based on the above properties, it becomes evident that cryptocurrencies can actually be used as real money.
