An article on crypto? Now?!
Yes. Because the time when nobody talks about it is a great time to enter the market. Whether you're on the side of the haters, the sceptics, the hesitant, or the crypto fanatics, I've put together the most basic information you need to know about crypto and how it works. Stay tuned for the next article, which will go into the specifics on investing in this space.
Let's start with the basics: What is cryptocurrency and why does it exist?
BTC = Bitcoin = the first digital currency
Today, there are thousands of different cryptocurrencies, but the one that started it all was Bitcoin. Bitcoin was created in 2008 by a person or collective known under the pseudonym Satoshi Nakamoto.
Bitcoin was invented to create a monetary system which is safe, independent from third parties, and immutable (not at risk of being manipulated).
Before Bitcoin was created, online transactions and payments always relied on a third party (e.g. a bank or payment provider like Paypal), which created a dependency on the provider. This set-up requires you to believe that the provider is trustworthy, will process your transactions correctly and will keep your data private (meaning only accessible to the parties involved in the transaction). Cryptocurrency tries to solve exactly this issue. Bitcoin, for instance, keeps all transaction history public, but no data of individuals is publicized. "The public can see that someone is sending an amount to someone else, but without information linking the transaction to anyone" (source).
So Bitcoin is a 'peer-to-peer version of electronic cash', cutting out the need for a third party. This decentralized and anonymous way of managing transactions is made possible through the technology of blockchains.
What is a blockchain?
Blockchain = a technology to verify the legitimacy of digital transactions while preventing fraud.
Literally, a blockchain consists of blocks of data, which contain information (for instance about cryptocurrency transactions, such as who sent how much to who and when). In the case of Bitcoin, these blocks record a history of all transactions, which can be reviewed. Blockchains are decentralized and immutable, meaning they cannot be manipulated by a third party.
Why do Bitcoins need to be mined?
Mining = the verification, processing and storing of Bitcoin transactions. Literally the process of adding new blocks to the blockchain, thereby creating new Bitcoins. Some other digital currencies are also "mined", but not all of them. The mining is done by computers solving highly complex math problems. Due to a very slow transaction speed, it can take around 10 minutes for BTC transactions to be approved, which is much slower than the transaction speed for other digital payments such as credit cards.
Miners = the people providing the processing power or data centers that process Bitcoin transactions.
They are rewarded for their efforts in the form of new Bitcoins, which are sent directly to their digital wallets. These rewards are decreasing over the years, the amount being cut in half about every 4 years. For instance in the early days of BTC, you were rewarded with 50 BTC for mining new Bitcoin, whereas now you 'only' receive 6.25 newly created BTC per block added to the blockchain (as of May 2020). This 'halving' will continue every 4 years for another 120 years (until 2140), until the limit of 21 million created BTC is reached. At that point in time, miners will no longer be rewarded for their efforts with new BTC, but instead will be paid in fees.
The limit of 21 million BTC was set as market cap by Satoshi Nakamoto in order to create scarcity. If the supply of BTC was unlimited, the price would likely drop very low as more and more BTC are created, since the supply would eventually exceed the demand.
The miners have a say in decisions that are being made concerning the network protocol of Bitcoin. This means that if any changes need to be implemented in the technology (for instance because it was hacked), miners can decide together on the best way forward. No one entity has the decision power, it is a collaborative process.
Whereas it used to be fairly easy to become a Bitcoin miner (in the beginning you only needed a computer), the mining problems that need to be solved have become so complex and the necessary processing power is so large that today you practically need a whole building full of GPUs.
What are the best cryptocurrencies?
As mentioned above, there are thousands of cryptocurrencies at this point, and not all of them are legit. The second biggest currency after BTC in terms of market capitalization (at the time of this writing) is ETH = Ether.
Ether is the currency connected to the Ethereum network, which is a network that was founded by Vitalik Buterin to support decentralized applications (also called dApps). Similar to digital currencies, dApps were created to supply services that do not depend on a third party or single authority, but which can run independently on a blockchain.
Ether, which launched in 2015, is the digital coin that facilitates transactions on this network. It was not developed to be a digital currency just for the sake of exchanging money, but rather as a currency to facilitate transactions on the Ethereum network. While the Bitcoin blockchain only keeps transaction records, the Ethereum blockchain can enable more complex processes, such as the creation of "smart contracts".
What are smart contracts?
A smart contract is a contract (an agreement) between two parties, which is based on certain conditions that have to be fulfilled in order for the contract to be executed. To explain it in simple terms, imagine you want to buy a used laptop from a stranger without an intermediary platform like ebay. You would transfer the money to the person, and then hope that they will send the laptop to you, but there is always a risk that they won't, or more generally that one party does not fulfil their end of the contract.
A smart contract would act as an automated intermediary, which releases both parts of the interaction as soon as the requirements by both parties are fulfilled. For instance, the seller would only receive the money once they have shipped the laptop. This way, intermediaries for digital transactions are not needed anymore, so the interactions can happen fully decentralized.
Altcoins and other cryptocurrencies
Altcoins = all cryptocurrencies besides Bitcoin
Some other well known digital currencies besides BTC and ETH are Cardano (ADA), Polkadot (DOT), XRP, Litecoin (LTE) and the now widely known Dogecoin (DOGE). And then there are Stablecoins, which are digital versions of actual currencies, like the US Dollar. These always mirror the price of the actual currency, so you can use them to store your value on crypto exchanges, and eventually exchange them for other digital currencies.
Okay, now we've covered the crypto basics, but the last question is:
What the hell are NFTs?
NFT = non-fungible token
Meaning a unique certificate of ownership of a digital good. An NFT can represent a work of art, music, video, collectible or other goods in the digital world. NFTs are not cryptocurrencies, but rather collectibles that can be purchased with digital currencies. So they are another asset class you can invest in, besides cryptocurrencies.
Trading NFTs can be compared to trading art: the only reason an NFT holds value is because a group of people ascribe value to it. The initial reason why someone would want to own an NFT is to claim the "digital bragging rights". To be the only person able to say they own this specific piece. But looking at the hype that some NFTs are getting at this point, many people are in it for the quick money. They are looking for NFTs that are likely to multiply in value, so that they can make profit by re-selling it for a much higher price.
With most NFTs, only one person can own the original piece, and can prove this ownership with the NFT (some NFTs have multiple copies, which can be owned by a limited number of people). Since NFTs are held on a blockchain - most of them on the Ethereum blockchain - the ownership is clearly traceable and immutable.
Besides these benefits for the NFT owners, the benefits for the artists or institutions that create them, are the possibility to sell the artwork in a decentralized manner instead of having to involve galleries or auction houses as intermediaries, and the ability to program them in a way so that the artist receives royalties with every re-sale of the piece to a new owner.
That's all the crypto talk for now. Stay tuned for the next article on how to start investing into cryptocurrencies!
Disclaimer:
I am not an expert, I just researched this topic from a place of personal interest. If I used incorrect terminology or expressed something incorrectly, please feel free to let me know.
Sources:
Bitcoin Whitepaper: https://bitcoin.org/bitcoin.pdf