Virtual currencies are basically digital representations of value, which can either be decided by a central issuer—the value of a particular coupon or code issued by a retail company or airline miles.
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Now that we have a basic understanding of blockchains and the various ways they can be used, it is time we understood more about the most popular application of blockchains: cryptocurrencies.
Cryptocurrencies are a form of virtual currency, which makes it important to understand what those are before we can move ahead. Virtual currencies are basically digital representations of value, which can either be decided by a central issuer—the value of a particular coupon or code issued by a retail company or airline miles, for example—or in a decentralised manner, as with cryptocurrencies.
● Virtual currencies come in various forms and can be differentiated along their attributes. For example, one attribute is convertibility. That is, can the virtual currency be converted into any other asset or into real money. Most online coupons or airline miles cannot be converted, as per the issuing company’s rules. Cryptocurrencies, however, can be converted into real currency, or into other cryptocurrencies. They are highly convertible.
● Cryptocurrencies are assets that reside purely in the digital space and that use methods of cryptography for security purposes—hence the name ‘cryptocurrency’. One of the most important things to note about cryptocurrencies is that neither do they have any intrinsic value of their own, nor is any value assigned to them by any centralised agency. For example, gold has a value of its own, and the rupee has a value assigned to it by the Reserve Bank of India. The value of cryptocurrencies are determined purely by the dynamics of supply and demand.
● Blockchain technology is central to cryptocurrencies as it allows transactions to be processed and authenticated without any central authority. There is no Central Bank of Bitcoin, for example. Instead, the consensus algorithms built into the blockchain behind each cryptocurrency is what determines the authenticity of a transaction.
Some blockchains have a rule that says that a transaction can be authenticated only if all nodes on the blockchain authenticate it. This becomes an unwieldy rule for popular cryptocurrencies like Bitcoin, which have thousands of nodes. Instead, the consensus rule for popular cryptocurrencies requires a certain percentage of nodes to authenticate a transaction before it is added to the blockchain.
Now, given the name ‘cryptocurrency’, the basic question arises of: are cryptocurrencies money? According to the International Monetary Fund (IMF), currency has some basic characteristics: 1) It is a medium of exchange, 2) they are issued by a central authority, 3) they are legal tender and 4) they are an independent unit of account. In essence, cryptocurrencies cannot be considered as an alternative or competition to fiat currency but are more aligned, for consideration, as an alternate asset class, similar to Gold.
According to most estimates, Bitcoin and Etherium together account for almost 60% of the market capitalisation of all cryptocurrencies. Bitcoin itself accounts for about 40%. It’s no surprise, then, that Bitcoin and cryptocurrencies are more or less synonymous with each other.
The first Bitcoin transaction was carried out in January 2009, when the legendary creator of Bitcoin, Mr Satoshi Nakamoto (a pseudonym) transferred 10 Bitcoins to the first person to download the software. However, it took till 2010 for the first commercial transaction using Bitcoin to take place. A programmer named Laszlo Hanyecz ordered two pizzas through an intermediary by paying him 10,000 Bitcoins. To put the growth of Bitcoin since then in perspective, 10,000 Bitcoins are now worth about ₹3,490 crore!
While ‘crypto’ part of cryptocurrencies is a correct usage of the term, since it is derived from cryptography, it may be better in terms of helping people understand, to replace the word ‘currency’ with ‘asset’. Cryptoassets convey what they are much more effectively, since they behave in the way many financial assets such as stocks do.
Now that we know what cryptocurrencies are, the next article will deal with how cryptocurrencies are created.
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