Everything you need to know about crytocurrency

IT’S the revolutionary digital currency system that has the world talking, but what is cryptocurrency and why should you care? Read our guide to find out what it is and how it works.

CRYPTOCURRENCY didn’t actually come into existence intentionally.

The forerunner of this phenomenon, Bitcoin, was announced in late 2008 as a ‘Peer-to-Peer Electronic Cash System’ and was a side-product of another invention created by an unknown individual or individuals.

Claiming to be a Japanese man, Bitcoin’s creator uses the alias Satoshi Nakamoto, however there has been scepticism regarding his true identity.

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Basically, Nakamoto had created a decentralised digital cash system, or, digital money. This was an important breakthrough as there had been many attempts to do this in the 1990s. Where they all failed, Nakamoto succeeded.

Crypocurrency can be difficult to get your head around.

Try to think of it like this:

•In order to operate, every payment network requires accounts, balances and transactions. However, one of the most important components it requires is a central entity that keeps track of every component in order to prevent double spending, which is when one entity spends the same amount twice.

•This central entity (usually a server) does not exist within a decentralised network. Instead, this responsibility is passed along to every single entity, or peer, in the network to help keep track of all the transactions. The network relies on these entities to ensure that future transactions are valid and to prevent double spending.

It sounds good in theory, but how can this actually be put into practice?

The good thing about traditional payment networks is that they have a central authority to oversee transactions and track balances, like a bank.

The problem with a decentralised network is that it is prone to collapse if peers disagree about a single balance, regardless of how small.

Remarkably, Nakamoto managed to overcome this seemingly impossible issue through the creation of Bitcoin, and the world immediately took notice.

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University dropout Nick Smith turned $7000 into over $350,000 through Bitcoin and other cryptocurrency investments, and has also started a consulting business. Photo: Peter Ristevski

WHAT EXACTLY ARE CRYPTOCURRENCIES?
A currency can be defined as “limited entries in a database no one can change without fulfilling specific conditions”.

This is true even when using physical coins and notes, where a public database is altered according to how these objects are exchanged to create a series of transactions.

This applies to cryptocurrency, except that it has a peer-based database. Unlike a centralised cash system, every peer is privy to the history of every transaction and account balance.

In order to make a transfer, a file with details of the sender and recipient is generated and signed with the former’s private key. This transaction is then broadcast throughout the network, updating every peer.

While this information is quickly broadcast throughout the network, it takes a bit longer to be confirmed. Confirmation is one of the most important aspects of cryptocurrency as unconfirmed transactions are pending and vulnerable to forgery. Once confirmed, the transaction is absolute and becomes part of a record of historical transactions known as the ‘blockchain’.

But how are these transactions confirmed? This is the job of cryptocurrency miners. Their role is to examine a transaction and mark it as being legitimate before it is added to the blockchain.

You may have heard of people making money through mining for cryptocurrency. As it is such an important function, miners are rewarded with some of the currency for their efforts. This is something that anyone can do, however there’s a bit of a catch.

To prevent someone from gaining too much authority (which has the potential to be abused) and thus destabilising the decentralised system, Nakamoto implemented a rule that miners’ computers would have to do some work in order to be rewarded. They have to find a ‘hash’ to help connect a new data block to the blockchain. This involves solving a cryptologic puzzle, with the process known as ‘proof of work’.

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A picture shows a Bitcoin ATM in Rovereto, northern Italy. Picture: AFP/Pierre Teyssot

WHY SHOULD WE CARE ABOUT CRYPTOCURRENCIES?

One of the main benefits of this form of currency is that it is decentralised. We do not have to rely on a central bank that is controlled by people, some of whom may be untrustworthy. Cryptocurrency is underpinned by complex maths and is incredibly difficult to compromise, unlike banks.

There are many important features of cryptocurrency which distinguish it from and even make it preferable to traditional monetary systems:

•Transactions are completely irreversible (which can be a negative), however some may find comfort in this certainty.

•The anonymity of cryptocurrency (when used correctly) makes it highly difficult to connect transactions and accounts with the identity of users. For this reason, when Bitcoin first emerged it was used by dark web marketplaces such as Silk Road to facilitate the trade of illicit drugs and other illegal contraband.

•Gone is the era of waiting days to transfer money. Cryptocurrency allows you to send funds anywhere in the world, with transactions confirmed within a couple of minutes.

•Cryptocurrency is highly secure (when the correct processes are followed) due to the use of blockchain technology that prevents data from being altered.

•It is also accessible to anyone. Simply download the software and away you go.

•From a monetary perspective, a key property of most cryptocurrencies is that the tokens are finite, with Bitcoin scheduled to be depleted in around 2140. This scheduling helps to eliminate surprise.

•Cryptocurrencies also don’t work off the IOU system like banks do. If everyone suddenly tried to withdraw their money from a bank at the same time it would be impossible since we do not use the gold standard anymore and rely on a fiat money system. Cryptocurrencies are worth their face value and can be considered the same as possessing gold coins.

•Ultimately, cryptocurrencies allow citizens to take control of their money without being hindered or controlled by banks and the government.

Bitcoin remains the gold standard in the cryptocurrency world. Photo by Dan Kitwood/Getty Images

WHAT CRYPTOCURRENCY SHOULD I USE?

It seems like a whole host of cryptocurrencies have sprung up overnight, and many people are understandably confused. While it has attracted many investors, the cryptocurrency market is wild and, at times, unpredictable.
While many cryptocurrencies emerge with the sole intent to draw investors and make money quickly, some present the opportunity to innovate and experiment with cryptocurrency technology.

BITCOIN

Bitcoin is the currency that started it all. The whole cryptocurrency industry uses it as a gold standard and it is now widely accepted as a form of payment across the world, with over 200,000 transactions per day, many of those pertaining to illicit drugs and other dark web activity.

ETHEREUM

Ethereum is Bitcoin’s biggest competitor and has evolved to perform multiple functions, as the blockchain technology it is built on allows developers to create decentralised applications. The currency that Ethereum uses is known as Ether, a cryptocurrency token similar to Bitcoin. However, the main purpose of Ethereum is to create smart contracts, which refers to the ability to create transactions exchanging shares, property, content, money and the like in a decentralised, secure fashion.

RIPPLE

Ripple is an unpopular project among cryptocurrency aficionados. Its currency is known as XRP and, unlike Bitcoin, the company has full control over it and is responsible for circulation, not the users. It cannot be mined as it is not an actual currency, but rather a ‘token’ which is used to represent traditional currencies. Its key purpose is to facilitate quick money transfers across the world. Some transactions only take a few seconds to process as Ripple was created to help pay transaction fees across different banks. So when two different banks both accept Ripple, the fees are quickly processed and the money transferred.

LITECOIN

Litecoin was developed to be faster than Bitcoin with more tokens available and a different mining algorithm. Initially it was prominent however its popularity has now faded. Despite this, some people continue to trade and hoard the currency as a Bitcoin backup.

MONERO

Monero was designed to have more privacy than Bitcoin, which documents every transaction and leaves a trail. This cryptocurrency claims to be 100% untraceable and as a result it has been popular among dark web market places, for obvious reasons. A key feature of Monero is that the transaction history of the currency is unknown, meaning that if your Monero tokens have been used previously in an illegal transaction, there is no trace of this. Another benefit is that you can selectively reveal transaction details, for example if you are being audited. While Monero is lauded for its privacy and security, it is not beginner friendly, therefore it is a less popular cryptocurrency.


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