1. What is a cryptocurrency?
So you want to learn about Ethereum and Bitcoin? First you need to know what a cryptocurrency is. A cryptocurrency is a currency that only exists on the internet. It is a digital currency.
“But why is it called a cryptocurrency?”
Crypto comes from the word cryptography. Cryptography keeps your currency safe and stops other people from using it. Cryptography encrypts your information, and you can only decrypt it with a personal key. Think of it as a bank safe on the internet. There is only one key to open it, which you hold. Instead of a real key, you have a decryption code.
A cryptocurrency, such as Ethereum or Bitcoin, is very different from a traditional currency like the $USD, £GBP or €EUR, also known as FIAT.
But what are the key differences between a cryptocurrency and a FIAT currency?
a) There are no cryptocurrencies in physical form.
They only exist in code. You may see some coins with a printed B on it sold on various websites, but those are not bitcoins.
b) Central banks control FIAT currencies.
They do not control cryptocurrencies.
c) Regular currencies require a third party (a bank) to make online transfers.
Cryptocurrency transfers are peer-to-peer and do not require a third party.
d) Regular currencies are expensive and slow to transfer across nation borders.
Cryptocurrencies ignore national borders and are almost instant and free, no matter the size.
e) Only 1/6’th of the worlds population has access to modern banking which allows easy money transfers.
A lot of more people have access to the internet, which is the only requirement to use cryptocurrencies.
So more people can use cryptocurrency than regular banking services.
Many of you are probably thinking:
“Okay, so encryption protects my money and data and the transfers seem great. But how does it really work?”
To explain this, I need to introduce you to the blockchain technology.
Instead of being all technical, I will use an anology to first introduce the concept of a blockchain. Imagine a magic notebook, and every person all over the world can easily get a copy of it for free.
Every time someone writes something in it, it appears in everyone else’s copy. The more people who read what is written in their book, the harder it becomes to erase. After a while, everyone with a notebook are in agreement, or consensus about what is written in it.
Your entry becomes the truth according to the network.
For example, Alice writes in her notebook that she transfers 5 bitcoin to Bob. As 10 people holding the notebook have read it, it is now accepted as the truth and Alice can not take it back.
“Cool, but how do I know who I am transfering my currency to?”
Instead of your name, the network assigns you a long string of letters and numbers, an address. Your real identity has no connection to the address unless you enter your personal information on an exchange or if you use an unprotected IP-address. With the notebook I can transfer money by writing the amount I wish to transfer and the address of my recipient in the notebook.
This notebook is the blockchain.
Every page in the notebook is a block on the blockchain. Every copy of the notebook is a ledger, and every user connected to the blockchain network has one. People who read the notebook, miners, verify the transactions people write in it.
Ethereum has its own blockchain. Bitcoin has its own too.
“All right, I understand the blockchain technology. But why can’t just a bank run it instead?”
Since everyone is anonymous and is running the same code (everyone has an identical copy of the notebook), the power is distributed among all of the owners of the notebook. Every person with a notebook is part of running the network, and in order to make any changes to the rules of the network, at least 51% of notebooks need to agree by running the new code. As a result of this, the notebook (or in reality the public blockchain), is decentralized. Banks and governments are centralized. A small group of people have the power to make decisions that affects a large group of people, the users.
Centralization is very efficient, but also very insecure.
From a political view, centralization enables the leaders to make decisions that benefit a few at the cost of many. From a more technical view, centralization is very efficient but also very insecure. Centralized entitys, such as banks, are security holes.
A bank only holds one or a few copies of the notebook and is constantly under attack. Someone can succesfully hack it and break in and steal or destroy the data. It’s impossible for someone to steal and destroy every copy of the notebook, distributed to millions of users all over the world.
This is why blockchain technology combined with decentralization offers both more security and freedom to its users than the centralized alternatives today.
“Okay, it is a clever way to transfer money. But is that it?”
Bitcoin, Ethereum and other cryptocurrencies are known for being exactly that, currencies. However, they can be used for so much more. Blockchains allows you to safely, and very inexpensivly, store sensitive and important data. They also enable you to make contracts online, smart contracts, which are verified by the blockchain network and do not require a third party to be validated.
This is just the tip of the iceberg. There is already many more uses for cryptocurrencies, but the best is still to come.
Right now cryptocurrencies are like the internet in 1995.
So, simply calling bitcoin a currency is like saying the internet is a clever way to call your aunt on her birthday.
Blockchains will revolutionize a lot of industries and markets. Banking, contract law and data storage are just a few areas which all benefit massively from blockchains and cryptocurrencies.
What ideas can you come up with to put on the blockchain?
2. What determines the value of a currency?
So now you know what a cryptocurrency is, but how do you decide its value?
Well, how do you decide what a dollar bill is worth? Or any other currency for that matter. Isn’t it just a piece of paper?
To answer this question we need to go back in time: Before there was paper money, goods were traded for each other.
Let’s make an example:
I am a fisherman, you are a corn farmer and we want to trade.Pretty fast a few complications arise:
Your harvest comes in once per year and I can’t trade you for a harvest you don’t have yet.
also
The extra fish I caught today will be pretty rot by the time your harvest comes in. Even though this seems like a pretty specific example, trade for food was the most common trade in the ancient world.
So…
We need to find a universal third good that we all want and can trade for.
MONEY.
All money is, is a third good that we all agree has value and doesn’t spoil. Therefore becoming a unit of exchange and a way to store value
In the beginning money came in forms of collectibles like shells or gold nuggets.
It’s value was determined by its scarcity, how rare it was. Many different items that have some form of scarcity have served as money. When the Europeans arrived to America alcohol served as a form of money. In prisons cigarettes serve as a form of money.
The list goes on…
As it turns out gold was the third good most people agreed on had value. Therefore golden coins were crafted and used for trade and storing value.
Now:
For many reasons gold coins were not optimal as a means of exchange. The biggest problem of them all was that over time countries evolved and transactions got bigger.
Imagine you are selling your farm and you receive payment in gold coins. It’s going to quite a pain in the ass to transport all those gold coins.
So money had its first technological revolution:
Central banks were created and started distributing paper money backed by gold. Meaning you can actually trade the paper bill at the central bank for gold. This was called “The Gold Standard”. The paper money was easier to store and transport making it possible for economies to grow even further.
Now here’s where it gets interesting:
During the second world war every country except one abandoned the gold standard and started printing money in excess. The United States of America.
How would the other countries decide what their currencies were worth when they weren’t backed by anything?
The solution was simple, just peg all other currencies to the US dollar.
As a result of this the US dollar is redeemable in gold and all other currencies are redeemable in US dollars.
This was how it worked up until the USA decided to take the dollar off the gold standard in year 1971.
However:
This didn’t stop other countries from keeping their currency pegged to the US dollar.
So…
Now you had other currencies redeemable for US dollar and the US dollar pegged to nothing. This is where the term “floating currency” was born.
A floating currency basically means that the currency is worth whatever we agree that it’s worth.
You might still be wondering:
“How do we decide the value of a cryptocurrency?”
Well, let’s look at it:
It has scarcity, it’s impossible to counterfeit, it’s easy to store and divide, doesn’t spoil, and it’s the currency that is hands down the smoothest to transport.
Also:
It’s traded 24 hours per day 365 days per year on global exchanges.
The bottom line?
The value of a cryptocurrency is decided by what we agree on that it’s worth. And its the latest technological revolution thats happened to money since the credit card was invented about 60 years ago.
Thank you guys from Coinworld for sharing!