Let us preface right now that this is not an article where we are giving advice. We are explaining what cryptocurrencies are, how they work, and then our personal thoughts on them as a summary from our podcast on them.
To listen to our podcast on our thoughts on crypto, check it out here.
Great, now that that’s out of the way, let’s talk about cryptocurrencies.
Cryptocurrencies, or cryptos, are a fascinating, new age form of spending, buying, and transactions. We’re so used to the tangible forms of money existing in banks or our wallets, a cryptocurrency exists only on computers. Cryptocurrencies aren’t issued or regulated by any central authority, such as governments or banks. This makes a cryptocurrency exchange rate incredibly volatile and can change its worth in a matter of seconds, dropping up and down.
What is a cryptocurrency?
The word ‘cryptocurrency’ itself actually comes from the encryption techniques used to secure the data. Imagine a digital or virtual currency, it’s not tangible, and is secured by cryptography (encrypted using a secret ‘key’) and hosted across different computers around the world. Using an encrypted secret key or password as a form of security, it makes cryptocurrency basically impossible to counterfeit or double-spend. Instead of using a centralised authority to regulate the currency and record transactions, an algorithm does.
Cryptocurrencies are stored on a type of technology called ‘blockchain’.
What is a blockchain?
If you have ever searched Blockchains and Cryptocurrencies, you will find many convoluted answers and not-so-simple terms. In the most simplistic way we can write what a blockchain is, it’s a data structure that holds transactional records to ensure security and decentralisation. It’s a distributed ledger that is open and available to anyone on the network, and once information is stored on the blockchain, it’s incredibly difficult to change or alter it. When a cryptocurrency transaction is made, the transaction is sent out to all of the users hosting a copy of the blockchain. The process of adding to the public ledger is called “mining”. There are some users, called miners, who use software to solve the crypto puzzle and get a few coins as a reward.
Let’s look at what a blockchain is practically. Say you want to send money to your mate who lives somewhere else, perhaps Auckland to London. You would usually use a bank transfer or another third party application to send money across. Using these third parties (including a bank) can often result in a transferring fee, and you never know if a hacker will disrupt the network as you’re trying to send it across. Both options mean you can lose money!
This is why blockchain was created – the process is more direct, easier, and more secure.
How does cryptocurrency work?
Cryptocurrencies use virtual tokens, represented by ledgers in an online system. You can buy goods and services from peers on the online network, but instead of using your traditional debit card, you use numbers on the screen to represent the cryptocurrency in a cryptocurrency wallet.
You can use the software of the cryptocurrency wallet to transfer from one account to another, which means you will need a password (a private key) associated with the account you want to transfer to.
The blockchain database and algorithm is founded on consensus, meaning if the users all solve the puzzle of the transaction, submit the same data, it confirms the transaction is correct. This then goes into the queue for the public ledger to be submitted and voila, transaction complete!
What are the types of cryptocurrency?
There are thousands of alternate cryptocurrencies out there, but for the purpose of this article, we will talk about five of the main ones.
- BITCOIN: The very first, and most popular, type of blockchain-based cryptocurrency is Bitcoin created back in 2009. The first transaction ever recorded on this platform was for a pizza! PayPal has also recently opened themselves up to using Bitcoin as a form of payment.
- DOGECOIN: This cryptocurrency was created using a meme featuring a Shiba Inu dog. It was popularised after receiving support from Elon Musk, Tesla CEO on Twitter, shaking up the already volatile market. Unlike Bitcoin, Dogecoin has no limitations on the number of coins that can be mined using its server.
- ETHEREUM: Another type of cryptocurrency that uses blockchain technology. This software allows contracts to be built and created on its network, without fear or fraud from a third party. To enable transactions on this network, the token to be used is ‘Ether’.
- CARDANO: This was created by a team of engineers, cryptographers, and mathematicians, and was formed through a non-traditional research-based approach. Because it was created through research, it claims to be more sustainable and balanced in comparison to other coins.
- LITECOIN: A cryptocurrency created in 2011 that followed the same tech as Bitcoin, although prides itself on being faster. This means the blocks that are generated, and therefore transactions, are faster than Bitcoin.
Criticisms and commendations about crypto.
Many cryptocurrencies, and crypto as a whole, face criticism for many reasons. Because there is nothing ‘governing’ them, or even remotely regulating them, they are used in illegal activities, and have exchange rate volatility. There are even some vulnerabilities in the infrastructure that creates and binds them. In regards to their relationship to finance and banking as a whole, they are also criticised by regulating authorities for shaping or changing the way people approach money and banking in the future.
On the plus side, these centralised platforms have had praise for their inflation resistance and transparency. It gives more ownership to the individual who owns the currency and provides more security.
Getting your head around cryptocurrencies is a huge task, especially when taking into account the complexity of the software to create and transact on these platforms. Because we’re in the finance game, we love to see how these will change and shake up our industry. We think if a bank were to start to use digital currency, they would have to create and price their own form of it.
Now, that is where it will get interesting! At the moment, it’s a pretty grey area, there isn’t a bank account with it and there is a lack of regulation. We will continue seeing changes in this type of currency, because although we don’t give advice on cryptocurrencies, it is an interesting area to observe!
Head back to our blog to find out more about the industry.