Cryptocurrencies are digital currencies that use cryptography to keep all transactions on their public ledger decentralized and transparent- thus not requiring a centralized institution or authority to oversee any transactions.
Bitcoin, the most used and well-known crypto currency, has a finite and defined money supply that uses a completely transparent and open ledger on a global, decentralized network. This means all transactions that occur are public and confirmed on a network of “mines” and “nodes”. This network — or blockchain — of millions of computers exist in diverse places from massive “mining farms” to individual computers in apartment closets. These computers are incentivized to confirm transactions by receiving a small fee in Bitcoin, and by randomly generating new currency in the process. This is how new Bitcoin enters the market- generating new coins as it processes current transactions. Even when all Bitcoins do get mined, the blockchain will continue to process transactions incentivized by these small user fees.
Currently (Feb 2021) there are over 18.6 Bitcoins in existence; however there will only ever be 21 million Bitcoins total. The amount of Bitcoins entering the market has been decreasing and will continue to diminish. With rewards for mining Bitcoin halving every 4 years, it is predicted that the last Bitcoin will be mined in the year 2140. With no “federal reserve bank” to control the money supply, there is no monetary policy that can be manipulated or controlled to give one user of this currency an advantage over another.
This lack of a central bank is a very important distinguishing factor for Bitcoin. What is interesting about this lack of a central bank is that no one can inflate, or hyper inflate the money supply. Its price volatility is almost completely due to the change in demand. This is advantageous to parts of the world where inflation, money controls, and bank withdrawal limits hurt consumers and workers- especially those with limited access to banking. We saw this during the economic crises in Greece and Cyprus, where the government placed limits on the amount of Euros individuals could withdraw per day from ATMs while branches were closed. Again we saw this in India, when the government eliminated all high denomination bills- families who could not reach a bank branch saw their savings turned into worthless pieces of paper. And in Venezuela, with a currency dependent on the declining cost of oil, hyperinflation caused financial ruin, economic panic, and social unrest. In all of these cases, some people turned to Bitcoin as a safe place to store their hard-earned money. While the number of people who used Bitcoin as a safe alternative was relatively small compared to the population as whole, as this technology evolves and becomes more accessible, users will have more opportunities to protect themselves from future financial crises. This is important to note: the greatest future success stories of this currency, and similar currencies, will likely occur outside of the United States.
Another popular feature of Bitcoin is that it stores your currency using cryptography by generating public and private “keys” for your money. For example, if you purchase 1 Bitcoin (or half a bitcoin or .00001 bitcoins), the blockchain generates one of each key to represent your purchase. The pubic key is represented on the public ledger, whereas the owner of the Bitcoin only knows their private key. Think of the public key as the key to your house, and the private key as your title. You can give the key to your house to someone so they can look around, but they do not own the house until you transfer the title.
This may sound confusing but I can assure you, it is far easier than explaining how central banks generate and circulate currency, let alone how money moves between bank accounts! Unlike your bank account or your atm card, the cryptography behind these keys makes it impossible for your money to get stolen — unless you give someone else your keys. When you hear about people losing their BTC, it is because their money was stored on an account where their private keys were shared. This most famously occurred when an early Bitcoin exchange — Mt. Gox — was hacked.
It is important to keep in mind that Bitcoin, unlike many currencies, whose smallest denomination is .01 (or with currencies like the Chinese Yuan or Japanese Yen, 1), is divisible to one hundred millionth of a BTC (or .00000001 BTC). One hundred millionth BTC is called a “Satoshi” — named after the unknown creator (or creators) of Bitcoin who went by the name “Satoshi Nakomoto.” This means that you can buy and use miniscule amounts of Bitcoin and other currencies for your transactions. This also means that its price is relative. As demand for BTC increases, and supply — as previously stated — is predictable and diminishing, the price of Bitcoin remains relative.
While Bitcoin was the first currency to use both cryptography and a decentralized blockchain, there are thousands of other digital currencies that use some of these ideas behind bitcoin. It is important to note that these “cryptos” have varying degrees of decentralization, as not all are true blockchains. This isn’t necessarily a bad thing, they are just different tools for different applications of the technology.
Other cryptocurrencies — often referred to as “alt coins” or “alts”- have developed functionality that goes beyond that of a currency. Many of these alts have commercial, financial, and technological components. While many of these alts and their ideas are exciting, others are simply cashing in on a new fad.
Remember: crypto currencies are simply that — just currencies, NOT shares. If a software company develops a currency, the value of that often-speculative currency does not mean you have any equity in the company, nor does it mean that you are entitled to any of that company’s profits. But enough about altcoins — I will get into that in more detail in future posts
