We break down what cryptocurrency is, where it came from, and where it's going.
Our Education 101 Series #1-4, we’ve set the stage for why a new asset class and technology emerged out of the last financial crisis and why we should be paying attention to the ongoing economy today. We have not yet broken down what cryptocurrency is, where it came from, or where it's going - so buckle up! This segment will go into the origin of cryptocurrencies.
So Bitcoin uses blockchain technology to complete transactions without a middleman confirming those transactions. Many cryptocurrencies use blockchain technology, but not all cryptocurrencies are Bitcoin.
How did we get here?
Digital currency also referred to as digital money, electronic money or electronic currency, has been around since the early 1990s in various forms, often finding a home in the virtual economies of massively multiplayer online role-playing games (MMORPGs) like World of Warcraft and Second Life.
American cryptographer and computer scientist David Chaum has been credited with outlining the idea of digital cash in his 1982 research paper: Blind Signatures for Untraceable Payments.
In 1990, Chaum founded DigiCash to bring his vision to life.
While the company filed for bankruptcy in 1998, the idea sparked a revolution that made and lost fortunes for thousands of people, inspired millions, and spawned countless iterations with the hope of offering a viable digital currency.
In this article, we’re going to tell the story of one of the critical turning points in the evolution of digital currency: the decentralization of digital assets.
The birth of cryptocurrency
In 2008, an individual or group of people using the pseudonym Satoshi Nakamoto began working on a digital currency to be released as open-source software and maintained by a decentralized network of participants responsible for validating transactions.
The launch of Bitcoin on January 3, 2009, marked the birth of cryptocurrency and the decentralization of digital assets. Mind-blown? Soak it in: What is Bitcoin?
What does it mean to decentralize digital assets?
Before Bitcoin, digital currencies faced a technological hurdle known as the “double-spend problem.” The double-spend problem refers to the fact that a savvy hacker with some digital currency could program two transactions to occur at the same time using the same asset.
Imagine being able to go to an online retailer like Amazon, take the same $100, and spend it on two different pairs of $100 shoes without Amazon being able to tell the difference. You can see how double-spending could easily wreck the whole system!
How do we deal with double-spending?
Double-spending can happen because “centralized” schemes for digital currency rely on databases that can be manipulated in various ways by dishonest actors.
What separates a distributed database from a blockchain is whether or not the nodes of the network trust each other. With a distributed database, participants assume nodes can trust each other and that each node will participate in good faith.
With a distributed ledger, we don’t make that assumption. The invention of the proof-of-work consensus algorithm that now powers Bitcoin provides a way for nodes to validate that all participants in the network share the same information and can’t double-spend.
Unlike “centralized” digital currencies, cryptocurrencies like Bitcoin rely on things like cryptography, game theory, and computer science to automate the creation and exchange of digital assets in ways that can’t be easily manipulated by dishonest participants.
Automating digital assets
What good are digital currencies if we don’t have an easy way to create and program them?
Launched on July 30, 2015, Ethereum takes the functionality of a cryptocurrency like Bitcoin and extends it by adding a framework for creating digital assets and automating interactions between them that we now refer to as “smart contracts.” Sound like the cool kids: Ethereum is pronounced Eethh-ear-i-umm and can be referred to as Ether or ETH, pronounced Eethh, not E-T-H.
Making it easy to create new digital assets and program them in unique ways sparked a frenzy of initial coin offerings (ICOs), resulting in the bull run of the cryptocurrency market in late 2017.
Bull Run of 2017 visible in the Total Market Capitalization of Digital Assets
In addition to being a cryptocurrency, ETH can be described as a “utility token” because tiny amounts of it typically need to be spent in order for miners to accept a transaction and add it to the network.
In addition to trading ETH and tokens created using the platform, deploying a smart contract also counts as a transaction.
Requiring ETH, also referred to as GAS when spent for transactions, acts as an anti-spam mechanism and encourages developers to use the network’s resources efficiently.
Launched by Binance in 2017, BNB can also be considered a utility token but instead of governing a platform for smart contracts it enables traders to receive discounts on trading fees.
As people began issuing new cryptocurrencies and tokens, one of the major problems people found when trying to use them was the tremendous volatility on digital exchanges.
One moment, someone could have $1000 worth of Bitcoin or Ether and a sudden drop in the exchange rate could mean their assets are only worth $800 just a few hours later.
To help deal with this problem, people began experimenting with stablecoins. Stablecoins include cryptocurrencies and tokens whose value is tied to an underlying asset. The underlying asset could be a currency like USD or RMB or it might be a commodity like gold or oil.
Digital assets backed by stocks are referred to as “security tokens.” Unlike stablecoins that aim to provide a safe store of value, security tokens offer access to equity in an organization.
What are stablecoins used for?
The industry has come to recognize two main types of stablecoins: fiat-backed and crypto-backed.
Sometimes criticized for not being as “decentralized,” fiat-backed stablecoins are typically run by organizations that accept fiat currency in exchange for stablecoins. For example, traders can deposit $100 of USD on Binance.US to receive $100 in BUSD.
Crypto-backed stablecoins are minted by smart contracts that enable people to “stake” their digital assets as collateral and essentially take a loan against their digital assets denominated in stablecoins.
What is staking?
“Staking” digital assets is like moving money from a checking account to a savings account.
When we move money to a savings account, we essentially say to the bank: “I’ll allow you to use my deposit for business if you pay me rewards on the deposit.”
When we “stake” digital assets, we tell the smart contract: “I’ll allow you to use my deposit in exchange for something.” In the case of stablecoins, the smart contract takes the deposit and gives the user the ability to mint stablecoins.
Crypto-backed stablecoins like the DAI stablecoin from MakerDAO have become the foundation of an area of application for distributed ledger technologies that has come to be known as “decentralized finance” (DeFi).
The DeFi movement has been around for the last two to three years, depending on how you define its origin, but as an application of distributed ledger technology, DeFi has been around for as long as cryptocurrency.
Two of the early uses of Bitcoin include a “pseudo-anonymous” poker tournament and the (in)famous pizza purchase. Today, the DeFi ecosystem includes dozens of projects working to develop censorship-resistant financial applications.
What does censorship-resistant mean?
Censorship-resistance and decentralization refer to efforts to develop software capable of remaining accessible to users without the possibility of interference from entities like governments, Internet infrastructure providers, and even the creators of the software.
In addition to stablecoins, DeFi projects work on things like:
- Decentralized exchange - How to facilitate the private, secure, peer-to-peer trade of digital assets.
- Decentralized lending - How to lend digital assets to margin traders in exchange for interest.
- Decentralized derivatives - How to package virtual assets into different financial instruments.
Where digital assets find value
Since the launch of Bitcoin, the applications of distributed ledger technology have expanded far beyond that of cryptocurrency.
In addition to the thriving DeFi ecosystem, exciting progress is happening in fields like digital identity, decentralized governance, and supply chain management.
Follow along as we add to our Binance.US Education 101 Series: Your Guide to Crypto Literacy
#1 Demystifying Digital Dollars
#2 Evolution of the Internet
#3 Finance, Rhymes with …
#4 Back that Asset Class Up
#5 What are Cryptocurrencies?
#6 Defining Decentralized Finance
#7 Cryptoeconomics Explained
#8 Intro to Consensus Algorithms
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