Digital currency has been around for many years but it is only during the past 7-8 years that cryptocurrency has emerged and is the new kid on the block with Bitcoin being the leader, Ethereum following and about 1500 others trailing behind. But what is bitcoin and what on earth is Blockchain? Let’s work through this together and gain a better understanding of these new currencies. We will start with fiat currency.
Fiat currency is of course is what we all know such as Dollars, Pounds, Euros, Yen, Yuan and so forth. This is the cash we use to buy goods and services and pay our bills and what we all traditionally know as money or hard currency. Money, or currency, is basically an idea backed by confidence. The more confident we are about a particular currency the more value we place in it. The value of a currency changes day by day and this is what currency traders’ work on, how the confidence level of a particular currency changes in relationship to the confidence level of another currency.
Digital currency (digital money or electronic money or electronic currency) is a type of currency available only in digital form, not in physical (such as banknotes and coins). It exhibits properties similar to physical currencies, but allows for instantaneous transactions and border-lesstransfer-of- ownership. Think in terms of credit cards and money in the bank. These are digital currencies and they can be transferred from one individual, or business or bank to another. 95 percent of all currency in the world is actually digital, held as what is called M2 or M3 (Definition of M0, M1, M2, M3. Different measures of money supply. M0 and M1, are generally called narrow money and include coins and notes that are in circulation and other money equivalents that can be converted easily to cash. M2 includes M1 plus short-term time deposits in banks and 24-hour money market funds. M3 includes M2 plus longer-term time deposits and money market funds with more than 24-hour maturity.) in the global financial system and not held in physical form. This is your dollars, yen, yuan, pounds or whatever country currency is being used and is called digital currency because no actual cash changes hands with the transactions or trading of currencies. It is increasingly being accounted for and traded on the Internet, where it can be exchanged at an ever lower cost.
Virtual currency is a little different in that it is an online currency only and is not exchanged or traded outside of the internet. This type of currency is mostly used as exchange for physical items such as T-shirts, hats, mugs and other items, also some services can be obtained with virtual currencies. Virtual currencies originated from gaming systems and are still used in the arena. Where the confusion can lie is where a virtual currency, such as Bitcoin, starts to be used to purchase items or service such as in Japan where one can use Bitcoin to buy merchandise in a store or a meal in a restaurant. This tends to make them now digital currencies since they have a specific value against the fiat currency normally or previously used. This applies now to person to person exchanges and so the demarcation between the two tends to disappear. If one accepts the European Central Bank's
October 2012 report on emerging currencies, one can assume that the distinction between a digital and a virtual currency is found only in an exchange or interchange between entities such as people or companies.
Crypto Currency – Bitcoin
The two terms Digital and crypto are often interchanged but there are some significant differences between digital and crypto currencies. Firstly crypto currency, whether Bitcoin or some other is like any other currency, an idea built on confidence. The dramatic rise of Bitcoin since its inception is testament to that. There is a lot of confidence in Bitcoin. Remarkably more so than in the dollar, since the dollar is reducing in value as evidenced by the need to use more to purchase the same value of goods or services. If one has confidence in any medium of exchange then it can be used as a medium of exchange otherwise it will not and will have no value. So strictly speaking it is a digital currency Bitcoin is an electronic virtual currency created by a complex mathematical formula (actually called a cryptographic algorithm such as Sha-256, Script for example). Cryptocurrency can be both a digital and a virtual currency then, whose creation is based on a cryptographic algorithm. A computer solves cryptographic algorithms using hardware and electricity to get the representation of one unit of value, typically called a "coin". Bitcoin, Etherum and other coins are all produced the same way. Their value, again, depends on how much confidence is placed in them. It takes a lot of computer power and energy (electricity) to create a bitcoin so it is not something a person can do on their home computer. Bitcoins are created in large warehouses or factories if you like, with hundreds of computers using massive amounts of energy. For example, there is one in Iceland that has an energy bill of a million dollars a month. So In answer to the question, where do Bitcoins come from, no one actually ‘mints’ bitcoins. A bitcoin is created or ‘mined’ as it is called, when a certain amount of energy is used to solve a complex equation. A bitcoin does cost some value then to create. It is not free. This essentially applies to all types of crypto currencies.
According to Wikipedia, “A cryptocurrency (or crypto currency) is a digital asset designed to work as a medium of exchange using cryptography to secure the transactions and to control the creation of additional units of the currency. Cryptocurrencies are classified as a subset of digital currencies and are also classified as a subset of alternative currencies and virtual currencies.”
“Bitcoin was the first decentralized cryptocurrency, and was created in 2009 by developer Satoshi Nakamoto who issued a white paper, Bitcoin: A Peer-to- Peer Electronic Cash System. Bitcoin and its derivatives use decentralized control as opposed to centralized electronic money/centralized banking systems."
Blockchain is a concept that is confusing to many people. What does it actually mean? Well there are many technical explanations for the term and of course it is explained, somewhat technically, in the original paper on the subject by the pseudonymous developer Satoshi Nakamoto. Blockchain is a digital ledger in which transactions made in bitcoin or any other cryptocurrency are recorded chronologically and where publicly one can actually look at the blockchain and see evidence of what has occurred.
Whereas in the banking world a ledger is centralised and all the data is kept in that one ledger, with blockchain the data is de-centralized and duplicated around the world on millions of computers that belong to the blockchain network. Once a transaction occurs it is recorded in the latest block on the blockchain and is ‘set in stone’ you might say, forever. A good analogy of blockchain is by imagining a spreadsheet, such as an excel spreadsheet for example shared by a number of people. In the normal course of events with a spreadsheet being shared one person can update the spreadsheet and the others are blocked out while that editing is being done. The others can then eventually see the edited version and can then do their editing also. Here there is only one copy of a spreadsheet updated and all the viewers have to manually save the edited version provided they get a copy of the new version. However if you can imagine a network that is designed to regularly update this spreadsheet on a continual basis you will begin to see how blockchain works. There is a bit more to it that that of course. A blockchain is essentially a data base that is constantly being reconciled with the transactions are kept in blocks. A block is established to be a certain size and when it reaches that size it is frozen and a new block is created. Hence the term blockchain. Additionally it is not stored in one location. It is not centralized as bank databases are. So the records are truly public and easy to verify. It cannot itself be corrupted as there is no central database to corrupt. Instead, the data is hosted on millions of computers, called nodes, simultaneously. Hence the term decentralized. Attempts to change one record base would fail as it would immediately be in conflict with the rest of the blockchain. When everyone has a copy of a record it is not possible to change one persons copy once a transaction has been recorded. Of course a persons access could be hacked if they are careless with their private key (more on that later) so being sensible and secure applies here just as with any financial records or transactions. In addition it does not allow for transactions to be rescinded or charged back such as with credit card transactions. If a mistake is made then it would be up to the recipient to initial a new transaction for the same amount to the original sender. Difficult as the only record of ownership is a string of characters that does not include a name or contact details.
A blockchain specialist puts it like this, “The traditional way of sharing documents with collaboration is to send a Microsoft Word document to another recipient, and ask them to make revisions to it. The problem with that scenario is that you need to wait until receiving a return copy before you can see or make other changes because you are locked out of editing it until the other person is done with it. That’s how databases work today. Two owners can’t be messing with the same record at once. That’s how banks maintain money balances and transfers; they briefly lock access (or decrease the balance) while they make a transfer, then update the other side, then re-open access (or update again).” For those more technically minded a blockchain is a network of so-called computing “nodes” that make up the blockchain. A node is a computer connected to the blockchain network using a client that performs the task of validating and relaying transactions and gets a copy of the blockchain, which is downloaded automatically upon joining the blockchain network.
Crypto Keys and Wallets
Most people are familiar with and use username and password technology and the two-step verification code but this is a system that can be exploited by hackers so instead blockchain uses an encryption technology instead. This works by each person having both a public and a private ‘key.’ These keys are usually about 30 plus characters long and composed of numbers and letters. A “public key” (a long, randomly-generated string of numbers and letters) is basically the users address or username address on the blockchain. All bitcoins that are sent across the network to an individual’s public key are recorded as belonging to that individual. However these bitcoins are inaccessible except by the use of a private key that is somewhat like a password and gives the owner access to their bitcoins. Of course one needs to carefully save and keep secure one’s private key just as one does with any password. Your bitcoins are ‘contained’ within your wallet. This is like the wallet in your back pocket except that it is digital and encrypted so only you know who owns the wallet and how much value there is in it in Bitcoins or any other currency for that matter. Although there are different types of wallets they are all generally anonymous.