Cryptocurrency

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Cryptocurrency

A cryptocurrency, crypto currency or crypto is a digital asset designed to work as a medium of exchange wherein individual coin ownership records are stored in a ledger existing in a form of computerized database using strong cryptography to secure transaction records, to control the creation of additional coins, and to verify the transfer of coin ownership.^[1][2] It typically does not exist in physical form (like paper money) and is typically not issued by a central authority. Cryptocurrencies typically use decentralized control as opposed to centralized digital currency and central banking systems.^[3] When a cryptocurrency is minted or created prior to issuance or issued by a single issuer, it is generally considered centralized. When implemented with decentralized control, each cryptocurrency works through distributed ledger technology, typically a blockchain, that serves as a public financial transaction database.^[4]

Bitcoin, first released as open-source software in 2009, is the first decentralized cryptocurrency.^[5] Since the release of bitcoin, other cryptocurrencies have been created.

History

In 1983, the American cryptographer David Chaum conceived an anonymous cryptographic electronic money called ecash.^[6][7] Later, in 1995, he implemented it through Digicash,^[8] an early form of cryptographic electronic payments which required user software in order to withdraw notes from a bank and designate specific encrypted keys before it can be sent to a recipient. This allowed the digital currency to be untraceable by the issuing bank, the government, or any third party.

In 1996, the National Security Agency published a paper entitled How to Make a Mint: the Cryptography of Anonymous Electronic Cash, describing a Cryptocurrency system, first publishing it in an MIT mailing list^[9] and later in 1997, in The American Law Review (Vol. 46, Issue 4).^[10]

In 1998, Wei Dai published a description of “b-money”, characterized as an anonymous, distributed electronic cash system.^[11] Shortly thereafter, Nick Szabo described bit gold.^[12] Like bitcoin and other cryptocurrencies that would follow it, bit gold (not to be confused with the later gold-based exchange, BitGold) was described as an electronic currency system which required users to complete a proof of work function with solutions being cryptographically put together and published.

The first decentralized cryptocurrency, bitcoin, was created in 2009 by presumably pseudonymous developer Satoshi Nakamoto. It used SHA-256, a cryptographic hash function, in its proof-of-work scheme.^[13][14] In April 2011, Namecoin was created as an attempt at forming a decentralized DNS, which would make internet censorship very difficult. Soon after, in October 2011, Litecoin was released. It used scrypt as its hash function instead of SHA-256. Another notable cryptocurrency, Peercoin used a proof-of-work/proof-of-stake hybrid.^[15]

On 6 August 2014, the UK announced its Treasury had been commissioned a study of cryptocurrencies, and what role, if any, they can play in the UK economy. The study was also to report on whether regulation should be considered.^[16]

Formal definition

According to Jan Lansky, a cryptocurrency is a system that meets six conditions:^[17]

1. The system does not require a central authority; its state is maintained through distributed consensus.
2. The system keeps an overview of cryptocurrency units and their ownership.
3. The system defines whether new cryptocurrency units can be created. If new cryptocurrency units can be created, the system defines the circumstances of their origin and how to determine the ownership of these new units.
4. Ownership of cryptocurrency units can be proved exclusively cryptographically.
5. The system allows transactions to be performed in which ownership of the cryptographic units is changed. A transaction statement can only be issued by an entity proving the current ownership of these units.
6. If two different instructions for changing the ownership of the same cryptographic units are simultaneously entered, the system performs at most one of them.

In March 2018, the word cryptocurrency was added to the Merriam-Webster Dictionary.^[18]

Altcoins

Tokens, cryptocurrencies, and other types of digital assets that are not bitcoin are collectively known as alternative cryptocurrencies,^[19][20][21] typically shortened to “altcoins” or “alt coins”.^[22][23] Paul Vigna of The Wall Street Journal also described altcoins as “alternative versions of bitcoin”^[24] given its role as the model protocol for altcoin designers. The term is commonly used to describe coins and tokens created after bitcoin. The list of such cryptocurrencies can be found in the List of cryptocurrencies article.

Altcoins often have underlying differences with bitcoin. For example, Litecoin aims to process a block every 2.5 minutes, rather than bitcoin’s 10 minutes which allows Litecoin to confirm transactions faster than bitcoin.^[25] Another example is Ethereum, which has smart contract functionality that allows decentralized applications to be run on its blockchain.^[26] Ethereum is the most-actively used blockchain in the world according to Bloomberg News^[27] and has the largest “following” of any altcoins according to the New York Times.^[28]

Significant rallies across altcoin markets are often referred to as an “altseason”.^[29][30]

Crypto token

A blockchain account can provide functions other than making payments, for example in decentralized applications or smart contracts. In this case, the units or coins are sometimes referred to as crypto tokens (or cryptotokens). Cryptocurrencies are generally generated by their own blockchain like Bitcoin and Litecoin whereas tokens are usually issued within a smart contract running on top of a blockchain such as Ethereum.^[31]

Architecture

Decentralized cryptocurrency is produced by the entire cryptocurrency system collectively, at a rate which is defined when the system is created and which is publicly known. In centralized banking and economic systems such as the Federal Reserve System, corporate boards or governments control the supply of currency by printing units of fiat money or demanding additions to digital banking ledgers. In the case of decentralized cryptocurrency, companies or governments cannot produce new units, and have not so far provided backing for other firms, banks or corporate entities which hold asset value measured in it. The underlying technical system upon which decentralized cryptocurrencies are based was created by the group or individual known as Satoshi Nakamoto.^[32]

As of May 2018, over 1,800 cryptocurrency specifications existed.^[33] Within a cryptocurrency system, the safety, integrity and balance of ledgers is maintained by a community of mutually distrustful parties referred to as miners: who use their computers to help validate and timestamp transactions, adding them to the ledger in accordance with a particular timestamping scheme.^[13]

Most cryptocurrencies are designed to gradually decrease production of that currency, placing a cap on the total amount of that currency that will ever be in circulation.^[34] Compared with ordinary currencies held by financial institutions or kept as cash on hand, cryptocurrencies can be more difficult for seizure by law enforcement.^[1]

Blockchain

The validity of each cryptocurrency’s coins is provided by a blockchain. A blockchain is a continuously growing list of records, called blocks, which are linked and secured using cryptography.^[32][35] Each block typically contains a hash pointer as a link to a previous block,^[35] a timestamp and transaction data.^[36] By design, blockchains are inherently resistant to modification of the data. It is “an open, distributed ledger that can record transactions between two parties efficiently and in a verifiable and permanent way”.^[37] For use as a distributed ledger, a blockchain is typically managed by a peer-to-peer network collectively adhering to a protocol for validating new blocks. Once recorded, the data in any given block cannot be altered retroactively without the alteration of all subsequent blocks, which requires collusion of the network majority.

Blockchains are secure by design and are an example of a distributed computing system with high Byzantine fault tolerance. Decentralized consensus has therefore been achieved with a blockchain.^[38]

Timestamping

Cryptocurrencies use various timestamping schemes to “prove” the validity of transactions added to the blockchain ledger without the need for a trusted third party.

The first timestamping scheme invented was the proof-of-work scheme. The most widely used proof-of-work schemes are based on SHA-256 and scrypt.^[15]

Some other hashing algorithms that are used for proof-of-work include CryptoNight, Blake, SHA-3, and X11.

The proof-of-stake is a method of securing a cryptocurrency network and achieving distributed consensus through requesting users to show ownership of a certain amount of currency. It is different from proof-of-work systems that run difficult hashing algorithms to validate electronic transactions. The scheme is largely dependent on the coin, and there’s currently no standard form of it. Some cryptocurrencies use a combined proof-of-work and proof-of-stake scheme.^[15]

Mining

In cryptocurrency networks, mining is a validation of transactions. For this effort, successful miners obtain new cryptocurrency as a reward. The reward decreases transaction fees by creating a complementary incentive to contribute to the processing power of the network. The rate of generating hashes, which validate any transaction, has been increased by the use of specialized machines such as FPGAs and ASICs running complex hashing algorithms like SHA-256 and scrypt.^[39] This arms race for cheaper-yet-efficient machines has existed since the day the first cryptocurrency, bitcoin, was introduced in 2009.^[39] With more people venturing into the world of virtual currency, generating hashes for this validation has become far more complex over the years, with miners having to invest large sums of money on employing multiple high performance ASICs. Thus the value of the currency obtained for finding a hash often does not justify the amount of money spent on setting up the machines, the cooling facilities to overcome the heat they produce, and the electricity required to run them.^[40] Favorite regions for mining are those with cheap electricity and/or a cold climate. As of July 2019, bitcoin’s electricity consumption is estimated to about 7 gigawatts, 0.2% of the global total, or equivalent to that of Switzerland.^[41]

Some miners pool resources, sharing their processing power over a network to split the reward equally, according to the amount of work they contributed to the probability of finding a block. A “share” is awarded to members of the mining pool who present a valid partial proof-of-work.

As of February 2018, the Chinese Government halted trading of virtual currency, banned initial coin offerings and shut down mining. Some Chinese miners have since relocated to Canada.^[42] One company is operating data centers for mining operations at Canadian oil and gas field sites, due to low gas prices.^[43] In June 2018, Hydro Quebec proposed to the provincial government to allocate 500 MW to crypto companies for mining.^[44] According to a February 2018 report from Fortune,^[45] Iceland has become a haven for cryptocurrency miners in part because of its cheap electricity.

In March 2018, the city of Plattsburgh in upstate New York put an 18-month moratorium on all cryptocurrency mining in an effort to preserve natural resources and the “character and direction” of the city.^[46]