Suddenly, all mainstream media outlets wanted a piece of the action. Without much to go on, they started using terms like cryptocurrency, digital cash or token interchangeably, not understanding how confusing it all was to the average viewer. But what is a cryptocurrency? Now that the mania has calmed down, we have time to improve our understanding of this space.
Despite the scepticism of some established business leaders like Bill Gates or Warren Buffett, cryptocurrencies are here to stay, and we’d be foolish to ignore them purely on the advice of those they threaten. In this article, we’ll define what a cryptocurrency is, look at the technology that supports it, and identify the different types of cryptocurrencies out there.
Blockchain – the technology powering cryptocurrency
Before we dive into cryptocurrencies, let’s revise the concept of blockchain technology. Blockchain is the underlying technology powering cryptocurrencies. It’s used to create, update and maintain a decentralised, trusted ledger of transactions which occur within a network. This network is made up of independently-owned nodes that use a cryptographic protocol to validate transactions in a cryptocurrency.
The protocol rewards accuracy in a way that ensures the data entered into the ledger cannot be wrong or subject to changes. It is immutable, secure, and completely transparent. Blockchain technology makes it possible to trust the information kept on that ledger without having to rely on a central institution. A lot of the hype surrounding cryptos comes mostly from the fact that virtually our entire economy does, in fact, rely on centralised institutions which guarantee trust in the whole system.
Analysts look at cryptos and recognise in them the potential to revolutionise the banking and finance industries. It’s important to remember these sectors have existed for centuries. In that time, banks have changed, but they’ve primarily remained in control of their destiny.
Large financial institutions have been keen to understand blockchain-powered cryptocurrencies. They have poured millions into research and development to understand and integrate the underlying technology, hoping this will allow them to stay ahead of the curve.
Cryptos first emerged with Satoshi Nakamoto’s Bitcoin whitepaper at the start of 2009. Although it was quite technical, this outlined a clear vision of a “purely peer-to-peer version of electronic cash (allowing) online payments to be sent directly from one party to another without going through a financial institution”.
In the last nine years, over 1,000 cryptocurrencies have appeared – a number which will inevitably increase over the coming years. A cryptocurrency is a digital currency that uses cryptography to secure and verify its transactions chronologically, recording them in a decentralised and immutable ledger known as blockchain. They can be used as a medium of exchange or a store of value, and are traded in many exchanges around the world.
Cryptocurrencies can be divided into two categories: those that are supported by their own blockchains like Ethereum and Bitcoin, and those built on top of other blockchains, also known as tokens. ERC20 tokens such as OmiseGo (OMG) and Jibrel Network Token (JNT) are examples of the cryptocurrencies built on Ethereum’s platform.
While Ethereum is an independent cryptocurrency with its own native token Ether (ETH), ERC20 tokens such as OMG, JNT or 0x are tokens that would not exist without Ethereum’s platform.
A token is merely a unit of value issued by an organisation, accepted by a community and supported by an existing blockchain. That organisation sets it up within a particular business model to incentivise user interaction by distributing rewards among its network’s participants. These tokens have more uses but are most commonly divided into security tokens and utility tokens.
Security tokens are similar to traditional company shares since they derive their value from a tradable external asset. A utility token grants access to a company’s future product or service before it can be delivered, much like when a bookstore lets customer pre-order a book that hasn’t come out.
The best method of identifying the difference between an independent cryptocurrency and a token is to ask the question: Is this crypto independent from other platforms or does a pre-existing blockchain support it?
An independent cryptocurrency uses its own blockchain while a token is merely a cryptocurrency built on top of another pre-existing blockchain. Tokens are a subset of all cryptocurrencies. Within the independent ones, there is another difference. They can either be Bitcoin-based blockchains such as Dash or Litecoin, or they can have their own native blockchains like Ripple or Ethereum.
We will cover this topic in a future guide, but all cryptos in these two categories can also be called alternative coins. Alt-coins get their name from being alternatives to the original cryptocurrency: Bitcoin.
Find more of our guides about cryptocurrencies here.