Blockchains replace intermediaries with mathematics. Before blockchains, digital currencies had to run through central servers and be logged by central bookkeepers. Your money had to rely on several single points of failure before it would reach your intended destination.
Blockchain solved that problem.
This is all greatly oversimplifying. But it’s useful. And it’s a good starting point for understanding crypto.
So zooming out, here’s what all of this really means in a nutshell:
• No geographic borders
• No banks
• Anonymity (in bitcoin, the size of the transaction can be seen, but James’ and Joe’s names can’t be seen. In other cryptocurrencies, there might be much greater anonymity).
• The validation (much like a deli clerk checking to see if a $100 bill is forged) is done by computers that raise their hands and say, “We are miners and will do it for free.” The miners don’t charge transaction costs, but depending on how the currency is designed, they might get more coins depending on how much “work” they do to validate transactions.
• Decentralized. Which is part of the privacy of the transaction and also ensures that no one source is controlling the validation (and then possibly faking transactions or minting more money).
A blockchain
A) guarantees the correctness of its past and present data.
B) guarantees the correctness of its future state and data.
THE MANY PROS AND CONS OF CRYPTO
We’ll start with the good this time.The good:
A) A standardized and neutral confirmation policy backed by software that has no human agendas.
What does this mean?
Imagine I want to send Joe dollars to buy his house. I need to trust all of the middlemen between Joe and me: local bank, central bank, lawyers, governments, Joe’s bank, etc., to approve of this transaction if I do it in dollars.
This is OK, but at each step, someone could be untrustworthy. They are all humans, even the government (humans subtly influence the price of the dollar and also share details of the transaction with unfriendly parties (the IRS)).
Also, each step in the above has a transaction cost. So inflation is built into the system.
If this were a bitcoin transaction, enough miners need to approve that this transaction is valid. So even if a few miners are not trustworthy, the bulk of them will be, and we can trust that the transaction between Joe and me is legit.
This is the ENTIRE reason for cryptocurrency: to avoid governments, borders, middlemen and extra transaction costs. As well as have high security and avoid forgery.
(There is another reason for cryptocurrency, which is to do more complicated transactions that we can call “contracts” (also known as “smart ontracts” without lawyers, etc.) This reason is sometimes the basis for legit ICOs. We’ll get into that later.)
This was also originally the entire reason for the origin of money as opposed to a barter system (which requires an exponential number of negotiations to determine the correct exchange rates between each object).
Crypto is just the next step after that.
For bitcoin, the cost might be zero (depending on your exchange), and miners get paid by getting more bitcoin depending on the computation power used to verify these transactions.
One more good: Blockchains are incredibly resilient. A blockchain can survive unaffected as long as just one stays alive. So if there’s a catastrophic failure throughout the nodes, it takes just one lone survivor to keep the network running without any loss of data.
With bitcoin, nodes are running all over the world. The power is distributed. There’s no single vector of attack. To kill it, you have to eradicate it completely, globally, totally, without fail, all at once.
This is very hard to do. It’s why bitcoin is incredibly strong — the most secure network on Earth.
The bad:
Miners approve transactions one block at a time. A block is a set of transactions. A “blockchain” is a chain of these timestamped blocks. If a transaction doesn’t make it into one block, it waits a certain period of time to get into the next block. So there lag.
Blockchains are slow.
Blockchains are slow because blockchains are extremely inefficient — especially compared to Visa, MasterCard or PayPal. There’s a reason. Decentralization and censorship-resistance. That’s what sets Bitcoin apart from traditional payment systems and inefficiency is the trade-off.
Blockchains are inefficient.
Another “bad” is that everyone can see the transaction (on bitcoin) although nobody knows it was Joe and me involved in the transaction.
Blockchains aren’t inherently anonymous.
Another “bad” is that for certain types of transactions (buying a cup of coffee), the blockchain allows for a layer of software above it to quickly verify before the blockchain protocol validates the transaction... or software to provide other services on the blockchain (e.g. a bitcoin exchange that stores wallets for people).
That software layer involves humans (humans are bad), which invites good players and bad players to be involved (hence, the Mt. Gox $400 million theft).
Blockchains are very hard to scale.
In exchange for security, trust, fewer middlemen and avoidance of governments and boundaries, society pays in computational costs, storage (the same blockchain stored on millions of computers is a waste) and slower transaction speeds. And the softwar layer above the blockchain needs to evolve, which it is (the same way internet software evolved post 1991).
FOR EVERYTHING BAD, THERE ARE SOLUTIONS
For all of these problems (“the bad” described above) there are solutions.
This is the ENTIRE reason multiple currencies exist and why there is a huge need to keep things simple and not get caught up in the hype.
Coins can be divided into two types:
A) They keep the same rough philosophy of bitcoin (security, limit on minting of new coins, elimination of middlemen and boundaries, validations of trades, impossible to forge).
B) NOT the above (scams that pretend to be “A,” but there are backdoors available to bad players).
As you’ll see in the next chapter, most cryptocurrencies on the market are B) — they are scams. But that doesn’t mean you shouldn’t pay attention to the “altcoins.” The cryptocurrency space needs more than just bitcoin.
I’ll tell you why.
ONE COIN TO RULE THEM ALL? NO.
(“ALTCOINS” EXPLAINED)
There’s bitcoin, ether, ripple, dash, blah, blah, blah. Anything that’s not bitcoin is often referred to as an “altcoin.” People who love bitcoin and hate altcoins sometimes call themselves “bitcoin maximalists.” They believe bitcoin is the only true cryptocurrency — and everything else is a scam.
To their credit, they’re not completely wrong. Of the close to 1,000 cryptocurrencies out there, about 90–95% are complete Ponzi schemes and will eventually go to zero. That’s just the truth.
Unfortunately, the only way to know this is to read the code, and there are hundreds of thousands of people using these currencies right now, unaware of the trap they are in.But that doesn’t mean the bitcoin maximalists are completely right, either.
So… why more than one? Why didn’t they stop at bitcoin?
Well, for one, it’s extremely easy to create a new currency. You don’t even need to know how to code. You can be a teenage “script kiddy” and just copy and paste the bitcoin code, slap a new logo on a Wordpress page and voila.
For example, here’s all you need to create a new token on the ethereum platform:
You could just copy and paste this into a new contract in the ethereum wallet and create your token in minutes. (If you don’t know what any of this means, don’t worry.We'll get to how etheraum work in next post.
TWO REASONS CRYPTO EXISTS
A) To solve a problem in the currency. Bitcoin is very slow to validate a transaction. So it’s hard to buy a cup of coffee with it (there are a lot of technical details on this, but it is a legitimate problem of bitcoin).
Someone can work on the software and say, “Ahh! I found a possible solution.” They can then implement the currency and if the solution works, their currency might get more popular and get used for those types of transactions that require speed.
Another problem: privacy. Bitcoin transactions have privacy. But not total anonymity since every transaction is stored (without names) on what is called “the blockchain.”
Many currencies have developed to help solve this problem.
Legitimate problems in certain cases and a lack of geographic borders are what create new cryptocurrencies.
B) A data-based currency can have some functionality. It’s like traditional currency mixed with apps.
For instance, there is a coin (full disclosure: I own some) called filecoin that creates peer-to-peer storage. What does this mean? Let’s say you store data on Dropbox or Google Drive.
That’s not Peer to Peer. Your data sits on servers owned by Google or Dropbox. There is a potential for human error and privacy loss. A cryptocurrency in which transactions include the ability to allow people to store data with your currency (and allowing you to get more currency if you let your “digital wallet” be used in this way) solves a problem.
Again, problems in specific use cases are the “data boundaries” that have replaced geographic boundaries.
This is a lot for this introduction.
But it gets to the heart of the matter and I can sum it up:
• Cryptocurrencies (or, I almost prefer, data-driven currencies) are here to stay and only going to get bigger.
I will describe the size of the opportunity in a future issue.
• 95% of currencies are scams. How come? Because in any euphoria, criminals are created. We saw it with internet stocks in 1999;
we saw it with hedge funds in the 2000s; we saw it with mortgage-backed securities in 2008 and now we are going to see it in cryptocurrencies within the next year or so.
But the industry itself will boom.
This was a lot for one issue. And cryptocurrencies are a very complicated subject. Like I said, to actually know for sure if a cryptocurrency is legitimate or not, the only way is to read the actual software that created it.
The good news is that, unlike the dollar, the software is available. And I’ve read it.
WE NEED NEW CRYPTOCURRENCIES
Unless they’re blatant scams, new coins and/or a fork in bitcoin are attempts to solve the above problems. There is NO SINGLE solution. Many solutions may exist, hence the reason why there may be more than one winner as cryptocurrency evolves.
Analogy: America has “dollars.” Mexico has “pesos.” In human currencies, both currencies have “won.” The “problem” solved above is that Americans might trust the U.S. government and Mexicans trust the Mexican government.
Geographic boundaries create new currencies. But geographic boundaries are manmade and artificial, and many possible untrustworthy middlemen are required.
In crypto terms, “zcash” might be used for transactions requiring high anonymity. “Filecoin” might be used for transactions that have a specific storage application.
In other words, “crypto boundaries” are determined by real problems being solved rather than artificial geographic boundaries.
