A Crypto-Currency Primer
Part Two – Definitions (From Wikipedia except as noted)
A good understanding of a topic starts with a frame of reference. In this case that frame is a list of definitions for terms emanating from the marketplace of cryptocurrencies. Yes, this can be tedious, but it is necessary to begin to understand this new financial world. I have included the three definitions from Part One so that they are all in one document.
Note: Some of these terms will not be new to bankers. Others will have wildly different meanings from what you might expect. For a more complete understanding spend the time and do the research as these definitions are really limited overviews.
Currency – A currency (from Middle English: curraunt, “in circulation”, from Latin: currens, -entis) in the most specific use of the word refers to money in any form when in actual use or circulation as a medium of exchange, especially circulating banknotes and coins. A more general definition is that a currency is a system of money (monetary units) in common use, especially in a nation. Under this definition, US dollars, British pounds, Australian dollars, and European euros are examples of currency. These various currencies are recognized stores of value and are traded between nations in foreign exchange markets, which determine the relative values of the different currencies. Currencies in this sense are defined by governments, and each type has limited boundaries of acceptance.
Fiat Money – Fiat money is a currency established as money by government regulation or law. The term derives from the Latin fiat (“let it become”, “it will become”) used in the sense of an order or decree. It differs from commodity money and representative money. Commodity money is created from a good, often a precious metal such as gold or silver, which has uses other than as a medium of exchange (such a good is called a commodity), while representative money simply represents a claim on such a good.
Cryptocurrency – 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 a subset of alternative currencies, or specifically of digital currencies.
Bitcoin became the first decentralized cryptocurrency in 2009. Since then, numerous cryptocurrencies have been created. These are frequently called altcoins, as a blend of bitcoin alternative. Bitcoin and its derivatives use decentralized control as opposed to centralized electronic money/centralized banking systems. The decentralized control is related to the use of bitcoin’s blockchain transaction database in the role of a distributed ledger.
Distributed Ledger System – A distributed ledger (also called shared ledger) is a consensus of replicated, shared, and synchronized digital data geographically spread across multiple sites, countries, or institutions. There is no central administrator or centralised data storage.
A peer-to-peer network is required as well as consensus algorithms to ensure replication across nodes is undertaken. One distributed ledger design is through implementation of a public or private blockchain system. But all distributed ledgers do not have to necessarily employ a chain of blocks to successfully provide secure and valid achievement of distributed consensus, a Blockchain is only one type of data structure considered to be a distributed ledger.
Blockchain – A blockchain – originally block chain – is a distributed database that is used to maintain a continuously growing list of records, called blocks. Each block contains a timestamp and a link to a previous block. A blockchain is typically managed by a peer-to-peer network collectively adhering to a protocol for validating new blocks. By design, blockchains are inherently resistant to modification of the data. Once recorded, the data in any given block cannot be altered retroactively without the alteration of all subsequent blocks and the collusion of the network. Functionally, a blockchain can serve as “an open, distributed ledger that can record transactions between two parties efficiently and in a verifiable and permanent way. The ledger itself can also be programmed to trigger transactions automatically.”
Blockchains are secure by design and are an example of a distributed computing system with high byzantine fault tolerance. Decentralized consensus can therefore be achieved with a blockchain. This makes blockchains potentially suitable for the recording of events, medical records, and other records management activities, identity management, transaction processing, and documenting provenance.
The first blockchain was conceptualised by Satoshi Nakamoto in 2008 and implemented the following year as a core component of the digital currency bitcoin, where it serves as the public ledger for all transactions. The invention of the blockchain for bitcoin made it the first digital currency to solve the double spending problem, without the use of a trusted authority or central server. The bitcoin design has been the inspiration for other applications.
Mining – Bitcoin mining is the process of authenticating and legitimizing bitcoin transactions — sort of like being a bitcoin bank teller. Every time a new transaction comes along, it needs to be added to the final bitcoin ledger or blockchain, which records every bitcoin exchange. Transactions are added up until they reach “block” status, and the block is sent to miners. The miners use their specialized hardware and data keys called “nonces” to encrypt the block of transaction data into a “hash,” or an identification sequence that also includes all the block data (the hash has many useful properties, but this is its basic function). This hash is then added to the block, authenticating it, and the block is officially added to the block.
Hard Fork – As it relates to blockchain technology, a hard fork (or sometimes hardfork) is a radical change to the protocol that makes previously invalid blocks/transactions valid (or vice-versa), and as such requires all nodes or users to upgrade to the latest version of the protocol software. Put differently, a hard fork is a permanent divergence from the previous version of the blockchain, and nodes running previous versions will no longer be accepted by the newest version. This essentially creates a fork in the blockchain, one path which follows the new, upgraded blockchain, and one path which continues along the old path. Generally, after a short period of time, those on the old chain will realize that their version of the blockchain is outdated or irrelevant and quickly upgrade to the latest version.
Wallet – What? You thought you actually got to touch cryptocurrency?
Digital Wallet – A wallet stores the information necessary to transact bitcoins. While wallets are often described as a place to hold or store bitcoins, due to the nature of the system, bitcoins are inseparable from the blockchain transaction ledger. A better way to describe a wallet is something that “stores the digital credentials for your bitcoin holdings” and allows one to access (and spend) them. Bitcoin uses public-key cryptography, in which two cryptographic keys, one public and one private, are generated. At its most basic, a wallet is a collection of these keys.
Mobile Wallet – The mobile wallet is an app that would need to be installed or a feature that is already in-built with the smartphone. Think of a mobile wallet like a storage container that stores your credit cards, debit cards, coupons and reward cards. Once the app is installed and the user inputs his payment information, the wallet stores this information by linking a personal identification format like a number or key, QR code or an image of the owner to each card that is stored. When a user makes a payment at a merchant, the mobile app uses a technology called Near-Field Communication (NFC) which uses radio frequencies to communicate between devices. NFC uses the personal identification format created for the user to communicate the payment information to the merchant’s POS (Point-of-Service) terminal. The information transfer is usually triggered when the user waves or holds his NFC-enabled mobile device over the store’s NFC reader.
BTM – A bitcoin ATM is an internet machine that allows a person to exchange bitcoins and cash. Some Bitcoin ATMs offer bi-directional functionality; these machines enable both the purchase of Bitcoin as well as the redemption of Bitcoin for cash. In some cases, Bitcoin ATM providers require users to have an existing account in order to transact on the machine.
Bitcoin machines are not ATMs in the traditional sense and probably use the wording ATM as a neologism. Bitcoin kiosks are machines which are connected to the Internet, allowing the insertion of cash in exchange for bitcoins given as a paper receipt or by moving money to a public key on the blockchain. They look like traditional ATMs, but Bitcoin kiosks do not connect to a bank account and instead connect the user directly to a Bitcoin exchange.
It will come as no surprise to those that made it here that this is different financial ground to stand on. We have only scratched the surface of cryptocurrency. The next offering in the series focuses on the Market Cap leaders in the Cryptocurrency marketplace.