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What is Cryptocurrency?

The Beginner’s Guide


Since the earliest days of networked computing, researchers and scientists have theorized that a protocol could be devised to allow people to exchange truly digital money. 

However, as often occurs in the domain of science, this idea took some time to become reality. Indeed, despite prominent attempts to create forms of electronic cash in the 20th Century, the idea remained little more than a dream until the invention of Bitcoin in 2009. 

Flash forward to today and there are thousands of technologies that claim to have satisfied the original definition of cryptocurrency or else that they have innovated beyond these confines to create something new entirely.

Still, despite varying individual claims, cryptocurrencies do have much in common as a class of computing protocols. Most, for example, were born out of the perceived necessity for greater digital privacy and the need to remove third parties from digital exchange.

While Bitcoin is currently the most prominent of cryptocurrencies available today, all use similar building blocks.

The common properties of cryptocurrencies generally include:

  1. Borderless: You can send and receive cryptocurrency from anywhere in the world.
  2. Durable: Cryptocurrency can be used over and over again without degrading.
  3. Irreversible: Transactions cannot be reversed and units cannot be spent twice.
  4. Permissionless: You do not need to provide information, nor permission, to create a wallet and own a cryptocurrency.
  5. Pseudonymous: No personal names or identifying information needs to be attached to the transactions.

What is cryptocurrency crypto


Early Attempts at Cryptocurrency

 

It wasn’t until the 1970s that commercial, non-military uses of cryptography began to see wider exploration. It was then that the cypherpunk movement, dedicated to building new systems through cryptography and open source code, was born.

Major early projects included: 

eCash by Dr. David Chaum: The first major attempt to create a digital currency, eCash users would store their money in a digital format, cryptographically signed by a bank, and could then spend it at any shop accepting eCash.

Hashcash by Dr. Adam Back: An anti-spam mechanism that added a cost to sending emails, and did not require users to create an account to have access to it.

B-money by Wei Dai: A proposal for an anonymous, distributed digital cash system where every participant kept a separate database of how much money belongs to the users. Participants were incentivized to remain honest by putting their money on the line.

Reusable proof of work (RPOW) by Hal Finney: A scheme for creating unique cryptographic tokens that could only be used once. In this system, validation and double-spending prevention were done by a central server

Bit Gold by Nick Szabo: A digital collectible based on Finney’s RPOW. Units would be valued based on the amount of computational work performed. Bit Gold also introduced the idea of scarcity for digital currencies. 


Despite their similar vision, most early attempts at cryptocurrency failed due to an inability to avoid central control and the inability of their units to sustain an economic value.

That is, until October 31st, 2008, when Bitcoin was introduced by a pseudonymous actor, or actors, who built upon these previous ideas while solving for their shortcomings.

The Origins of Cryptocurrency


In order to fully understand modern cryptocurrencies, however, one needs to dig deep into the rich history of the various attempts to realize digital money. 

That’s because cryptocurrencies today are best described as “combinatorial inventions,” ones that create a new technology using only a combination of older, established works. 

At the root of all cryptocurrencies today lies cryptography, the techniques used for secure private communication, and encryption, the process of encoding that information. 
 

What is cryptography?

 

Cryptography is the science behind creating codes and cyphers that allows people to transmit information in a private and secure way.

The earliest forms of cryptography can be traced back to certain ancient civilizations, a famous example being the use of symbol replacement in Egyptian writings. 

However, cryptography has been developed extensively since then and has undergone many iterations to adapt to the times. For example, in the middle ages, messages were encoded using two alphabets, with readers needing access to both to decipher the messages.

In the early 1900s, cryptography was mainly used by the military and spy agencies, particularly during war, where secret communications were a vital way to send information between posts. One of the most famous early 20th century cryptographers was Alan Turing, who built a machine that helped decrypt german messages during WW2.

Today, the method that secures cryptographic transmissions when they are in transit from one party to the next, particularly over the internet, is called encryption. 

Digital Signatures

 

In modern day cryptography, information, or data, can be signed with a private key, and, much like in the earlier days, third parties can verify the message’s signature.

Digital signatures are often used to protect the integrity and authenticity of communications and for making the transitioning data immutable. In order to create and verify signatures, users rely on a set of keys, private and public. 

Cryptocurrency networks use digital signatures to enable the transfer of crypto-assets. The recipient provides their public key to the sender, and the sender’s private key signs a transaction assigning the asset to the recipient’s public key.

Hash functions are another feature native to cryptography, and are essential to mining, a way that some cryptocurrencies, like Bitcoin, secure their distributed network and regulate the release of new monetary units. 

Hashing is a mathematical process that takes an input of data information of any size and produces a fixed size output. In order to propose blocks in the Bitcoin protocol, computers race to generate hashes until one of the hashes has a small enough value.   

The winning hash is broadcasted to other computers for them to verify whether the solution is true or not. If it is true, the user who broadcasted the block is awarded new Bitcoin.

Digital signatures and hashing are also key technological assets behind many previous attempts at creating digital cash and are widely used in many cryptocurrencies. 

 

Bitcoin by Satoshi Nakamoto

 

Under the pseudonym Satoshi Nakamoto, a programmer (or group of programmers) published the whitepaper “Bitcoin: A Peer-to-Peer Electronic Cash System.”

Instead of relying on a centralized server or database to house information on transactions, accounts and balances, Bitcoin relied on its own network of users to provide that service. 

In early 2009, the first bitcoins were mined, leading to the growth of the cryptocurrency ecosystem we find ourselves in today.

If you would like more information on how Bitcoin works, feel free to read our ‘What is Bitcoin?’ guide, which offers a more extensive breakdown of its technology and vision. 


Kraken's Crypto Guides

 

Useful Resources

Since the 2010s, many cryptocurrency projects have attempted to build on this history of work. 

If you are interested in learning about the different types of cryptocurrency, please visit Kraken’s “Types of cryptocurrency” page. 

Want more in depth information on specific cryptocurrencies? If so, visit our Learn Center to further your education on this ever-growing space.

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