Are U tired of hearing about Crypto Currency and not really understanding how it works or what it’s for? Are you getting FOMO and don’t know what to do? Let us help you break it down, bit by bit (pun intended) so that no matter who you are you can understand this seemingly complex topic.
To start, what are Crypto Currencies?
Crypto currencies are a form of digital asset which exist on decentralised peer-to-peer networks known as ‘blockchains’. Cryptocurrencies imitate the idea of cryptography methods through the use of encryption keys, hence the ‘crypto’ in cryptocurrency. Cryptography techniques utilise progressed numerical codes to store and communicate information in a protected arrangement that guarantees just those, for whom the information or exchange is intended for, can get, read and cycle it, and guarantee the legitimacy of the exchange and member, similar to a true signature. Blockchains by nature are decentralised ledgers which are completely transparent. This means that every interaction between parties can be viewed on a blockchain explorer. Given that every transaction and wallet balance is visible, privacy is relatively nonexistent if your wallet address is known.
The original one is Bitcoin (BTC), which was launched back in January 2009 by someone known only as ‘Satoshi Nakamoto’. To this day, no one can be sure who he/she/they are, even as the market capitalisation of Cryptocurrencies surpassed the Trillion-dollar mark!
You may be wondering, how does it all work? After all, it is considered to be a high-risk asset group. Well, we are here to explain the basics! The first fundamental thing to understand is: What is a blockchain?
The blockchain is a platform defining a network of nodes working as a fully decentralised ledger across all the network participants. A blockchain has a wide range of applications such as transactions between two parties, or the execution of a smart contract which is a more evolved type of interaction described as a self-sustained trustless consensus between entities. This unlocks an infinite number of possibilities depending on the blockchain used.
But all of this requires some kind of ‘engine’ to power the network, right?
Well, the ‘power source’ that runs the blockchain as well as processes these transactions and smart contracts are known as Miners. All the Miners collectively compete to solve a ‘block’ by finding a solution to the mathematical problem (for a particular algorithm) which is known as ‘Mining’. For Bitcoin, this algorithm is called ‘SHA256’, and is now just one of many developed in the last 10 years.
This particular algorithm works on a ‘Proof of Work’ (POW) method of consensus which calculates each individual Miners’ contributions to solving a particular block. This is based on your Miners ‘hashrate’ which is essentially how many calculations and power your Miner has processed.
The result is that the collective ‘hashrate’ solves the mathematical problem and confirms ‘blocks’, and hence the transactions in them, creating a new ‘block’ and adding it to the ‘blockchain’. However, it is only one individual Miner which actually solve the problem and creates the new block (as well as unlocks and receive the BTC reward)
As the network grows and the block chain is faced with more and more issues and transactions increase, the collective power needed to solve blocks must increase. This means that more collective hash power is needed to solve blocks. As a result of this the companies which develop, sell and run these miners develop them to be more powerful and more efficient over time.
Good, so now you should understand the basics of how a block-chain works, how Miners power the network and the fundamental decentralized nature of crypto currencies.
The next step is to understand what block chains are used for and why cryptocurrencies are valuable.
Conventional currencies are regulated by centralized bodies who decide its supply. These are normally central banks which have control over 2 factors; inflation and interest rates. These 2 factors determine the value of currency as well as underlying demand. This is fundamentally different for Bitcoin as there are only 21 million which will ever exist as they cannot be destroyed or created (unless unlocked by minors as mentioned previously). It is effectively a mathematically backed capped supply network in which you have a share, and your share is never diluted, unlike for FIAT currencies where your capital is continuously debased due to compounding inflation year after year.
For Bitcoin, inflation is continuously reduced as the network grows. You may have heard of the term ‘Halving’ in crypto currency but what does it mean exactly, and how does it affect price?
When a ‘Halving’ occurs, the amount of ‘mined’ currency which is released from each completed ‘block’ is halved, meaning that the incentive to mine is technically halved. This is fundamentally good for the price of Bitcoin as Miners typically sell their mined coins to cover the costs of mining on a daily basis! When the new supply is restricted, demand typically increases as Bitcoin becomes more rare and less liquid.
A halving for Bitcoin occurs every time that 210,000 blocks are confirmed which usually takes around 4 years. The predictability in monetary supply means that Bitcoin typically rises in price after a halving which tends to create 4-year price cycles.
So, what kind of applications can cryptocurrency and blockchain have? These decentralised networks already enable cryptocurrencies as a mean of payment, however, more evolved types of operations are possible through the use of technologies such as smart contracts on the Ethereum blockchain for example. Some smart contracts can power decentralised applications which are known as dApps.
So what are dApps?
DApps are applications that uses a blockchain as their backend. Over the last few months these apps have managed to attract an ever-increasing number of users. Examples ranging from decentralised finance (DeFi) with yield farming and staking, to automated car rentals or physical key access authorised via smart contracts. Other examples include real time stream of payments in cryptocurrency, lending and borrowing cryptocurrencies, Interacting with real world data via oracles (bridge real world data and blockchain), track authenticity of goods….
Basically, there are lots and lots of potentially disruptive applications!
The reason for this is because there are multiple advantages of using these peer-to-peer digital network infrastructures compared to conventional systems. Here are just a couple examples:
- There is no downtime
The dApp’s code is deployed on the blockchain, so there is no single point of failure that can shut it down.
- Censorship resistant
No governments, powerful individual or corporations are able to shut down a decentralised app.
- Wallet to blockchain interaction (Web3)
With your on-chain cryptocurrency wallet you can actually sign messages, like transactions, to prove their authenticity or even vote on proposals as your wallet is essentially your digital identification.
This means that the utility of these systems goes far beyond just transacting on the blockchain or crypto currency as a store of value. For example, in 2020, France elected a mayor using blockchain based votes. Each voter was identified using their wallet and digitally signed and encrypted their vote into the ‘Ballot Contract’.
There are a lot of interesting dApps and web3 projects that have emerged recently. Below we have just outlined a few which we think are the most interesting:
- Status ( https://status.im/ )
This is a wallet that integrates with the Ethereum network and gives users the ability to make on chain transactions and chat on a censorship resistant decentralized network from wallet to wallet.
- Sablier.finance ( https://sablier.finance/)
This is an application which enables a real time stream of payment to payees. Imagine if you got your salary or if you could pay your rent, or any periodic payment, in real time. Sablier Finance enables this via the ERC1620 protocol.
- Aavegotchi ( https://aavegotchi.com/ )
This one is just for fun! You can own a blockchain pet with random special attributes and flex it on your wallet 🤙
Another very popular use of smart contracts is Decentralised Finance, also known as DeFi. It allows borrowers and lenders to transact currency via liquidity pools. As of January 2021 it has already reached a market capitalisation of $45B (around 5% of total crypto currency market capitalisation) which is very significant.
Here are some examples of DeFi platforms: Yearn finance, Curve finance, Alpha finance
Smart Contracts also allow for a very interesting alternative to conventional banking savings accounts through what is known as ‘Yield Farming’.
Yield Farming allows individuals to lock up their funds in a liquidity pool incentivised by a yield in return. This process entails lending out crypto assets to another party through Decentralised Finance protocols which earns the lender a fixed or variable interest. The interest rates for most of these projects are far greater than traditional investments. However, the higher return means that there is a higher associated risk due to the immense volatility of most crypto currencies.
Some people in the crypto space used to outline drawbacks with centralised crypto currency exchanges. It means that the exchange with which you bought and sold assets was responsible for the rates, fees and liquidity and (in some cases) trading availability. Smart Contracts have now paved the way for decentralised exchanges which can be accessed with any on-chain wallet.
Decentralised exchanges (DEX’s) have soared over the last few months. DEXs enable users to trade without the need of KYC verification or any third parties whatsoever. Some great examples of this include: Uniswap, 1inch, SushiSwap, Bonfida and Pancakeswap…
Different blockchains all have different fees in order to execute smart contracts and make trades which are known as ‘Gas Fees’. On the Ethereum network, as of today, the gas fee required to swap ~ $23 of ETH into LINK is roughly $14 in order to execute the transaction, which is more than 50% of the entire transaction! However, a transaction is confirmed in only 13 seconds which is the time a block takes to be mined on the Ethereum network.
Here is a small comparison of some options for Dex’s available on different blockchains:
Pancake Swap ( https://exchange.pancakeswap.finance/ )
Pancakeswap on Binance smart chain charges more or less ~ $0.09 per transaction and has a block time of 5 seconds. This exchange has even recently tokenized certain large cap American stocks which can be traded just like any other coin!
Bonfida DEX ( https://bonfida.com/ )
Bonfida is a decentralized exchange on Solana blockchain which one of the fastest blockchains with a block time of 400ms and the most unexpensive transaction fees averaging $0.00001!
You can also create any market you want using the Bonfida platform. For example, you could create a token representing a real-world item, like a t shirt, and auction it.
Overall, there are endless potential applications to these technologies. Blockchain is just the decentralized foundational framework on which these platforms are built and powered. One day, we will probably have much more blockchain based integration of many real-world processes. The lack of governance that block chain offers means that it may even one-day replace fundamental elements within governments. There are actually certain places which have started doing this, for example, in Georgia the land registry is block chain based. It just goes to show you how truly powerful this technology, which has only been around for just over 10 years, is and can be with just a little bit understanding from the masses.
We hope that this article has helped you understand blockchain, even if it’s just a little bit.
Good news is that if you are reading this in early 2021 you are still ahead of most retail investors and adopters! Remember, the early bird gets the worm! 😉