Chapter 1

What Is a Cryptocurrency?

IN THIS CHAPTER

Looking at the what, why, and how of the advent of cryptocurrencies

Getting an overview of your first steps before starting your crypto journey

So you've picked up this book, and your first question is probably this: "What the heck is a cryptocurrency, anyway?" Simply stated, a cryptocurrency is a new form of digital money. You can transfer your traditional, non-cryptocurrency money like the U.S. dollar digitally, but that's not quite the same as how cryptocurrencies work. When some cryptocurrencies become mainstream, you may be able to use them to pay for stuff electronically, just like you do with traditional currencies.

However, what sets cryptocurrencies apart is the technology behind them. You may say, "Who cares about the technology behind my money? I only care about how much of it there is in my wallet!" The issue is that the world's current money systems have a bunch of problems. Here are some examples:

• Payment systems such as credit cards and wire transfers are outdated.
• In most cases, a bunch of intermediaries, such as banks and brokers, take a cut in the process, making transactions expensive and slow.
• Financial inequality is growing around the globe.
• The threat of confiscation of your assets.
• Around 3 billion unbanked or underbanked people can't access financial services. That's a big chunk of the planet's population!

Cryptocurrencies aim to solve some of these problems, if not more. This chapter introduces you to crypto fundamentals.

Beginning with the Basics of Cryptocurrencies

You know how your everyday, government-based currency is reserved in banks? And that you need an ATM or a connection to a bank to get more of it or transfer it to other people? Well, with cryptocurrencies, you may be able to get rid of banks and other centralized intermediaries altogether. That's because cryptocurrencies rely on a technology called blockchain, which is decentralized (meaning no single entity is in charge of it). Instead, every computer in the network confirms the transactions. Flip to Chapter 4 to find out more about the blockchain technology that enables cool things like cryptocurrencies.

In the following sections, I go over the basics of cryptocurrencies: their background, benefits, and more.

The definition of money

Before getting into the nitty-gritty of cryptocurrencies, you need to understand the definition of money itself. The philosophy behind money is a bit like the whole "which came first: the chicken or the egg?" thing. In order for money to be valuable, it must have a number of characteristics, such as the following:

• Enough people must have it.
• Merchants must accept it as a form of payment.
• Society must trust that it's valuable and that it will remain valuable in the future.

Of course, in the old days, when you traded your chicken for shoes, the values of the exchanged materials were inherent to their nature. But when coins, cash, and credit cards came into play, the definition of money and, more importantly, the trust model of money changed.

Another key change in money has been its ease of transaction. The hassle of carrying a ton of gold bars from one country to another was one of the main reasons cash was invented. Then, when people got even lazier, credit cards were invented. But credit cards carry the money that your government controls. As the world becomes more interconnected and more concerned about authorities who may or may not have people's best interests in mind, cryptocurrencies may offer a valuable alternative.

Here's a fun fact: Your normal, government-backed currency, such as the U.S. dollar, must go by its fancy name, fiat currency, now that cryptocurrencies are around. Fiat is described as a legal tender like coins and banknotes that have value only because the government says so. Get the scoop on fiat currencies in Chapter 17.

Some cryptocurrency history

The first-ever cryptocurrency was (drumroll please) Bitcoin! You probably have heard of Bitcoin more than any other thing in the crypto industry. Bitcoin was the first product of the first blockchain developed by some anonymous entity who went by the name Satoshi Nakamoto. Satoshi released the idea of Bitcoin in 2008 and described it as a "purely peer-to-peer version" of electronic money.

Bitcoin was the first established cryptocurrency, but many attempts at creating digital currencies occurred years before Bitcoin was formally introduced.

Cryptocurrencies like Bitcoin are created through a process called mining. Very different than mining gold, mining cryptocurrencies involves powerful computers solving complicated problems. Flip to Chapter 13 for more on mining.

Bitcoin remained the only cryptocurrency until 2011. Then Bitcoin enthusiasts started noticing flaws in it, so they decided to create alternative coins, also known as altcoins, to improve Bitcoin's design for things like speed, security, anonymity, and more. Among the first altcoins was Litecoin, which aimed to become the silver to Bitcoin's gold. But as of the time of writing, over 20,000 cryptocurrencies are available, and the number is expected to increase in the future. That includes active, valuable, and non-active cryptocurrencies. Non-active cryptocurrencies are also reffered to as dead cryptocurrencies, which means they don't have any investors or people using them anymore. Check out Chapter 8 for just a sampling of cryptocurrencies available now.

Key crypto benefits

Still not convinced that cryptocurrencies (or any other sort of decentralized money) are a better solution than traditional government-based money? Here are a number of solutions that cryptocurrencies may be able to provide through their decentralized nature:

• Reducing corruption: With great power comes great responsibility. But when you give a ton of power to only one person or entity, the chances of their abusing that power increase. The 19th-century British politician Lord Acton said it best: "Power tends to corrupt, and absolute power corrupts absolutely." Cryptocurrencies aim to resolve the issue of absolute power by distributing power among many people or, better yet, among all the members of the network. During the crypto boom some people have been able to manipulate the market, but once things are truly decentralized corruption could go lower. That's the key idea behind blockchain technology (see Chapter 4) anyway.

• Eliminating extreme money printing: Governments have central banks, and central banks have the ability to simply print money when they're faced with a serious economic problem. This process is also called quantitative easing. By printing more money, a government may be able to bail out debt or devalue its currency. However, this approach is like putting a bandage on a broken leg. Not only does it rarely solve the problem, but the negative side effects also can sometimes surpass the original issue.

  For example, when a country like the Islamic regime in Iran or Venezuela printed too much money, the value of its currency dropped so much that inflation skyrockets and people couldn't even afford to buy everyday goods and services. Their cash became barely as valuable as rolls of toilet paper. Most cryptocurrencies have a limited, set amount of coins available. When all those coins are in circulation, a central entity or the company behind the blockchain has no easy way to simply create more coins or add on to its supply.

• Giving people charge of their own money: With traditional cash, you're basically giving away all your control to central banks and the government. If you trust your government, that's great, but keep in mind that at any point, your government is able to simply freeze your bank account and deny your access to your funds.

  For example, in the United States, if you don't have a legal will and own a business, the government has the right to all your assets if you pass away. Some governments can even simply abolish bank notes the way India did in 2016. With cryptocurrencies, you and only you can access your funds. (Unless someone steals them from you, that is. To find out how to secure your crypto assets, flip to Chapter 7.)

• Cutting out intermediaries: With traditional money, every time you make a transfer, an intermediary such as your bank or a digital payment service takes a cut. With cryptocurrencies, all the network members in the blockchain are that intermediary; their compensation is formulated differently from that of fiat money intermediaries and therefore is minimal in comparison. Flip to Chapter 5 for more on how cryptocurrencies work.
• Serving the unbanked: A vast portion of the world's citizens has no access or limited access to payment systems like banks. Cryptocurrencies aim to resolve this issue by spreading digital commerce around the globe so that anyone with a mobile phone can start making payments. And yes, more people have access to mobile phones than to banks. In fact, more people have mobile phones than have toilets, but at this point the blockchain technology may not be able to resolve the latter issue! (Flip to Chapter 2 for more on the...