Before money, the world used to operate on a Barter system. Someone looking for a particular good would have to find someone to trade with. However, this was problematic for a number of reasons, due to the double coincidence of wants. If a farmer had wheat and wanted to clothe, they would have to hope that the tailor was willing to accept wheat. You can see how quickly this would become complicated.
Currency solved this issue by creating a store of value. Now, backed by higher authority, currencies were used in order to exchange goods for money and it solved the problem.
Eventually, what is known as fiat currency (paper money backed by governments) took over the barter system.
A cryptocurrency is a new form of money…
Fiat currency (what we know as money today, such as US Dollars or Great British Pounds) is backed by governments or central banks, they defend their value through a number of measures. For example, they create a currency that is durable, hard to counterfeit, divisible, all things that are necessary to make money useful. They also try to ensure that prices are stable compared to other currencies. However, the internet brought a new opportunity. In the early days of the internet, the big problem was how to move money, peer to peer without a trusted central intermediary. One of the first websites selling a product was Pizza Hut, with a website name of Pizza.Net. But crucially, you couldn’t pay online. In 1994, Pizza.Net made its first sale, but crucially money still changed hands with the delivery. Commerce was quickly looking for solutions to move payments across the World Wide Web? This is where cryptocurrency comes in. The term derived from the Greek word kryptos and the idea became even more important with the internet as it had a chance of solving the problem of “how we move money on the internet”. One of the first known transactions of exchange a Bitcoin for goods was for Pizza,
- “I’ll pay 10,000 bitcoins for a couple of pizzas.. like maybe 2 large ones so I have some leftover for the next day. I like having leftover pizza to nibble on later. You can make the pizza yourself and bring it to my house or order it for me from a delivery place, but what I’m aiming for is getting food delivered in exchange for bitcoins where I don’t have to order or prepare it myself, kind of like ordering a ‘breakfast platter’ at a hotel or something, they just bring you something to eat and you’re happy!
- I like things like onions, peppers, sausage, mushrooms, tomatoes, pepperoni, etc.. just standard stuff no weird fish topping or anything like that. I also like regular cheese pizzas which may be cheaper to prepare or otherwise acquire.
- If you’re interested please let me know and we can work out a deal.
- Thanks, Laszlo”
Laszlo has wanted to trade 10,000 Bitcoins for two pizzas. Nobody took Laszlo up on this offer for three days, but eventually, 4 days later, Laszlo let everyone know that a successful trade had taken place, “I just want to report that I successfully traded 10,000 bitcoins for pizza.” 10,000 Bitcoins back when this happened was worth around £30/$40. Now, 10,000 Bitcoins are worth over 30 million dollars at the time of writing this article. So, a cryptocurrency is a digital or virtual currency that is secured by cryptography. It is a system that allows for secure payments online which are denominated in virtual tokens.
How does bitcoin work?
The bitcoin system is a collection of computers (also referred to as “nodes” or “miners”) that all run bitcoin’s code and store its blockchain.
A blockchain can be thought of as a collection of blocks. In each block is a collection of transactions. Because all the computers running the blockchain has the same list of blocks and transactions, and can transparently see these new blocks being filled with new bitcoin transactions, no one can cheat the system.
What is a blockchain?
A blockchain is a distributed database that is shared among the nodes of a computer network.
As a database, a blockchain stores information electronically in digital format.
Blockchains are best known for their crucial role in cryptocurrency systems, such as Bitcoin, for maintaining a secure and decentralized record of transactions.
The innovation of a blockchain is that it guarantees the security of a record of data and generates trust without the need for a trusted third party.
So what does this mean for money, finance, and normal currencies?
Cutting out the middle person (a bank or payment intermediary who charges fees)!
Regardless of whether Bitcoin and other cryptocurrencies yet adequately exhibit the three roles of money – a store of value, a medium of exchange, and a unit of account – blockchain technology does provide a means to move value and run computer code on the internet without relying upon a central intermediary.
That ties blockchain technology and cryptocurrencies directly to the essential plumbing of the financial sector, which at its core has the role of efficiently moving and allocating money and risk within an economy. Though there are many technical and commercial challenges – scaleability, efficiency, privacy, security, interoperability, and governance.
Bank fees are really small, so why do we need Bitcoin?
Bank fees and fees from payment providers are very small, but they add up to make a big amount, current estimates state that the new technology (cryptocurrencies and blockchain) can reduce costs which are as high of 7.5% of US gross domestic product (a lot of money!).
Why are some people optimistic about cryptocurrency and bitcoins?
Modern financial systems bring great benefits to economies. But also, repeated, instability and occasional crises. The 2008 global financial crisis wreaked havoc, affecting millions of bystanders far and wide. Fiat currencies have had bouts of inflation associated with unsound monetary or fiscal policies. Centralised intermediaries concentrate risks and collect economic rents. Cryptocurrencies may be a plausible alternative to what we have been used to.
Why are some people nervous or pessimistic about cryptocurrencies?
People who compare cryptocurrencies to other assets such as stocks are worried about the value of cryptocurrencies such as Bitcoin. They do not provide any cash flow for investors and therefore in some people’s eyes should be worth zero. It is still very difficult for anyone to know if Bitcoin and other cryptocurrencies will be worthless or not in the future.
Frequently asked questions on cryptocurrencies
Was bitcoin the first cryptocurrency?
No! Efforts to achieve peer-to-peer payments came much before bitcoin such as DigiCash and CyberCash with both projects failed. The internet still relied on traditional credit cards and banks.
Who created bitcoin?
Satoshi Nakamoto, but nobody knows who this is. Bitcoin is a decentralized digital currency created in January 2009. It follows the ideas set out by the mysterious Satoshi Nakamoto.
Are there any physical bitcoins?
Bitcoin is known as a type of cryptocurrency because it uses cryptography to keep it secure. There are no physical bitcoins, only balances kept on a public ledger that everyone has transparent access to (although each record is encrypted).
Can I pay with bitcoins?
A number of companies around the world now accept Bitcoins as a form of payment. Other companies are more reluctant due to how volatile the cryptocurrency is?
What are the potential uses of blockchain technology?
Potential uses of blockchain technology include (but are not limited to):
- cross-border payments
- clearing and settlement systems
- digital identities
- trade finance
- supply chain management