What are cryptocurrencies and what do they mean for our future?
Most people hear about cryptocurrencies and blockchains but don’t really understand what it means in a broader business context. Despite all the tech hype and confusing lingo around cryptocurrencies, there are only three key(plus two bonus) technological ideas you need to understand the current state of the crypto industry. Unhackable, irreversible databases(blockchains) -> Decentralized validation -> Smart contracts -> DAOs and NFTs(Bonus). These technologies all stack upon each other to create an entirely new way of doing business.
Avoiding the technical side of things, blockchains are a pretty straightforward concept. It is a database that can only move forward, hence the “chain” in blockchain. Each blockchain entry is “chained” onto the one before it. And once that entry is confirmed, there is no way to delete it. All cryptocurrencies are publicly visible blockchains, which means that when your great grandchildren are 80 they can still view the first Bitcoin transactions. The idea of storing current events on the blockchain has been brought up as a way to keep an unbiased account of history as no one could alter it say 20 years from now. Interesting idea, but would require a pretty rigorous process to make sure the initial data being entered is also unbiased.
The second concept is decentralized validation. This could be a very technical conversation but I’m going to avoid that as much as possible. The big buzzword you hear with cryptocurrencies is decentralized. So there are a few ways in which cryptocurrencies are decentralized, but the key innovation is the idea of decentralized validation. When you make a bank transfer your request gets sent to the bank, then its reviewed by some kind of software, maybe it gets put in front of an employee, and after a couple days your transaction is confirmed. In general, there is nothing wrong with that. Its worked well for a long time and continues to work well with few exceptions. Unfortunately these exceptions can have large consequences, eg if a bank goes bankrupt and you have a significant amount of money in the bank. Or, more conspiratorially, a high-ranking employee goes in and deletes or otherwise manipulates transactions. The point with both of these theoreticals is that a traditional banking company has a single point of failure. One person with bad intentions or one catastrophic event and its suddenly unreliable.
This is where decentralized validation comes in. Imagine you want to make a transaction, just like you did with the bank, but instead you’re using a cryptocurrency. You create the transfer and your request gets sent to the cryptocurrencies network. At this point your transfer is waiting to be added to the next block in the chain. But, just like the bank, someone needs to make sure your transfer is not fraudulent. Now, depending on the cryptocurrency, there are different ways of doing this, but the important thing to understand is that a group of random and totally unconnected people(often from all over the world) are all incentivized to confirm your transaction if its real, and deny it if its fraudulent. In other words, if they don’t do an honest job they don’t get paid. Once a significant amount of those validators agree on your transaction(the definition of significant depends on the blockchain), it is accepted and permanently added to that blockchain. For the Bitcoin blockchain, you know these validators as “Miners”.
Ok congrats, now you understand what a blockchain is. And thats really all Bitcoin is, a decentralized database that keeps track of transactions. In 2014, Ethereum added another layer that led to the wide-ranging crypto market you see today. The base structure of Ethereum is essentially the same as Bitcoin, the big difference is Ethereum added a framework for smart contracts, another crypto buzzword you’ve probably heard before. Put simply, a smart contract is a snippet of code where developers can create conditional rules for their application.
Imagine, for example, you make a simple sports betting app using the Ethereum framework that allows you to bet on a basketball game. You bet the Bucks will win, your friend bets they’ll lose. Once the game is over our app sends a request to another Ethereum app(most likely Chainlink) to pull and verify this information, which then determines who won the bet and distributes the money accordingly. So great, you got a betting app where you pay a transaction fee rather than paying a bookie the spread. Not bad, but nothing revolutionary either. Here’s where it gets fun.
Because you are using Ethereum’s framework, all of the transactions done on your app are recorded on Ethereum’s blockchain. So, let’s say your friend comes up with this great twist for your fantasy league where instead of building a team your score every week will be based on betting accuracy. But, you recently found out that another friend(the one you don’t really like) has also created a betting app on Ethereum, and he’s already recruited part of the fantasy league to use his app. Naturally, your app is better so you don’t want to stop using it but you also don’t want to make a big deal about other people switching. You tell this to your friend(the cool one), and he decides no problem, I’ll just make an Ethereum fantasy league app that keeps track of bets placed on both apps! He adds a slick-looking leaderboard, the ability to trade bets after they’ve been placed, a continuously updating stream of ESPN news, and a secure place to deposit your buy-in.
While this specific app has not been created, there have been hundreds of apps created that perform parallels of all of these functions, most focused on financial instruments, gaming, and digital art. Another way of viewing Ethereum is as this globally accessible computer that anyone can build an app on. Anyone can access all of the data on it. Anyone can be their own bank on it. As of today (9/15/21), there are roughly 800,000 unique addresses interacting with the Ethereum blockchain as well as approximately 1.2M transactions per day. Ethereum is the first and the largest, but there are many other cryptocurrencies that also have their own quickly growing ecosystem. In addition, there have been several “bridges” created recently that allow these apps to interact with apps on other blockchains, connecting all of these blockchain-specific ecosystems into one big crypto ecosystem.
From my point of view, I see this as potential for a new internet economy, where small businesses aren’t crushed just because they can’t access the same data troves. Crypto code is also largely public, and because of all this data and code sharing, I believe network effects will lead to unprecedented growth. They say data is the new oil, and a well-developed blockchain will have more data than any single company, simply because it has the data of hundreds(or thousands) of apps rather than just one or two. There are other promising signs, such as the Terra blockchain, which is increasingly being used for day-to-day purchases in Korea. Another interesting use case is expatriates with family in second or third-world countries can now easily send payments back to their family without having to pay huge fees to a bank every week(currently happening on a large scale in Nigeria). Lastly, and most exciting for the average person, there is a pokemon-style blockchain game called Axie Infinity that has allowed some players to earn a living wage playing the game.
Hopefully this has given you a brief understanding of what I believe blockchain technology is capable of. The cryptocurrency market has rapidly gotten more complex and has garnered attention from more and more corners of the economy. The future may bring obstacles such as regulation or network attacks(topics for another day), but to me it is clear that the core community sees the massive potential in this technology and will not let it die under any circumstance. I will post a link here to my follow-up article on NFTs and DAOs as soon as it is completed. Thanks for reading!