Intro to Cryptocurrencies
A brief introduction to the many kinds of cryptocurrencies besides Bitcoin.
Bitcoin was created as a peer to peer electronic cash system. It is a decentralized network of computers that stores transactions in a ledger, in the form of a blockchain. Bitcoin was created as an open-source project, which means the code was visible from the first day to the whole world to examine, copy, and modify.
Since Bitcoin’s inception in January 2009, there have been thousands of other projects that used similar ideas as Bitcoin. These are collectively referred to as “cryptocurrencies”. Some of these projects are not necessarily geared towards a currency application, but they are all ‘tokens’, like Bitcoin. They can be transferred from one user to another, and can usually be traded on an exchange.
Currently there are over 600 cryptocurrencies traded on the markets, tracked by Coinmarketcap. Bitcoin makes up over 80% of the total market today. Cryptocurrencies other than Bitcoin are usually traded against Bitcoin. Some of the larger ones are also traded against government-backed currencies like US Dollar and Chinese Yuan.
Cryptocurrencies, by their nature, are public for anyone to join and participate. They differ significantly in terms of details, such as the consensus protocol used by the network to agree on the list of valid transactions, the way transaction and account information is stored, the specific algorithms used for hashing, the type of public-private key cryptography, the real-world applications and use cases and the type of community.
Cryptocurrency vs. ‘Blockchain’
There is a lot of interest in the idea of ‘blockchain’ or ‘distributed ledger technology’ beyond the Bitcoin blockchain or beyond cryptocurrencies altogether. These proposals have morphed into a complex set of systems especially used in certain financial industry applications. These ‘blockchains’ are private by nature and usually work at an enterprise level. They may or may not have tokens to represent value. Even if they are tokens, they are unlikely to be traded on an exchange. They can also establish trust outside the blockchain, such as through legal contracts. The participating members are usually trusted and known entities. R3 is the most public of these experiments, and Microsoft Azure’s Blockchain-as-a-service (Baas) offers companies a private way to explore applications.
Conversely, cryptocurrencies are systems similar to Bitcoin in terms of public access, and the ability to send, receive, and trade the tokens. Cryptocurrencies need to come to a consensus among untrusted parties.
New Consensus Algorithms – Proof of Work and Proof of Stake
Every cryptocurrency has a consensus layer, which defines how a distributed network of untrusted nodes comes to a consensus around which transactions are valid and to be included in the blockchain. Bitcoin uses a SHA256 proof of work system. Several other cryptocurrencies also use a proof of work system but with a different algorithm. The most notable one is Litecoin, which uses Scrypt.
The push for new consensus models had many origins. One was the centralization of mining in Bitcoin with the rise of ASIC (application specific integrated circuits) that could perform hashing operations far more efficiently than regular CPUs or GPUs. Some currencies introduced new hash algorithms that were resistant to ASIC-type hardware. Ethereum is one of the most notable.
Still others use a proof of stake system, which doesn’t involve mining at all. Coins are ‘minted’ with each block, and currency holders (stake holders) have an opportunity to package blocks and earn block rewards. The first hybrid proof of work/proof of stake system was used in Peercoin. The first major purely proof of stake system was built into NXT. Several ‘flavors’ of proof of stake have since been implemented, such as the delegated proof of stake first proposed for Bitshares.
‘Useful’ Proof of Work
Proof of work is often criticized as being ‘wasteful’, since a lot of energy is being spent computing hashes that are ultimately discarded. Some cryptocurrencies have tried to make proof of work more ‘useful’.
Primecoin was the first attempt at a useful proof of work. It computes chains of prime numbers, specifically Cunningham chains and bi-twin chains. Several of the largest Cunningham chains known today were discovered by the Primecoin network.
Solarcoin was created to promote the use of solar energy, and reward people who have done so using the solarcoin cryptocurrency. This makes it more centralized than other cryptocurrencies, because people have to file a claim with coin creators that they’ve installed solar power.
Several newer cryptocurrencies are not currencies per se, but behave more like assets or tokens for an application. It is hard to provide a generalized feature set, since they can be quite different from one another.
For example, Ethereum is a ‘decentralized world computer’, Bitshares is ‘decentralized banking’, MaidsafeCoin (for use on Maidsafe network) is ‘decentralized internet’, and Storj is ‘decentralized file-storage’ system.
Several early cryptocurrencies were created not as separate blockchains themselves, but as meta- protocols on top of an existing blockchain, mostly Bitcoin. This allowed the newly created cryptocurrency to piggy-back off of the security provided by Bitcoin.
Mastercoin was the earliest such meta-protocol built on top of Bitcoin, via an ICO. Later, Counterparty was created on top of Bitcoin via the first largest proof-of-burn system. Counterparty is able to run more complex smart contracts that are ultimately secured by the Bitcoin blockchain.
Certain other cryptocurrencies had their own blockchains, but were merge-mined with Bitcoin. This gave them additional security in terms of hashing power, but they also tended to be more centralized in some mining pools. Namecoin, created to provide a ‘decentralized DNS’ system, was implemented to be merge-mined with Bitcoin.
Some cryptocurrencies have tried to distinguish themselves via additional privacy features. Even though Bitcoin addresses are pseudonymous, they are not well suited for privacy because all transactions from a given address are publicly accessible without ambiguity.
Notable cryptocurrencies in this category include Dash (previously Darkcoin), and cryptocurrencies using the Cryptonote algorithm, such as Monero. There is a proposal for Zcash that would be considerably more anonymous than the other cryptocurrencies but this hasn’t launched yet.
Alternative cryptocurrencies are likely not going to go away. We at Smith + Crown believe these ‘altcoins’ are anything but marginal. They are useful testing grounds for new protocols, rallying points for sub-communities, and can serve as a distributed bug-catching system for the ‘primary’ currencies like Bitcoin and Ethereum. In 2016, many new coins are focusing on their ability to scale, largely because the concerns about Bitcoin’s scaleability have become so prominent. In 2017, there will likely be more such concerns and more corresponding experimentation.