One of the greatest breakthroughs in financial technology is the innovation of cryptocurrency. While there has been a lot of buzz around cryptocurrency, there is disproportionately less clarity as to what it really is. Cryptocurrencies are a way of liberating the finance system from banks that occasionally failed, by making it transparent. They enable all transactions to be verified on a public ledger. Examples of leading cryptocurrencies are:
- Bitcoin
- Ethereum
- Factom
- Maidsafe
- Ripple
The principles behind the operation of cryptocurrencies are almost the same. In fact, most of them are just copy cuts of the other with minimal variations. All cryptocurrencies will have the following common characteristics;
- a) Digital
Cryptocurrencies are electronic as opposed to traditional currencies which are paper based. It is electronically held and run on the basis of a community’s agreement on the interpretation of digital bits in accordance with the relevant operating and accounting rules.
- b) Decentralised
Decentralisation is one of the features that distinguish cryptocurrencies from traditional currencies. Its essence is to prevent a small group monopolizing control for their own selfish gain. Access, transaction accounting, issuance, rules, and policies are visible, known and held by most or all participants.
- c) Independence
With cryptocurrencies, you do not have to trust any third party, unlike the traditional currency where you are forced to place your trust on a financial institution such as a bank. It operates independently of integrity, goodwill, practices, and decisions of any particular non-representative group.
- d) Cryptographic
Thanks to their decentralized information architecture, cryptocurrencies leverage on cryptographic data structures such as Merkle trees and hash-chains ensuring intrinsic data integrity. The cryptographic nature allows many people to host data without the ability to alter it.
- e) Identity
Cryptocurrency exists as bits. As such, it is critical to have a way of associating these bits with an account, wallet, agent or owner who can spend them. Therefore, there is always some kind identity or authorization infrastructure which may be an anonymous user. This is achieved through the use of cryptographic private and public keys.
Transaction Verification
All transactions in cryptocurrency such as bitcoin are verified by miners. Miners act as the nodes that verify transactions and include them in a block which then forms part of a longer blockchain. Verification involves the addition of proof of work to a block’s data. Proof of work refers to some kind of information that is usually difficult to generate but easy to verify. Since the process is tedious, miners are motivated by the fact that whoever becomes the first to produce a proof of work is rewarded with some amount of new bitcoins.
Generally, cryptocurrencies have a bright future as they are at the centre of financial technology and innovation.
