3 Oct 2020 | Crypto Column
While most newcomers to the world of Crypto can quickly understand the basic principles, nailing down more nuanced terminology is more difficult, especially using an analogy-based learning process, such as is necessary here. The learner may all too quickly utilize an equivalence where one does not exist. For example, “cryptocurrency” and “digital currency” are not the same thing, though they are both “digital”.
Our understanding advances with appreciation that “digital” as we use it in this context, is part of a growing and rapidly evolving ecosystem that includes digital entities, communication forms, quantum mechanics and artificial intelligence. Something similar may be said about the terms “blockchain”, “hashing”, “token” and indeed, pretty much all the critical nomenclature associated with cryptocurrencies. As a consequence, a number of analysts reflect that the crypto market and the underlying wider-use technologies are “widely misunderstood”.
Moving towards greater clarity requires the realization that we are studying overlapping and interacting digital infrastructures, where dynamics in one affect the others in such a way that frames the whole process of analysis and conclusion. As in the consideration of quantum theory, a shift in mindset is required to grasp the thing being examined.
In similitude then, cryptocurrencies must be seen as a “species” in the midst of an evolutionary process, but moving so fast that our taxonomic chart needs to be redrawn almost every week — with particular attention being drawn to paths of convergence, divergence and interaction as well as updated terms and changing definitions used to describe these dynamics.
As if these challenges were not enough, it is the nature of competitive environments that misunderstandings and false associations are deliberately exploited by Marketing to leverage confidence — and cash — from uninformed traders. This and FOMO (“fear of missing out”) are key drivers of so-called “bubbles”. “Digital” per se, does not convey value, but the hype suggests it does. Conversely, the potential threat that cryptocurrencies represent to existing financial institutions — including central banks — shapes the narrative they insert into the market place in a distinctly negative fashion, seeking to undermine and, therefore, dissuade would-be investors.
Having made it clear that our need is to understand the whole ecosystem, we are in a position to identify and deconstruct one of the core constituent elements of our multiverse, the cryptocurrency itself. We will consider a number of critical questions, two here, and the rest in subsequent articles.
“Cryptocurrency refers to a type of digital asset that uses distributed ledger, or blockchain technology to enable a secure transaction” Härdle et al (2020).
As to characteristics, we consider the three which define all the others:
Trustless in the autonomous sense of minimizing the amount and type of trust required from other parts of the ecosystem. In a fiat system, this is often the bank or credit card company that are a proven centralized intermediary-facilitator of any given transaction. With cryptocurrencies this is replaced by a protocol based on a peer-to-peer execution technology. At this juncture faith in the bank or other commercial intermediary is replaced with something more worthy of our confidence since it is faster, safer and inviolate.
Thus, the significance of blockchain technology is the innate characteristics that yield the very highest levels of autonomy, privacy and security. This is because every element of the transaction’s history is publicly recorded yielding the de facto immutability just noted; it is extremely difficult to undo history, doubly so when the additional cryptographic algorithm labeled “hashing“ is taken into account.
The particular type of blockchain used for most cryptocurrencies is decentralized. Essentially this means there is no logistical locus, no singular entity to control it, and no infrastructural crux to be compromised; the architecture is ubiquitous throughout the whole system. The genius is that these elements have been designed to act together in perfect synergy; they behave like a unitary system that inherently possess extremely high levels of resistance to error, external attack and corruption. This protects both asset and asset transaction. Not only does this mean an almost flawless and instant payments system, but — when it comes to crypto — a currency whose value is free from individual, consortia or government ability to arbitrarily impact supply. Thus, immune to any form of quantitative easing, the intersection of supply and demand are the only two forces determining its value.
That having been said, a qualification to the supply factor must now be introduced. The established cryptocurrencies are either limited to a finite supply or to publicly predefined and timetabled production parameters, many tailing off to zero. This introduces predictability now largely absent among fiat currencies.
At this juncture, it also needs to be restated that blockchain is a very advanced form of digital communication independent of the role it plays in cryptocurrencies; a potentially ubiquitous and quickly growing ecosystem with many other uses. As a result, blockchain in its centralized form is expected to replace much present-day commercial infrastructure within the next decade, allowing faster, cheaper and more secure transactions. Equally, current developments are taking place as regards the transmission of health and other sensitive data. Perhaps the most headlined adopters of this type of blockchain are the central banks.
If this is good news for the future of blockchain technology, it adds to the confusion surrounding cryptocurrencies as central banks introduce digital Yuan, Dollars and Pounds, as well as a variety of coins and token under the “crypto” label. Include these are it is crystal clear that cryptocurrencies are growing in type while increasing in divergence. Outside dissecting them individually, the best way of starting to make sense of them is to identify which of the seven broad classes each belongs:
Bitcoin — the original cryptocurrency — was designed as a transactional mechanism but quickly became an asset.
Ethereum — another well-known coin — examples a distributed computational token, a decentralized virtual machine which executes scripts using an international network of public nodes. This infrastructure now serves as the platform for over 1,900 other cryptocurrencies and tokens charging transactions or “gas” fees in ETH.
Utility tokens such as Golem, which as the same suggests, is used to secure some form of utility, in this case unused computational resources for memory-intensive tasks. Services are paid for using the company’s own cryptocurrency, the GNT.
Security tokens are a form of crypto species tied to stocks, bonds, derivatives, or other financial assets. The first of these at a governmental level was Venezuela’s finite token, El Petro, secured by the nation’s oil reserves.
Fungible tokens are really a broad class that represents the overwhelming majority of cryptocurrencies. Fungibility implies digital assets created so that each individual token (or fraction of a token) is equivalent to the next. One Bitcoin or fraction of a bitcoin is always equal to one Bitcoin or the same fraction of another Bitcoin.
Non-fungible tokens owe their popular consciousness to Crypto Kitties, digital kittens possessing an utterly unique cryptographic token identity. Non-fungible tokens are thus not mutually interchangeable but designed for verifiable scarcity, digital ownership, and interoperability across multiple platforms.
The number and complexity of the terms embraced in this article has been deliberate. Our purpose has been to create awareness of the amount and diversity of information that must be understood if the cryptocurrency ecosystem is to be truly engaged. More particularly, the need is not for mere information but for integrated thinking. The successful cryptocurrency trader is one who has learned to think in parallel with market dynamics and identify the first principles driving it, not merely to have collected facts and definitions. Even then this is not the end of the journey, but the very beginning.