To understand cryptocurrency, it’s best to start with the most popular and in many ways the simplest of these networks: Bitcoin
Bitcoin is the world’s first completely decentralized, open-source, and peer-to-peer digital currency. A short decade ago, knowledge of it was confined to a handful of hobbyists on Internet forums. Today, the bitcoin economy is larger than the economies of some of the world’s smaller nations. The value of a bitcoin (or BTC) has grown and fluctuated greatly, pennies to many thousands of dollars.
No Third Parties
Until Bitcoin’s invention in 2008 by the unidentified programmer known as Satoshi Nakamoto, online transactions always required a trusted third-party intermediary. For example, if Alice wanted to send $100 to Bob over the Internet, she would have had to rely on a third-party service like PayPal or MasterCard. Intermediaries like PayPal keep a ledger of account holders’ balances. When Alice sends Bob $100, PayPal deducts the amount from her account and adds it to Bob’s account. Without such intermediaries, digital money could be spent twice. Imagine there are no intermediaries with ledgers, and digital cash is simply a computer file, just as digital documents are computer files. Alice could send $100 to Bob by attaching a money file to a message. But just as with email, sending an attachment does not remove it from one’s computer. Alice would retain a copy of the money file after she sends it. She could then easily send the same $100 to Charlie. In computer science, this is known as the “double-spending” problem and until Bitcoin, it could only be solved by employing a trusted ledger-keeping third party. Bitcoin’s invention is revolutionary because, for the first time, the double-spending problem can be solved without a third party.
Bitcoin does this by distributing the necessary ledger among all the users of the system via a peer-to-peer network. Every transaction that occurs in the bitcoin economy is registered in a publicly distributed ledger, which is called the blockchain. New transactions are checked against the blockchain to ensure that the same bitcoins haven’t already been spent, thus eliminating the double-spending problem. The global peer-to-peer network, composed of thousands of users, takes the place of an intermediary; Alice and Bob can transact without PayPal. One thing to note right away is that transactions on the Bitcoin network are not denominated in dollars or euros or yen as they are on PayPal, but are instead denominated in bitcoins. This makes it a virtual currency in addition to a decentralized payments network. The value of the currency is not derived from gold or government fiat, but from the value that people assign to it. The dollar value of a bitcoin is determined on an open market, just like the exchange rate between different world currencies.
Bitcoin is not the first permissionless, decentralized, peer-to-peer payments technology in the world. Paper cash is. If someone hands you a banknote, that is a settled transaction. There were no intermediaries and no one knows about it but the two parties involved. Until now it has been unfortunately necessary to include a third party to make these transactions online. And those third parties see everything.
What makes Bitcoin remarkable is that it is the first internet payment system that is that resembles physical cash. Now, instead of being limited to using cash only with people who you interact with face to face, or taking the chance on mailing bills, you can send digital cash in the form of bitcoin to anyone in the world.
There have been countless attempts to build on the Bitcoin system we’ve just described. Technologists have been experimenting with ways to build functionality into the Bitcoin network, or have opted to try to build entirely new networks built with similar decentralized designs and native tokens. These projects have given us hundreds of other cryptocurrencies. They are testing a host of experimental new features, from sophisticated programming languages, enhanced privacy, different forms of mining, and much more.