What is a cryptocurrency?

Introduction

In this article, we are coming back to where we left off in the historic overview of money covered in our article on the history of money.

In the continuous evolution of money, we saw that Bitcoin is the latest iteration that started the new era of cryptocurrencies.

But what is a cryptocurrency, really? In this article we will present what it means, how it works and the different types that exist, but we can already give a general definition: a cryptocurrency is a form of digital money that you can own and hold yourself without intermediaries, and that relies on math and code to operate securely without any central overseeing authority.

More than just any iteration, we can say that Bitcoin and cryptocurrencies are the beginning of a whole new chapter: for the first time in history, we have a real form of digital money.

What do you mean, “real” digital money?

Today's payment options like bank deposits, credit cards, e-cash or mobile banking apps are commonly referred to as being digital. Now that the world has been introduced to Bitcoin, this definition is not exactly true any longer. In fact, one should speak of electronic currencies and electronic payment when talking about these traditional tools.

As Bitcoin allows for value to be exchanged over the Internet, at first glance, it appears to be just one more electronic currency. However, a closer looks that it has many things in common with cash. A Bitcoin transaction is fundamentally different from an ordinary electronic money transfer. Let's see why.

Today's main currencies - US dollars, Euros or Swiss francs, operate almost exclusively on electronic money. An ever-greater amount of consumers pays for goods and services electronically (at least in industrialized countries) whether it be via credit card, online bank transfer or Google Pay, Apple Pay or PayPal. These financial transactions, of course, are extremely efficient and convenient.

But as discussed in our introduction to money, there is one crucial thing to keep in mind: electronic payments are mere entries recorded in a third party-controlled central database. All financial activities are monitored by an intermediary and can theoretically be censored, declined, or confiscated.

A solution to the double spend problem

This is the crucial difference between electronic currency and a cryptocurrency. The latter represent a true digital bearer instrument.

This rather archaic term simply describes an asset that can be owned self-sovereignly, meaning that a person can take actual ownership of it. This is also true for cash (coins and banknotes), but not for the money you put on a bank account. When you do so, the money belongs to the bank, which then has a debt with you. And as you probably know, debts can be defaulted.

Compared to bank deposits or mobile banking money, which are only account-based and reside on a central authority's ledger, a cryptocurrency is a token-based money that represents true equity and is no one else's debt or liability.

This achievement was made possible with Bitcoin, which was the first successful solution to the problem that previous attempts to create true digital money failed to overcome: the double spend problem.

Ever since the advent of digital technologies, there was no way of making sure that digital units of money could not be spent twice (double-spent), unless a central authority would intervene to verify transactions. Without solving that double spend problem, truly digital money could not be possible as there would be no guarantee that units couldn't be copied at will, leading to run-away inflation of its supply and a major trust issue.

With Bitcoin, its creator(s) Satoshi Nakamoto managed to bootstrap a virtual money network in the style of an economic system governed by a well-balanced incentive structure. The system's units are truly digital, meaning that although they are abstract, they cannot be counterfeited or recreated at will.

How does a cryptocurrency work?

You might wonder how can a purely digital object be impossible to counterfeit or duplicate? After all, copy-pasting anything digital is usually trivial.

The answer to this revolutionary technological feat lies in something called the blockchain. Instead of relying on a central authority like a bank or a government to validate transactions and maintain account balances, Bitcoin and most cryptocurrencies operate with a blockchain, a shared public database that is maintained simultaneously by thousands of computers around the world.

Every transaction is batched, verified and recorded in a block, which is cryptographically linked to the one before it, forming a chain going all the way back to the blockchain's very first transaction. Altering any record would require rewriting the entire chain across the majority of the network at once, a task so computationally expensive that it becomes practically impossible.

The result is a monetary network that exists and operates on its own, without any central entity. All its rules are written in its public code and enforced by mathematics and collective consensus rather than institutions.

To learn more about how a blockchain works, read our dedicated article about understanding blockchain technology.

The different types of cryptocurrencies

Bitcoin is the mother of a large variety of other cryptocurrencies. As such, the term “cryptocurrency” is rather ambiguous and does not do justice to the many forms and functions of all these different things. A much better word to generically describe this catalogue and its many items would be crypto-assets, which can then allow us to classify them by purpose and function as shown in the diagram below:

Store of value

As we have seen in our article on the nature of money, the three main roles that money serve are being a medium of exchange, a unit of account, and/or a store of value.

Bitcoin was created to be a new form of digital money, and we can safely say that after more than 15 years of existence, it didn't really succeed in the two first roles. It's not used as a unit of account (almost noone on earth sells stuff with a price determined in BTC) and its usage as a medium of exchange to send and receive value with others remains niche.

We can say however that Bitcoin succeeded in being a store of value. Indeed, its value denominated in fiat currency increases on the long run (+15000% in ten years) and, just like gold, it is a tool to prevent inflation from eating away your savings.

Bitcoin being the largest cryptocurrency by far, we can say that store of value is the first type of crypto-asset. Interestingly, Bitcoin is also the only successful crypto-asset in that category. The other cryptocurrencies that tried didn't break through, and most others were created to serve different purposes as we will see below.

Utility tokens

In the wake of Bitcoin's take off, Ethereum was created in 2015 to offer something that Bitcoin did not: the possibility to code pretty much anything on a blockchain via smart contracts. With it was born the first blockchain that was better described as smart contract platform, where the native cryptocurrency of the network, ETH, was the main asset to use the platform.

The concept of utility token was born: a crypto-asset that is required to use a platform or a service. As examples of utility tokens, we can list:

• ETH, BNB, SOL: used to pay for transactions made on their respective networks and to pay for the deployment of smart contracts.
• LINK: used with Chainlink's price oracle services.
• BAT: used with the Brave browser for advertising and tipping.
• TON: used for services and integrations within the Telegram ecosystem.
• BTT: used for file sharing and storage within the BitTorrent ecosystem.

Stablecoins

Another key category of crypto-asset, stablecoins are cryptocurrencies that are designed to follow the price of a traditional fiat currency, like the dollar, the euro or the Swiss franc. They can achieve that peg by various techniques, some are centralized and some are decentralized, but they all serve the same purpose: allow users to switch their funds to a non-volatile reference currency while remaining on chain.

Stablecoins allow users to exit volatile crypto positions while remaining on-chain, avoiding the friction of converting back to fiat. They are also widely used for cross-border transfers and payments, combining the speed and accessibility of crypto with the price predictability of traditional currencies.

The three main types of stablecoins are defined by how they are backed and how they maintain their peg:

• Fiat-backed stablecoins (USDT, USDC, EURC): each token is backed 1:1 by fiat currency or equivalent reserves held by a centralised issuer.
• Crypto-backed stablecoins (DAI, ZCHF, fxUSD): backed by crypto collaterals locked in smart contracts, maintained through over-collateralisation.
• Algorithmic stablecoins (USDe, frxUSD): use supply-and-demand mechanisms rather than direct backing.

Privacy coins

Privacy is another distinctive feature of some crypto-assets. While Bitcoin or Ethereum are pseudonymous (and not anonymous), so-called privacy coins are privacy-focused by default. Transactions happening within their network are anonymous as their ledger is obfuscated using different cryptographic means. With Bitcoin, privacy features can be achieved off-chain as well, while with crypto-assets like Monero or Zcash anonymity is built into the public blockchain itself.

Meme coins

As its name indicate, a meme coin is a joke embodied in a cryptocurrency. It doesn't serve any other function that the fun it represents, and its price is usually linked to the virality of the meme itself.

Asset tokens

Last but not least, asset tokens are crypto-assets that represent a right to something, which means it's a very diverse category. But inside it we can identify three main sub-categories:

Real world assets (RWA)

A real world asset (also known as a security token) is the tokenized version of a traditionnal asset that is already defined and regulated by law. Shares (like the MPS token), bonds (like Circle's USYC, a tokenized short term US T-bill), funds (like BlackRock's BUIDL token), precious metals (like XAUt and PAXG) or real estate (like RealT tokens) are prime examples of off-chain assets that can be brought on-chain in a tokenized form.

Governance tokens

Very present in the DeFi ecosystem, governance tokens are crypto-assets that provide to participate and vote in the decision-making process of an entity, usually a decentralized protocol or a DAO like Aave or Uniswap.

NFTs

A non-fungible tokens (NFT) is a non-mutually interchangeable (i.e. each token is unique) token representing ownership of unique asset, whether from the real world (art, collections) or from the blockchain world (crypto art, collectibles, etc).

Why do cryptocurrencies matter?

To conclude this article, let's elaborate on why crypto-assets are a positive addition to today's world of financial assets.

First, the unique case of Bitcoin must be brought forward as a store of value. Its absolute digital scarcity is a deep innovation, as it is the first decentralized online asset able to provide a hedge against inflation and today's ever accelerating credit expansion and aggressive monetary policies. Thanks to Bitcoin, anyone anywhere in the world can access such a hedge easily, even with a few dollars.

Then, beyond Bitcoin, the factor that is common to all crypto-assets is self-custody. All the different types of cryptocurrencies discussed above can be held self-sovereignly on your own wallet, without intermediaries and with no possibilities to seize or block funds in most cases (some stablecoins and RWAs are centralized and can be censored).

Finally, cryptocurrencies are also revolutionary for payments: money and assets can be sent and received by anyone, anytime, anywhere in the world, virtually instantly, and with zero to low costs. Considering that cross-border payments have traditionally be a territory of opaque and high fees closely guarded by banks, cryptocurrencies bring a real disruptive power in the payment sector.

In a world where financial privacy is continuously undermined and offshore banking solutions are being fought vehemently, the new alternative realm of cryptocurrencies that allow for more financial privacy and more financial self-control should be highly welcomed, as competition is generally a good thing that benefits users and consumers.

What is so enticing about crypto is the fact that it mainly comes in the form of a peaceful protest. Crypto-assets and their networks don't destroy. They offer a better, faster, more reliable, and honest alternative. Compared to traditional systems, they offer a better global interoperability and a higher social scalability by design.

But they do not only represent an asymmetric bet against the current system. Crypto-assets are programmable money, which allows for deeper innovation unseen before.

With all these positive, constructive features of Bitcoin and crypto-assets, it is important to bear in mind the fact that the crypto ecosystem is not perfect by any stretch of the imagination.

All it offers is a true alternative: a monetary system that is based on a non-dilutive, non-politicized form of digital money. On top of this, it offers a new financial system with many amazing features that nobody would have thought possible just a few years ago.