C for Cryptocurrencies – which are not blockchain
Although conversations around blockchain, bitcoin and cryptocurrency have largely picked up over the last few years, we still often see confusion in the market around the terminology and differences between blockchain and cryptocurrency. It is time to introduce clarity once and for all and learn what each of these expressions mean.
“Virtual currencies, perhaps most notably Bitcoin, have captured the imagination of some, struck fear among others, and confused the heck out of the rest of us.”
– Thomas Carper, US-Senator, Blockgeeks
What is blockchain?
Blockchain technology combines cryptographic elements with modern computational techniques to create a tamper-evident database. Information is registered in the form of blocks, sealed with cryptography and linked to one another. Blockchain is a revolutionary data structure, which provides the underlying base of cryptocurrencies, just as the HTTP protocol creates the infrastructure for the internet.
What are cryptocurrencies?
Cryptocurrencies are digital currencies built on top of a blockchain network. They are an online medium of exchange, which uses the cryptographic principles of blockchain technology to complete financial transactions.
Cryptocurrencies are public networks, without restrictions on participation. They are not controlled by any central authority, and the power to decide over the course of the network remains between members, known as nodes. These nodes approve new transactions via consensus, link them to the chain and update the shared ledger to earn rewards. During this process, value is exchanged directly between peers, without the need for a central entity.
Cryptocurrencies should not be confused with digital currencies, which are not strictly public. Central bank currencies can be issued on a closed, permissioned blockchain network.
One of the first and at the moment the most widespread example of cryptocurrency is Bitcoin. Bitcoin was invented by the mysterious pseudonym Satoshi Nakamoto in 2008 when he published his open-source code for a peer-to-peer digital currency.
Transactions are validated through the process of mining. This means that a node needs to solve a complex computational puzzle to prove the transaction, add it to the chain and earn a reward. This process has been heavily criticised due to the high amount of computer power consumed during this process. According to a study completed by MIT and the Technical University of Munich, Bitcoin mining contributes as much CO2 to the atmosphere as Kansas city and accounts for 0.2% of global electricity consumption.
The pros of cryptocurrencies
- Efficiency: direct connection between peers allows for faster and cheaper transactions
- Security: cryptographic techniques bring an added level of data security, both in terms of identity protection and ledger manipulation
The cons of cryptocurrencies
- Lack of control: cryptocurrencies do not have a central entity controlling them, which means the responsibility for any error is taken on by the user. Funds cannot be recovered without private keys, nor can incorrect transactions be reversed.
- Complexity: starting to transact with cryptocurrencies comes with a long learning curve, as the technology brings a brand new set of complexities and risks. These include the use of private and public keys, wallets and exchanges and more.
- Technological issues: cryptocurrencies often have a trade-off between scalability, security and efficiency. As blockchains grow, bigger transaction processing becomes more cumbersome and resource-intensive, and thus less viable for the network.
- Pseudo-anonymity: cryptocurrency transactions provide a high level of anonymity to users, which makes it a perfect track for criminals. According to a 2015 Europol report, bitcoin has been featured in high-profile investigations involving payments between criminals, and was used in over 40% of illicit transactions in the European Union.
- Volatility: the market value of cryptocurrencies is highly volatile, with changes of up to 25% happening within hours. This makes it a highly risky store of value.
When it comes to blockchain versus cryptocurrency, we need to remember that:
- Blockchain is the underlying protocol behind cryptocurrency
- Bitcoin (and more widely cryptocurrency) is just one application of blockchain technology. There is more to blockchain than peer-to-peer payments such as provenance in supply chains and timestamping document records.
- Blockchain is primarily a data structure, which can be used in many other environments
- Cryptocurrencies are virtual currencies circulating on a public network without the control of a central authority, enabling peer-to-peer transactions
- Although cryptocurrencies have some benefits such as efficiency and cryptographic security, they have an even larger set of risks and challenges in terms of complexity, volatility and technological hurdles