To properly illustrate how it came about, let’s start with the early beginnings of cryptocurrency, in contrast to traditional fiat currency, and how it works and serves a need in modern society. Some form of currency is necessary for humans to have an agreed upon medium of exchange with a level of inherent value attached to it. This makes for easy trade and sets an even playing field for the exchange of goods and services between the public and merchants providing them. Before the Great Depression, “notes” or what we would consider a bill, used to bear the phrase “payable to the bearer on demand”. This signified that these government issued notes were backed by, and could be redeemable in precious metals, such as gold and silver.
The issue that has arisen over the years is the extreme deviation from the gold standard (Since 1933) and in turn, devaluation of the dollar. Since many currencies around the world are in some form, tethered to the US Dollar, this is not a national issue, but a potential global one. A small group of visionaries in the 1990’s saw this playing out and knew they had to act accordingly.
This vision came in the form of Bitcoin creator, Satoshi Nakamoto. In 2008, Bitcoin was launched sparking a global phenomenon, to this day not yet fully realized. This became the world’s first cryptocurrency. However, prior to Satoshi’s most notable creation, there had been earlier projects.
As early as 1998, computer scientists Wei Dai and Nick Szabo had already proposed two other independently distributed digital money networks, called B-Money and Bit Gold. These projects would set the stage for digital money and introduce the most necessary component of all cryptocurrencies to this day, Blockchain technology.
Explained in simple terms, cryptocurrency is a digital form of money, able to be exchanged and sent from wallet (digital) to wallet across the world at lightning speed, without needing to go through a bank or financial institution. This digital money can be used to buy goods and services, but can also be used to transfer large sums of wealth across the globe, extremely quickly, efficiently, and securely. These transactions are encrypted, to prevent any unauthorized access to information, while being processed. This is why we call it CRYPTOcurrency, due to its encrypted, or coded, nature.
As mentioned before, all these transactions occurring simultaneously, need a place to be verified and a “master” log, called a ledger, must be kept, and maintained in order to keep a record, much like traditional banking would. This “place” is called the Blockchain.
What is a Blockchain?
Simply put, the blockchain is a digital landscape, where all the transactions occur and are processed, and the ledger of data is recorded. This blockchain in essence, is the portion of the cryptocurrency technology, which truly replaces the need for a central bank. Traditionally, when someone sends or receives money, it needs to go through a financial institution to verify the funds are available to be sent and can be deposited into the other bank account. This typically takes days, incurs a service fee of some kind, and has strict limitations on the amount that can be sent and timeline constraints, due to banks only operating during standard business hours.
All these points are non-issues with the inception of blockchain technology. This digital landscape has a running log (ledger) of all transactions that are occurring, and have occurred in the past, and are verified by computers in a peer-to-peer type fashion. Much like the internet protocol we all use daily, with file and information sharing, this technology has similarities. Instead of sharing files, the blockchain is sharing encrypted/secure data from computer to computer, each doing its job to validate the money is available, through the solving of a complex, and encrypted, algorithm. This algorithm was designed specifically by Satoshi Nakamoto, to do explicit instructions and is exclusive to the Bitcoin network. Other cryptos have different validation mechanisms and protocols.
As outlined in Satoshi’s 2008 Bitcoin White Paper, the Bitcoin protocol is “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double-spending.
We propose a solution to the double-spending problem using a peer-to-peer network. The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work, forming a record that cannot be changed without redoing the proof-of-work”.
This “proof-of-work” solution Nakamoto details is involving the use of physical computing power using graphics cards, computer processing chips, etc. to crunch or “Hash” the data and form a verifiable, chain of events. Groupings of multiple verified transactions form a block and many blocks that are verified, from computer to computer, then form a chain, hence the name blockchain. If one link in the chain were to be changed, the entire chain after it would not be valid or verifiable. This is what makes Blockchain so secure and supreme to traditional banking and institutions.
Once this process is complete, the funds in the form of BTC are sent to the desired wallet and are digitally timestamped into the Bitcoin Blockchain records forever. The wallet these funds are sent to is not the old, worn, leather wallet we keep in our back pocket, but the 21st century form, digital wallets.
How Do Digital Wallets Work?
A digital wallet is exactly what one would think of when hearing the words. A digital version of your financial accounts and statements, able to be accessed by some form of Internet connection. The contents of the wallet can be viewed by simply logging into the wallet, from a computer or smart device, much like online banking. Just like choosing which checking account has the most perks, there are a large variety of different companies offering competitive digital wallet features. Of these features include, paying compound interest for storing your cryptocurrency with them, giving cash back type benefits for using crypto instead of US dollars, and even issuing credit lines and cards backed by your own cryptocurrency assets. This essentially makes it possible for each crypto holder to be their own bank and leverage the digital assets they already own to make other purchases or embark on a business venture.
Since the emergence of smart phones loaded with apps, these digital wallets have become integrated with the times. These wallets used to be stand alone and much more basic, only allowing for funds to be deposited or withdrawn in that specific cryptocurrency, whether it be BTC, ETH, or any of the many others.
Now with cash-apps like Venmo, Zelle, and Apple Pay, one can access the crypto they hold through the use of an intermediate application, called the application layer or layer-2, to send payments, exchange for another form of cryptocurrency, or borrow against the crypto they already hold and store in these wallets.
Digital wallets are extremely secure due to the encrypted nature of their design. Digital wallets also add another layer of security using something called “tokenization”. This means instead of sending your card numbers and data directly through a payment gateway, like a card processing machine, each digit of data is encrypted and represented as a token that can only be used if matched properly to the merchant’s payment gateway/portal.