Crypto guide for beginners
In this blog post we would like to introduce you to the fundamentals of blockchain technology, we help you find out what cryptocurrencies are and examine the most important ones. Don't miss it!
In 2021 one of the hottest topics in the financial services industry is cryptocurrencies. Despite the fact that not only retail investors but more and more large financial institutions and well-known corporations are starting to invest in Bitcoin and other cryptocurrencies, most of the world’s population doesn’t even know what these are. In this blog post we would like to introduce you to the fundamentals of blockchain technology, we help you find out what cryptocurrencies are and examine the most important ones. In the end, we’ll also take a look at the relationship between fintechs and cryptocurrencies. So without further ado let’s jump into this interesting buzz-topic!
Blockchain
So what the heck is crypto, anyways? Cryptocurrencies are a unique medium of exchange because they have no physical form and they only exist digitally. Cryptocurrencies are stored and traded on an online public ledger called the blockchain. In order to understand cryptocurrencies, first we must understand their basis, which is the blockchain technology. Simply put, blockchain is a special type of database. But what makes this database so special? Well, it is shared across millions of computers all around the world, which form a network together. When someone initiates a transaction on the blockchain there will be a record of it. Several nodes of the network (the other computers) check and verify the transactions and make sure that they are valid by using difficult computing methods and algorithms. These validators are called miners whose jobs are rewarded with cryptocurrency (e.g. BTC, if the miner validates the Bitcoin blockchain). This is called the proof-of-work (PoW) method for blockchain verification. Then a certain amount of transaction data is bundled together and formed into a “block”. Every block has a unique hash code, which contains a part of the previous block’s hash code. A new block is added to the blockchain by linking it to the previous block and getting timestamped, which makes it virtually impossible to hack. Let’s see an example. Assume that the miners are working on the 42nd block. Then a malicious user decides it wants to manipulate the transaction data of the 24th block for instance. In order to do that, it has to change not only the 24th block’s data but all of the consequent blocks’ data as well! Therefore it must alter 18 blocks before the other miners finish working on the 42nd block. In order to do this, one needs to hijack at least 51% of the network’s nodes at the same time. Now imagine trying to do this on a larger scale with millions of blocks and computers.
Therefore with the help of blockchain technology cryptocurrency users can eliminate the middleman of the transactions by creating a peer-to-peer (P2P), decentralised financial system, where there is no need for banks or other regulatory institutions in order to manage their personal finances. This is one of the most powerful benefits of cryptocurrencies. Before Bitcoin was invented, the only way to use digital money was through an intermediary, such as banks. Even then, governments issued and controlled the money that people used. By creating a decentralised currency, cryptocurrencies let people trade directly without the need of an intermediary, which was a real game changer. The following figure visualises the whole process of how blockchain technology works.
Cryptocurrencies
Now that we understand the basics, let’s learn about the cryptocurrencies themselves. However the name cryptocurrency might be misleading. Most of the crypto projects people invest their money in have nothing to do with currencies, although they can be grouped into certain categories. For example VeChain is considered to be a supply chain type of cryptocurrency, while there exist decentralised finance (DeFi) projects like UniSwap or PancakeSwap: DeFi projects are focusing on taking out the middleman of the transactions, as it was mentioned previously. There are privacy coins like Monero, which focus on being an anonymous decentralised currency like the original vision of Bitcoin and of course there are currency coins as well like - again - Bitcoin or Litecoin.
Everybody heard about Bitcoin (BTC), the first and most popular cryptocurrency but as you might have already seen, it’s not the only one. Nowadays there exist thousands of different cryptocurrencies (or in other words, coins). These “other coins'' besides Bitcoin are called altcoins (alternative coins). Ethereum (ETH) is the largest and most important one amongst them, although there are several promising altcoins, which also hold great potential. In this blog post however we will focus only on Bitcoin and Ethereum, the two largest ones. At the moment of writing the article (May 4th, 2021), the market capitalisation of cryptocurrencies stood at more than 2 trillion dollars, meaning that more money lied in the crypto market than in companies like Microsoft, Amazon, Alphabet or Facebook, whose market capitalisation are each below 2 trillion $. In the last two months, however, the price of BTC halved, which decreased the crypto market cap from 2 trillion dollars to 1.29 trillion. The following tables from www.coinmarketcap.com1 compare the top 10 cryptocurrencies by market capitalisation from May 4th, 2021 and July 19th, 2021:
Some cryptocurrencies have their own blockchains on which they operate. For instance Ether (ETH) has its own network, called Ethereum, while Binance Coin (BNB) uses the Binance Smart Chain (BSC). ETH and BNB are native coins but there exist many other tokens which don’t have their own network. Chainlink (LINK) is a great example because it is an ERC-20 token, which means it works on Ethereum’s blockchain. Besides Chainlink, there are thousands of ERC-20 tokens, which operate on the Ethereum network. ERC-20 stands for the technical standards that are required from a token in order to be deployable on the Ethereum blockchain. The reason why Ethereum is so popular is because people can manage smart contracts, projects and apps on its network. But before we examine Ethereum, first we should take a look at Bitcoin, the most important cryptocurrency with which everything began.
Bitcoin
Bitcoin (BTC) is an open-source peer-to-peer technology, which is meant to be an electronic cash system. The idea of Bitcoin was invented back in 2008 by Satoshi Nakamoto whose identity is a mystery for the world. Today we still don’t know who is behind the name, though he/she/they created something truly revolutionary, which might change the whole financial industry forever. If you are really interested in the details of the technology, you can find Bitcoin’s whitepaper here2.Bitcoin was launched in January, 2009 and since then its price skyrocketed from $0 to an all time high of $64,000 in April, 2021! There are two main reasons behind that. The first one is that the number of mineable Bitcoins are maximized in 21 million BTCs, which makes it really scarce. The second is coming from Bitcoin’s deflationary nature. That means BTC is hedging against inflation by halving its mineable supply approximately every 4 years. The predetermined supply and its halving process are written in Bitcoin’s immutable code, making it an interesting investment opportunity for more and more individuals and companies. Because Bitcoin’s price is extremely volatile people started to not consider it as a currency but rather a store of value whose price is going to greatly increase over time. That’s why many people tend to consider it as “digital gold”. However, Bitcoin is still regarded as a speculative asset and because of this one should invest in it really cautiously. The following diagram shows how Bitcoin’s price exfoliated over the years:
As you can see on the graph, the price of BTC moves in cycles. This means that after every halving there is a sharp increase where Bitcoin’s price goes parabolic, which is followed by a 50-80% drop. Although there is a significant decrease, the price stays above the previous cycle’s all time high. Currently, we are in the 4th Bitcoin cycle, which means that 3 halvings have already happened before (2012, 2016, 2020). The last halving was issued in May, 2020, meaning that we are in a Bitcoin “bull market” right now, whereas the price of BTC steadily increases (with some necessary corrections). However, this bull market will not last forever and a “bear market” will eventually come when the price will sharply drop. The next Bitcoin halving is projected to happen in 2024. Although Bitcoin is regarded as a store of value in the long run, numerous companies that invested in it have started to accept BTC as a payment for their products/services. According to FXCintelligence, leading payment processors and card networks such as Visa, MasterCard and PayPal have all announced that they will accept cryptocurrency payments in the future. This suggests that cryptos slowly but steadily are getting to the point where they can become mainstream.
Bitcoin has many advantages, however, its major drawback is the extreme energy consumption. Bitcoin mining requires a tremendous amount of electricity which is coming from the numerous computers and video cards that miners use. In fact, with more than 110 TWh/year Bitcoin’s energy consumption is larger than Belgium’s.
Yet, this might lead to a positive outcome because BTC’s unsustainable electricity consumption could incentivise people to a faster change for more sustainable and renewable energy utilisation with the use of solar-, wind- and water power. On the other hand, around 56% of Bitcoin's energy consumption is already backed up by renewable energy usage.
Ethereum
Now that we saw how Bitcoin works, let’s take a closer look at the second largest crypto by market cap, Ether. You could ask, what is the difference between two cryptocurrencies if they are all based on the same technology? Well, the answer might surprise you because there are huge differences between the two. Ethereum uses a more advanced technology than Bitcoin whereas it doesn’t only let you send and receive cryptocurrency but it also powers applications that everyone can use and no one can take down. It was first proposed in 2013 by Vitalik Buterin but it was only launched later in 2015. The main difference between the blockchain of Bitcoin and Ethereum is that the latter is programmable which enables users to manage it for different digital assets. Ethereum is a platform that is specifically designed for people to build decentralised applications (or in other words DApps) on it. Once a DApp or a program is deployed on Ethereum’s blockchain network, the nodes will ensure that it executes as it is written. Basically it is an infrastructure of the running DApps worldwide, which means Ethereum itself is not a currency but a platform. Ethereum’s currency is called Ether and it is earned by miners for their jobs, the same way as Bitcoin. Ethereum is constantly developing its platform and they decided to use the proof-of-stake (PoS) concept instead of the previously presented proof-of-work method. What does this mean? Well, in case of a PoS validation an individual can mine and validate the transactions of a blockchain in accordance with the amount of coins he/she holds. Therefore the more coins a person disposes the greater mining power he/she has. Unlike the PoW method, PoS is a much more environmentally friendly solution as there is no need for huge crypto mines, which have Kazakhstan-sized energy consumption (as in the case of BTC).
The goal of Ethereum is to fully decentralise the internet. Right now we can’t say that the internet is truly decentralised because huge corporations such as Google, Facebook or Amazon have too much control over it. Ethereum’s initiative is to eliminate 3rd party platforms and companies by allowing people to connect with each other directly without a central authority. That sounds great, but how does Ethereum want to achieve that? Well, the answer is Ethereum’s coding language, Solidity which is used to write so-called smart contracts. Smart contracts are the logic behind DApps. What makes a contract smart? According to Ethereum’s own definition cited from their website3,a smart contract is:
“... a program that runs on the Ethereum blockchain. It's a collection of code (its functions) and data (its state) that resides at a specific address on the Ethereum blockchain.”
They are called smart contracts because they deal with every aspect of a contract (e.g. payments, performance, management, etc). Once a smart contract is deployed on the blockchain it will run as it’s programmed, hence it can't be controlled by any user, not even the one who programmed it. However, users can interact with smart contracts by submitting transactions that execute specific functions which are defined in the contract. For instance, in the case of a smart contract that is used to pay rent, the landlord does not need to actively collect the money because the contract or DApp knows whether the money was actually sent or not and it acts accordingly. Similarly to traditional contracts, smart contracts can define rules as well and they can enforce them automatically via the code.
While Bitcoin is often regarded as “digital gold”, people tend to refer to Ethereum as “digital oil" or "digital electricity" because it is going to power all the apps and services that we will use in the future. It holds great potential but only if software engineers can keep constantly developing its functions therefore providing solutions for real problems.
Fintechs and crypto
Now that we explored the world of cryptocurrencies, let’s examine its relationship with fintech companies. Cryptocurrencies are often considered as one of the greatest innovations of the financial world, while fintech companies are the biggest innovators of the industry. So it seems evident that their paths will eventually cross in the future. Oh, wait. Their paths already have crossed! A great example for this “crossroad situation” is Revolut, which is one of the largest neobanks in the world. By using the Revolut mobile app, users can buy, sell, withdraw cryptocurrencies and transfer them to their friends through the application. Besides Revolut, the German neobank N26 is also planning to extend its functionalities with crypto features (e.g. trading tools), as part of a new marketplace initiative.
Another fintech company that uses cryptocurrencies is Strive4,whose mission is to teach kids about financial literacy and cryptocurrencies in a fun, easy and safe way. They are doing this by using an interactive piggy bank, called Penny the Pig, which is the very first tool of its kind. Strive is a comprehensive service package, containing an app, a piggy bank and a platform that lets parents display the holdings of a crypto wallet (initially Coinbase) to kids in a fun and interactive way. It integrates its app with the physical piggy bank and a Coinbase wallet. Coinbase is one of the largest online cryptocurrency exchange platforms by trading volume in the United States. More than 68 million people use crypto wallets worldwide, out of that 56 million are using Coinbase wallets. Moreover, Strive is planning to extend Penny’s features with a “mining function” which will enable the piggies to mine Bitcoin. Furthermore, Strive is also penetrating the NFT (Non-Fungible Token) market by launching its own TopMinds series. These are digital 3D characters which represent famous historical people and they are meant to help children to learn about finance and investments in a more entertaining way.
Conclusion
With more than 1 trillion dollar market capitalisation it is clear that cryptocurrencies are going to stay with us. This is even more incredible in the light of the fact that they achieved this within just 12 years. The following figure puts this into perspective:
With more and more companies, financial institutions and banks investing in crypto, it will slowly but steadily become part of our lives. It might take 5, 10 or 20 years but we do believe that in the constantly evolving, digital world in which we live, cryptocurrencies will have a huge impact.
We hope that you found this blog post useful! Do not hesitate to follow us, so you won’t miss interesting stories in the future either. This article was provided by Bence Siklós, Business Analyst at ff.next.
1 http://www.coinmarketcap.com
2 https://bitcoin.org/bitcoin.pdf
3 https://ethereum.org/en/developers/docs/smart-contracts/
4 https://www.strivefam.com/
Sources
IP Specialist, 2019. How Blockchain Technology Works.
Murray, M., 2018. Blockchain explained.
Reiff, N., 2020. What Is ERC-20 and What Does It Mean for Ethereum?
Kelemen, Sz. 2021. Bitcoin Price History Chart Since 2009.
Ingham, L., 2021. The future of crypto payment enablement.
Bitcoin’s Energy Consumption Index
Frankenfield, J., 2021. Proof of Stake (PoS)
Anthill Magazine, 2021. Penny the Pig: World’s pioneering kid-friendly Bitcoin piggy bank unveiled.
Ali, A., 2021. Bitcoin is the Fastest Asset to Reach a $1 Trillion Market Cap.
