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Demystifying Cryptocurrency

Cryptocurrency has been major talking point over the last 12-18 months for many reasons. For those who got into the market in 2017 or before, cryptocurrency has been a great investment with tremendous upside but if you’re new to the market, you would have been victim to a harsh bear market. Not only are people divided by the gains or losses, people are also divided over the future of cryptocurrency and whether or not it is good for society. 

The amount of F.U.D (fear, uncertainty and doubt) and bad press around cryptocurrency  has made some afraid to invest or even flat out against cryptocurrency. But most of the doubt arises as a result of not having a clear understanding of what cryptocurrency actually is. This article is written with the hope of giving you a clear understanding of what cryptocurrency is, and shedding light on some of the major misconceptions being spread. 

Before we get into cryptocurrency itself, we first have to ask ourselves, what is currency?   Bheemaiah defines “currency” as the part that actually facilitates exchange of value. This exchange of value can take on different forms, and “currency” has therefore included the exchange of physical assets for trade (for example, precious gems, oils, or even salt), as well as embodiments of value in the form of coins or paper bills.

Now let’s have a brief look at the history of cryptocurrency. Bitcoin was the first ever cryptocurrency and was invented in 2008 in response to the global financial crises. It was clear that something was wrong with the existing monetary system and bitcoin set out to be an alternative to this system. It was designed to be a peer-to-peer, decentralised currency based on cryptography that could not be governed by a central authority, and the blockchain was invented so that bitcoin could function as intended. 

The successful invention of bitcoin, has led to the invention of many alternative coins, or “altcoins”.  Some compete with bitcoin with different properties and different purposes.  However, there are over 1500 different cryptocurrencies and so this is where it all starts to get a bit confusing. As such, we can segregate cryptocurrencies into 3 major categories:

Cryptocurrencies Designed to be Digital Cash

Encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds. It is programmed digital scarcity with its own monetary system and its primary function is the transfer of value over the internet without the need for intermediaries such as banks. This comes with some controversy because of its potential to disrupt and even replace traditional fiat money, traditional banking and even the monetary system. It allows individuals to send and receive value as easily as sending and receiving an email.  Very few of  the 1500+ cryptocurrencies fall under this category. Examples however include Bitcoin, Bitcoin Cash, Zcash, Dash, Monero, and Decred.

Utility Tokens

The primary function is not to be a currency but rather these are services or units of services that can be purchased and are used to access the service. (Blockchain based businesses). Utility tokens confer a right on the holder to participate in the network in some way. Such tokens may give holders a right to use the network and take advantage of its services to vote on the governance of the network and its upgrade. Most blockchain startups are utility tokens. Some examples of utility tokens are Ethereum, EOS, Cardano, IOTA, Populous, Augur, Basic Attention Token, Golem. To access and use these blockchain startups, you need to use their token.

Tokenized securities 

These tokens represent digital shares of a business as well as digitising traditional commodities and physical assets, creating a new area of interest for blockchain technology. Equity ownership is being tokenised, especially in start-ups and private companies, which is a type of equity that has traditionally been inaccessible to retail investors. Even traditional companies, which have typically accessed capital through public markets, are exploring using blockchain-based tokens to raise capital in exchange for equity. One of the key benefits of tokenisation of equity ownership is liquidity, especially for venture investments and private equity investments that have historically been illiquid and associated with long lock-ups of 5 to 10 years. This has limited the investment in these types of equity to investors who are able to leave capital in these investments for a long time. Tokenised equity enables investors to trade positions in real time as the risk profile of a company changes. In addition, it provides increased transparency, so that investors can actually confirm how many shares have been issued, as well as validate the ownership of those shares.

Hopefully the above has provided a better understanding of the three major categories of cryptocurrencies and so it is worth clarifying one more confusing topic. What’s the difference between a coin and a token? It is worth noting that these two terms are often used interchangeably. Very broadly, a  coin is just that: a coin, or means of payment, whilst a token has wider functionality. 

I hope this short article has helped to shed some light on this mysterious new world. In addition to being a new asset class, with tremendous potential and investment opportunities, cryptocurrencies are powered by the blockchain is a paradigm shift. It opens up a new way of thinking about money, value transfer, business and the economy.  As such, we may see a future where cryptocurrency is at the heart of our new shared economy.