Explained: The Basics of the Cryptocurrency

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Basics of the Cryptocurrency : That cryptocurrencies are decentralized systems where transactions are authenticated by participants themselves by consensus. They are designed to bypass the financial system and all its controls. They cannot be traced or confiscated or frozen by Governments.

Mumbai (ABC Live India): Basics of the Cryptocurrency :Today Shri T Rabi Sankar, Deputy Governor, Reserve Bank of India at the Indian Banks Association 17th Annual Banking Technology Conference and Awards) expressed the official assessment of RBI on Cryptocurrencies and their future.

As per the RBI official statement in IBA conference, the Crypto technology and Web 3.0 is dominating the mind-space not just among the technology community but the financial industry as well. Cryptocurrencies, as per their proponents, have the potential to pay a critical role in how finance pans out in the future; indeed, there is open speculation about whether finance as we know it and banking as we know it can survive the rise of cryptocurrencies.

Before understanding the dynamics of Cryptocurrencies and their future let us briefly, and in very general terms, understand the basics of cryptocurrencies.

Know the Basics of Cryptocurrency

When a transaction is made using paper currency, all that the receiver needs to check is that the currency is not counterfeit. Thus, it is the receiver who authenticates the instrument of payment. This arrangement generally works, except for those few instances when the receiver fails to detect a counterfeit currency. In the case of digital transactions, the authentication of the payment is done by an intermediary like a bank, because almost all electronic transactions are transfer of money from one bank account to another. This arrangement also works as the bank certifies that the sender has adequate balance in her account to cover the transaction.

Some people felt that intermediation by banks is avoidable. Either they felt that banks are not trustworthy, or they considered that the cost charged by banks is excessive, or they were not comfortable with their transactions being tracked. Guided by the idea that cash remains one of the best ways to exercise free speech (refer footnote 3), their solution was to create their own private currency and a transaction arrangement or network that bypassed banks or any other financial or social institution. The basic problem they had to get over was as follows – since electronic money (just some lines of code) can be easily replicated, in the absence of a trust institution like a bank, how the network ensures that the same currency is not spent again, and again. This was called the ‘double spending problem’.

The first ‘person’ to effectively solve this problem was one Satoshi Nakamoto, a fictional person or persons or corporate or any other entity, no one knows as yet. And bitcoin was born. He did this by creating the blockchain. On a blockchain, when a transaction occurs, it is broadcast to all computers on the network. A set of new transactions, called a block, are authenticated by an agreed consensus mechanism, and then the validated transaction block is added to the previous chain of blocks. Every block is linked to the previous block, making double spending difficult because it would involve changing every subsequent block. Bitcoin was followed by many others, like ether, cardano, dogecoin, tether, stellar etc. Collectively they are called cryptocurrencies. The prefix ‘crypto-‘ refers to the fact that cryptography is used to generate or authenticate transactions.

The defining characteristics of cryptocurrencies are: -

a.       That cryptocurrencies are decentralized systems where transactions are authenticated by participants themselves by consensus. They are designed to bypass the financial system and all its controls. They cannot be traced or confiscated or frozen by Governments.

b.      They are anonymous – transactions are verified, but not the purposes or counterparties of transactions.

c.       They are borderless – that is, they work over the internet without any physical existence.

While Bitcoin started more than a decade back in 2008, until 5 years ago, total market capitalisation of all cryptocurrencies was only $20 billion (February 2017). This went up to $289 billion in February 2020 and thereafter exploded to reach a peak of $2.9 trillion in November 2021. Currently (Feb 09, 2022) it stands at $1.98 trillion. Bitcoin accounts for 42% of this market capitalisation, the top two cryptocurrencies account for 61% while the top five account for 71%. The total number of cryptocurrencies is at 17,436 and the total number of crypto exchanges is 458

To be continue in my next post.

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