What Are Cryptocurrencies?

A cryptocurrency is a type of electronic money that is powered by advanced mathematics. There are 11 types of cryptos.

First, there was "physical" money - notes and coins. Then came e-Money - numbers that show in your e-banking apps. Both these are issued by the Government.

And then came cryptocurrency, a type of electronic money that is not issued by any Government. It is also called Math Money because it is created and managed using blockchains which are computer networks powered by advanced mathematics.

1. What is blockchain?

Let's say Svetlana borrows 10,000 rupees from me. She is supposed to return it in a week but doesn’t. I remind her but she has conveniently "forgotten" about it. What can I do? Nothing, except never lending her anything ever again! True story.

Now suppose, at the time of lending the money, a few friends are present. They all clicked a pic or shot a video of me lending Svetlana the money and her promising to return it in a week. And each of these friends posts the pic / video on Instagram, Facebook, etc. Now that is solid evidence. And Svetlana can't really delete all these videos / pics from the Internet.

Now that's something like a blockchain.

A blockchain is typically a bunch of computers (nodes) connected to each other. All of these computers contain the same information (e.g. a ledger of transactions). To "hack" this information, you will need to "hack" most of these computers at the same time. And that’s a pretty tough thing to do!

There are many blockchains in the world. The Bitcoin Blockchain is the first and oldest one. It records all transactions of the bitcoin cryptocurrency. Anyone can run a node of this blockchain. All you need is a computer with enough storage space and a strong Internet connection.

2. How are cryptocurrencies created?

There are 2 common ways of creating crypto-currencies. One is the style used by Bitcoin and the other is the style used by Ethereum.

Bitcoin style

In the Bitcoin-style, there are a bunch of computers called miners who are constantly trying to solve mathematical puzzles. Roughly every 10 minutes, one of these miners wins this race to solve the puzzle. This miner wins a reward which is currently 6.25 bitcoins. That's about Rs. 2 crores. Yes, you read that right. Every 10 minutes there is someone getting 2 crores worth of bitcoin.

But don't get too jealous of these miners. They have to spend tons of money on computers and electricity. And they can never be sure how much they will actually end up earning.

Many years ago anyone could mine or create bitcoins using a laptop! Well, not anymore. Today you need a ton of computing power for this.

In case you want to understand this concept of mining in all its complicated tech glory, you can download the free "Future Money Playbook" that I have written.

Ethereum style

In the Ethereum-style, you can create your own crypto in minutes. My daughters were quite fed up hearing about Dogecoin. So they decided to create their own cat-based cryptocurrency. All they needed to do was customize a "smart contract" and publish it to the Ethereum blockchain.

That's it! In a few minutes, they had created a new cryptocurrency with a supply of 7 billion tokens - one for each human on Earth. True story.

3. What are the types of cryptocurrencies?

Did you know that there are 6,500+ active cryptos being traded in 400+ active exchanges across 47,000+ active market pairs?

Based on my analysis, these cryptos can be divided into 11 categories:

R = Ready money e.g. Bitcoin (BTC)
O = Open Blockchain Tokens e.g. Wrapped Asset Token (WRAP)
H = Hush coins e.g Monero (XMR)
A = Application coins e.g. Filecoin (FIL)
S = Security tokens e.g. Exodus

N = Non-Fungible Tokens (NFTs) e.g. Crypto Kitties
A = Algorithmic stablecoins e.g. Frax (FRAX)
G = Governance tokens e.g. Uniswap (UNI)
P = Public Blockchain natives e.g. Ether (ETH)
A = Asset-backed tokens e.g. Tether (USDT)
L = Lending / Borrowing cryptos e.g. Aave (AAVE)

Bonus points for you if you realized the acronym for these spells my name :-)

Let's have a quick look at these categories.

R = Ready money

Ready money cryptos are those that can be used to buy and sell stuff or which can be quickly converted to "cash".

Examples: Bitcoin (BTC), Bitcoin Cash (BCH), Litecoin (LTC), and fiat-pegged stablecoins such as Tether (USDT).

O = Open Blockchain Tokens

An Open Blockchain Token (OBT) is a unique form of crypto recognized under the laws of Wyoming, US. An OBT must be exchangeable for specified consumptive purposes services e.g. software, content, or real/tangible personal property.

Example: Wrapped Asset Token (WRAP)

H = Hush coins

Did you know that Bitcoin isn't 100% anonymous? All its transactions are recorded on its publicly available Blockchain like the one below:

That’s what led to the birth of hush coins or privacy coins - some of which are private by default, while others let the users decide if they want to activate the functionality or not.

Example: Monero (XMR)

A = Application coins

Application coins are those which are part of a specific use case.

Example: Filecoin (FIL) is the native crypto of the Filecoin network. It can be used to pay miners to store/distribute data and to retrieve information. Storage providers guarantee a minimum service level by providing FIL as collateral.

S = Security tokens 

Security tokens are like equity shares and represent ownership of a company.

Example: Exodus

N = Non-Fungible Tokens (NFTs) e.g. Crypto Kitties

 The INR balance in your mobile wallet is fungible - every rupee is exactly the same as another rupee. Any one rupee can be exchanged for another one rupee. Things like real estate and art are non-fungible because no two of them are identical.

Non-Fungible Tokens (NFT) are the crypto versions of things like art, and real estate. They are used as digital proof-of-ownership of the underlying asset.

NFTs can be of many types, including art, collectibles (trading cards, sneakers), domains, virtual game items (avatars, skins, weapons, etc).

Example: CryptoKitties

A = Algorithmic stablecoins

Algorithmic stablecoins are cryptos whose price stability is maintained by an algorithm. They are different from fiat-pegged stablecoins whose stability is maintained by the asset they have pegged to e.g. US dollar. 

Example: Frax (FRAX)

G = Governance tokens

Governance tokens gives holders a vote in a blockchain's development.

Example: Uniswap (UNI)

P = Public Blockchain natives

Using a public blockchain involves the payment of gas fees or transaction fees. This fee is payable in the native coin of that blockchain.

Example: Ether (ETH) 

A = Asset-backed tokens

An asset-backed token or a Wrapped Asset is a blockchain token pegged to or collateralized by an asset such as art, gold, fiat currency, debt instrument, equity shares, trade invoices, real estate, etc.

It’s called a "wrapped" asset or token because the original asset is put in a "wrapper" or "digital vault" that enables the wrapped version to be traded on a blockchain.

Example: Coffee coin

L = Lending / Borrowing cryptos

These tokens make it easy for investors to borrow and lend funds in a Decentralised Finance market.

Example: Aave (AAVE)

View this post on Instagram

A post shared by Rohas Nagpal (@rohasnagpal)

Next: Should YOU invest in cryptocurrencies?