A simple guide to cryptocurrency and NFTs
A straightforward guide from the perspective of a complete crypto novice: what is it and what’s the point?
There’s a dizzying amount of information out there and some of it is really complex and esoteric. Here’s a straightforward guide from the perspective of a complete crypto novice: what is it and what’s the point?
The first modern cryptocurrency has been around since 2009, and it essentially involves solving a set of mathematical equations to generate a unitof currency. Solving these equations uses quite a lot of computational effortand the different types of cryptocurrency, like Bitcoin and Ethereum, are solved indifferent ways. There are some other key differences when compared to traditionalcurrency, which is controlled by various banks, and you need to be very carefulthat you don't lose access to your digital wallet. In theory anyone can generate this currency, or you can buy it using conventional money. Cryptocurrency is the only way to buy a non-fungible token (NFT), which is a kind of status symbol. There are also some wider implications for society about climate change and the value it adds to our lives.
There are two different mechanisms to prove that you have solvedthe equations. Bitcoin uses a mechanism called proof of work where an individual has to provethat they have put the computational effort into solving the equations, and it takes a lot of effort tosolve them. This creates a competition to be the first tosolve a particular set of equations. Other cryptocurrencies like Ethereum use something called proof of stake, where individuals can pledge to produce a certain amount of cryptocurrency. An individual is then randomly chosen to solve the cryptographic equations. Proof of work requires more computational effort than proof of stake because the equations can be more difficultto solve, and because individuals aren’t competing against each other to solve the same set of equations. Instead each individual is solving the equations assigned to them.
Once there is proof that the equations have been solved, this is recorded in a publicly available ledger which is stored on the decentralised network. This is known as blockchain: transactions or blocks are recorded sequentially i.e. a block is added to a chain.
Crypto versus central banks
Instead of relying on central banks to 'print' more money, anyone can generate cryptocurrency but, somewhat paradoxically, this relies on having enough conventional money to purchase the equipment. This can be expensive given the computing power required. The computational requirements also mean high energy bills; all of those processors require a lot of electricity and in many cases that means greenhouse gas emissions. One study estimated that Bitcoin production generates as much carbon dioxide as anentire county.
Cryptocurrency exists on servers that are networked together. Decentralising a currency in this way means that an individual isn’t affectedby a failure of a bank, or the banks fees and policies: it puts you in control of your own money. This can be really helpful if you trade internationally and are at the mercy of theforeign transaction fees and exchange rates that many banks set. The combined cost of high fees and unfavorable exchange rates can be so high that customers can lose a lot of money during the transaction.
To access your cryptocurrency, you need a digital wallet, a password and a security phrase. If you lose your password or can't remember your security phrase then you essentially lose access to the cryptocurrency that you own. Central banks offer a lot more protection, unless you withdraw physical cash: in the UK, banks are regulated and they're covered by the Financial Services Compensation Scheme which means that if a bank loses your money, you can be compensated up to £85,000. And of course, if you lose your banking card, can't remember your PIN, or forget your online banking password,the bank can help you regain access to your money. The individual has a lotmore protection from central banks than they do with cryptocurrency where theonus is on the individual to take care of their assets.
NFTs and some considerations for society: is it all too risky?
You need cryptocurrency to buy a non-fungible token (NFT), aunique digital item such as a picture or music. Owning one of these it a little like owning a rare piece of art or a Gucci handbag; they are something to be coveted. While anyone could try and copy this digital object, ownership is recordedvia blockchain i.e. its written in ledger. This digital ledger is publiclyviewable so it’s easy to spot a fake NFT. In this way the rights of whoever produces the NFT are protected: it’s easy to see who owns this unique piece of property and where it originated from.
So is thisall worth it? Some say that cryptocurrency is nothing more than a pyramidscheme: a fraudulent system of recruiting investors based on a promiseof payment if they bring in more investors. It’s a way of getting people to spend money on computational resources without a tangible reward. The number of people interested in cryptocurrency has led to a dramatic increase in the value of cryptocurrencies like Bitcoin but you have to wonder if this is sustainable. Just like stocks and shares, the valuewill fluctuate and it seems that the market for crypto may now be declining.What are the influences that lead to something becoming popular or falling out of favor?
Questions arise about how value is determined. Unlike commodities such as food, fuel and building materials, it’s difficult to see what cryptocurrency adds to society.Traditional money is simply a way of getting hold of commodities so that you can build shelter, eat and stay warm whereas getting hold of cryptocurrencies seems like more of a status symbol: a way of making money for the sake of it. Given the climate emergency, do we need the extra greenhouse gas emissions? Owning cryptocurrency doesn’t seem much different to owning that Gucci handbag: it has intrinsic value because lots of people want it but what can you do with it? What is the practical purpose of a currency that you can so easily lose access to?
For many, the idea of using traditional banking – which often comes with transaction fees, bureaucracy, and a lack of trust in centralbanks– just isn’t appealing. A way of purchasing goods and services thatinvolves a shared network of resources, a transparent ledger of transactions, anda greater sense of individual ownership is more appealing. Countries like El Salvador accepted Bitcoin as a nationalcurrency because of benefits like no or low transaction fees. Conversely, the fluctuating value and the way in which this value seems to be determined makes currencies like Bitcoin simply too risky.
About this story
This story is based on a conversation that was recorded as part of podcast. Technically Speaking (a science and engineering discussion) recreates some of thoseslightly odd conversations that all scientists and engineers have in the lab; conversations that incorporate scientific fact, wild speculation and often quite a few film references. Episodes are released once a fortnight on apple, spotify, amazon music, google, podbean, or wherever you get your podcasts. You can follow the podcast on twitter to keep the conversation going.
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Passionate about sharing factual content and promoting critical thinking. Previously worked as a research fellow at The University of Manchester and for the UK's National Nuclear Laboratory. A generalist who is interested in many science and engineering topics.