In the beginning of 2009 there was bitcoin…
In this series on digital payments, we started with the disruptive innovation of Bitcoin, the first successful adoption of a decentralized digital currency (in part owing to the 2008 economic meltdown). We covered Bitcoin and the ecosystem around it extensively, without referring to the larger world of cryptocurrencies and blockchain solutions that have grown with it.
But bitcoin is not alone.
Note: This series does not cover new wave of proposed bank coins and tech coin patents and proposals that have been announced recently. Most of them are on the drawing board and in all likelihood proprietary, contradictory to the concept of a decentralized public ledger, but a separate topic of discussion nevertheless.
• Fiat currencies are secured with a legal tender issued by a central bank and sovereign government(s) with several features to verify their authenticity and double spending in payment transactions prevented by using trusted third party. Cryptocurrencies are encrypted adopting Adam Back’s hashcash based proof of work algorithms for authenticity.
• Instead of being backed by a central authority, cryptocurrencies are maintained and verified via a distributed transaction database (or electronic ledger) over a peer to peer network.
• The block chain is built as a linked chain of blocks of transactions to prevent double spending without the need for a trusted third party (a trust less environment). In general, the ledger is public, meaning the transaction can be accessible and verified computationally.
• Consensus method is used to prevent double spending and attacks to take control over on the network, all participants must agree to and use one version of the blockchain based on consensus rule.
Why so many alternative cryptocurrencies to bitcoins?
Reason 1: Anyone can do it! (almost)
A facetious and also correct answer is because you could. The vision of making your own brand of digital money has become accessible to anyone with practically no entry barriers. The Bitcoin code is open source and everyone could use the design or make a fork for their version of bitcoin. i.e. a de-centralized peer to peer digital cash or store of value. The initial coins which started appearing with Litecoin in 2011 followed by Peercoin were called alt-coins. They created forks of the Bitcoin source code with different consensus methods.
As bitcoin mining moved from commodity CPUs to special purpose ASIC hardware, other ASIC resistant versions were introduced to continue broader public participation in mining. Another feature was blockchains that confirmed transactions faster than the bitcoin blockchain. Alt-coins were also created as a less expensive alternative than buying bitcoins that have soared to hundreds of dollars in value.
And finally, the next generation of cryptocurrencies is designed to go beyond currency tokens and create crypto-assets and blockchain applications such as smart contracts, which we will explore in detail when covering leading cryptocurrency platforms.
The 600 to 700 cryptocurrencies that have arrived (and often disappeared) outnumber 180 active fiat currencies by a ratio of four to one. Financial indicators are used to as a key measure the popularity of a cryptocurrency. These are the exchange rate and market capitalization with respect to fiat. Bitcoin has grown in six years from an experiment to an economy with USD 6 billion market cap and over 1 billion invested in bitcoin/blockchain firms. Of the remaining currencies, around 50 have a market cap of USD 1 million and above and only 20 trade at USD 1 or higher.
Financial indicators are not the only test of success, as some forms have been created for specific purpose and applications outside payments. To recall Satoshi Nakamoto’s original bitcoin whitepaper, bitcoins are a secure token that have applications outside payments.
These are some reasons that can be attributed to success and failure of cryptocurrencies.
The incentive of building an alternative eco-system is another factor. Alt-coins have grown for specific applications or as a means to addressing some of the issues with bitcoins. Alt-coins can use different programming variations and consensus rules but have to offer differentiated or comparable capabilities to the security, growth and transaction speed of bitcoins. Most are forks from the bitcoin code with some variation of consensus rules. The top alternative coins have an ecosystem of third party block explorers, exchanges, wallets and mining which are critical to maintaining currency circulation and value. Ripple and Stellar are examples of premined currencies with a large market cap.
As of 2016, 600 cryptocurrencies outnumber 180 fiat currencies by 400% but only 20 trade at 1 USD or higher. Not all cryptocurrencies are designed to replace fiat payments. Some operate similar to other forms of virtual currencies such as gaming currencies, online casino tokens or used in dark web transactions. Other started as experiments which did not take off or were abandoned (dogecoins are the most famous exception, having started as a joke and top in the top 10). In the unregulated world of cryptocurrencies, many short-lived cryptocoins were actually designed as “pump and dump” schemes by their creators, burning many investors.