A Brief History of Cryptocurrencies

Caution: This is a brief article aimed towards giving a beginner the simplest history around cryptocurrencies possible. It is simple to the point of being an opinion article, and many of these topics have a lot more nuance to them than the way they are presented in this article.

Why so many cryptocurrencies?

It all started with Bitcoin. More precisely, in 2008 when an anonymous entity published a whitepaper that outlined a protocol that allows for the transfer of digital money between parties in a completely secure way that is not controlled by any single individual or small group. There are a limited and pre-determined number of Bitcoin that can be “won” by “miners” who are constantly competing to be the first ones to solve a mathematical encryption problem which is the backbone of what makes Bitcoin secure, but is not a topic we will dive into any further than this since there are lots of great articles on this topic already out there. The Bitcoin that miners are rewarded for these tasks decreases over time, which means that new BTC enters into circulation, but it does so in smaller and smaller quantities, which combined with the cryptographic “puzzles” becoming more difficult to solve, creates sound economic fundamentals since you can’t for example decide to arbitrarily print more Bitcoin. Because anyone is allowed to participate in both those activities and there is no central authority that gets to regulate the system, it is considered to be “decentralized”. What makes Bitcoin valuable, is that there will always be a network of individuals (big or small) that is interested in using it as a store of value (high or low), and there will also be a network of users interested in mining the currency, and a very delicate balance gets created between the two that has already proven to be well-engineered over the years. If any of that sounds really difficult, that’s because it is, but it also relies on decades of legitimate research and ideas that have led us to this point (see this great graphic by Dan Held). So why would anyone care about “Ethereum” or any other cryptocurrency?

Bitcoin sparked the blockchain revolution, and developers quickly started to realize the potential of combining the ideas introduced by Bitcoin as the first decentralize cryptocurrency with the idea of allowing an open source and decentralized community of developers to write actual code on top of these cryptocurrencies. This was what Ethereum set out to do, and we refer to this type of functionality as a “smart contract”, it’s like a legally binding contract with a large corporation in a lot of ways, but it gets executed by a decentralized network. Why would you want this? In many ways that we won’t dive into here these protocols end up being more efficient and can deliver better and more reliable services, but it also comes down to the decision making power being shifted from a corporation into the hands of the users of the platform themselves. For example, if your bank was a cryptocurrency, your interest rate in your savings account would never be arbitrarily set at a lower rate by your bank, but rather follow a protocol that will always function the way it was designed and do so in a publicly visible way that anyone can view and help to improve the design of, and only implement changes across the network when the users agree on them. It should also be noted that Bitcoin doesn't allow for these types of application and that inherently makes it a lot less vulnerable to be exploited by hackers, and it took a lot of time and monetary investment to actually make the idea viable (research why "Ethereum Classic" was created for more details on this topic). So if Ethereum solved this problem, why are there thousands of cryptocurrencies and what do they all do?

The system described earlier relating to Bitcoin miners is associated with a huge environmental footprint, and Ethereum operates on the same "Proof of Work" system. However, it turns out that this system doesn't work well at all when doing things like programming videogames that work with small micro-transactions and generally require the users to transact frequently with each other, because the cryptographic puzzles that need to be solved require a lot of electricity and infrastructure, which means as people become more interested in using these cryptocurrencies, the transactions will take longer for the network to verify and users of the network will need to pay the miners increasingly large fees to make a transaction. As of early 2021 the average transaction fee is around $10-$30 for both Bitcoin and Ethereum with major price spikes based on the current demand; having to pay $70 in fees to make a $0.2 transaction is never going to make sense, especially with most of that being spent on electricity costs that don't really benefit anyone and in fact are really damaging to the environment. As of writing this, a tool by the University of Cambridge estimates Bitcoin's annual electricity consumption is more than Argentina, The Netherlands, and the United Arab Emirates. As of March 2021 we estimate that using a Proof of Stake system like the "Tezos" cryptocurrency on the same scale as Bitcoin would have about 25 million times less energy costs on each transaction:

https://medium.com/tqtezos/proof-of-work-vs-proof-of-stake-the-ecological-footprint-c58029faee44

https://twitter.com/tezos/status/1372627387465224204

Wouldn't it be great if we had a system that gets us the same results achieved by BTC with Proof of Work but comes with no electricity cost and can therefore also have near-zero fees? Several projects (Cardano amongst them) recognized the importance of solving this problem, and that ultimately the cryptocurrency that executes on the ideas set out by Ethereum would need to be both the most secure, and the most cost effective, and that it couldn't sacrifice one aspect for the other. This took real research which took real time, but that research found that a "Proof of Stake" system can be just as secure, and in many cases to be more secure than Proof of Work. Instead of verifying transactions through mathematical processes that require ever-increasing large amounts of energy to operate, we now have very clever ways of asking lots of people if a transaction is valid, and if anyone lies and tries to cheat, they are badly penalized. Anyone can participate in staking in a Proof of Stake network, which can help the people authorizing the transaction become less of a centralized entity like some of the big Bitcoin mining conglomerates have risked becoming at times. For those "stakers" it becomes more accessible and less risky to be able to make % interest as passive income without upfront costs by temporarily locking their "stake" which they would only lose if they tried cheating the system, and they are otherwise rewarded with interest on their staked amount. Another big benefit is that the transactions would never start becoming expensive or slow because too many people are using the network, and is instead designed to be a system that inherently becomes stronger and more effective the more people participate. The network is still decentralized, with the difference being a Proof of Work miner operates under "Here is the mathematical proof that this transaction is valid", while in Proof of Stake a miner is participating in a system of "I will prove this transaction is legitimate by putting my money where my mouth is through a monetary stake, and if I am shown to have lied I will lose a lot of money". Intuitively it's easy to think this idea can't be more secure than Bitcoin is, but over years of research these ideas have been thoroughly validated, and we currently already have many cryptocurrencies that have been successfully running on Proof of Stake systems without being exploited/hacked, and they were able to learn from Bitcoin and Ethereum's problems over the years. Ethereum themselves have been working for years to move to a Proof of Stake system, known as "ETH 2.0", but has been really slow about the whole process and as of writing this is still at least 6-12 months away and there isn’t a lot of clarity on a lot of things, which has opened the door for other cryptocurrencies that are designed to evolve more dynamically. The Tezos cryptocurrency for example has been a usable Proof of Stake blockchain since June 2018 which has very effective ways for the protocol to keep improving over time by design and has great tools for developers that allow for things like marketplaces for the exchange of digital goods for under $0.01 in transaction fees no matter how many people are using the platform, and in many ways already operates in the ways that ETH 2.0 hopes to operate. Proof of Stake is not perfect either, so the answer to why there are so many cryptocurrencies lies in the fact that there are a lot of them who think they have solved more problems than all of the other ones.

Are all cryptocurrencies good? Definitely not! Not all ideas are useful or even innovative. DOGE for example was a joke that took the existing model created by Proof Of Work and made the illogical change of making it so as more people mine it over time, it becomes easier to mine rather than more difficult. There is plenty of worthless technology that creates speculative markets with pricing bubbles that can pop any time and generally be manipulated by large actors. That's why it's important to understand what's different about a particular project and what it can enable within the ecosystem, for example in early 2021 we saw big price spikes across cryptocurrencies that aim to connect all of the different blockchains, and different projects have found different solutions to all of these problems, and most are designed as a "Decentralized Autonomous Organization" (DAO) that can evolve to solve the problems being faced, decide on how to allocate resources, and integrate newer/better technology, which makes it difficult to know ahead of time which ones will be exploited through loopholes and generally not be able to operate the way they promise.

Here is a helpful graphic shared by Reddit user Relaix that shows the kind of comparisons that can be drawn across the main Proof of Stake cryptocurrencies as of March 2021:

Some of the cryptocurrencies mentioned above also provide the community with the tools to launch “tokens” which are typically just ways of transacting through a given application and operate under another protocol like Ethereum; this means they don’t usually bring the same level of technological innovation through the cryptocurrency itself, and are usually instead looking to innovate through the services facilitated by the token. For example the “MANA” token is built on Ethereum and facilitates the operation of a digital world owned by its users, where the users can use MANA to do things like purchase properties and vote on any meaningful changes through the decentralized autonomous organization.

Good luck on your journey, but be safe out there, if something is too good to be true, it probably is.