Understanding the Crypto Craze

  • Blockchain is a distributed and decentralized ledger that generally provides a higher level of trust, transparency, and security than other centralized ledgers or databases.
  • Bitcoin and Ethereum are coins that are mediums of exchange on blockchain networks. These differ from tokens which are also mediums of exchange.
  • Blockchain networks consist of 3-4 layers of protocols. Layer zero establishes interoperability between protocols, layer one ground rules for a given blockchain, layer two enhances features of a blockchain, and layer three allows applications and software to run on the network.

The hyperbole, hype, and hysterics around the cryptocurrency craze drown out the financial revolution underway that promises to make a lot of people money. Understanding what’s happening will help all of us make better investment decisions instead of impulsively buying a trendy crypto-asset because we fear missing out.

It starts with blockchain

Blockchain is a distributed and decentralized database. Unlike traditional centralized databases that store information on one ledger or server, blockchain refers to a network of ledgers, peer-to-peer computers, that are all connected via a “chain.” Each time a new entry, also known as a “block,” is made “on chain,” the entry is simultaneously recorded on every ledger within the network. 

Blockchain is most commonly used to document transactions. The two largest blockchain networks are the Bitcoin blockchain and the Ethereum blockchain. 

When a blockchain transaction occurs, the “block” is added to every ledger, or computer, on the network. Each block is connected to any prior block in a linear and chronological way. Blocks are identified via a “hash,” a code that is created by a mathematical equation that transforms data into a string of letters and numbers, along with a timestamp, and the hash of the block immediately preceding. 

Potential blockchain benefits

While there are risks to blockchain networks, such as lack of standardization and poor valuation of some crypto-assets, the benefits of documenting transactions or data on the blockchain include:

1. Trust 

— Anybody participating in a transaction can have greater confidence the transaction occurred due to the transaction’s verifiability, on every server across the network, rather than being housed in one central location.

2. Transparency

— The visibility and immutability of each transaction ensures that no third party can alter the record of that transaction. Currencies or data that are recorded on chains are safe from any alteration via governments, corporations, hackers, or other actors. 

3. Security

— It’s highly cumbersome and difficult to erase or reverse transactions that are recorded on chain. It’s only possible if a majority of computers on chain vote to do so. This has never happened with respect to Bitcoin and is not considered possible due to its degree of decentralization. Were a hacker to try and alter Bitcoin on their own computer, they would fail as their altered hash would not match the hashes housed on all other servers.

Blockchain provides encryption, which led to the term “crypto.” An encrypted blockchain network provides security against hackers— to change anything on the network, a hacker would have to hack the entire network and change each individual server on the network, an extremely challenging task that would require far more resources than hacking one or two servers alone. It’s unlikely that even a nation state would be able to accomplish this.

Frightening headlines about the theft of Bitcoin or other cryptocurrencies helped news organizations grab attention but missed an important fact: those thefts are never through alteration of the chain. They happened mostly through phishing attacks on individual users or attacks on crypto exchanges. 

Coins tokens and altcoins 

Most people think of Bitcoin and Ethereum as coins but it helps to remember they are each a medium of exchange on a blockchain network. 

As the crypto asset class has grown, the term token has come to represent its own medium of exchange independent of Bitcoin and Ethereum. Bitcoin is a closed blockchain that does not allow new token development.  But Ethereum does and in many cases developers are using the Ethereum blockchain to build new tokens. 

Those developers leverage Ethereum technology to create tokens, something they also do on other blockchain networks. Solana is another popular blockchain destination for new tokens.

The term altcoin is also gaining recognition and it simply means an alternative coin other than Bitcoin or Ethereum.  Altcoins are very much the same as tokens. 

Building blockchain with protocol layers

Blockchain networks consist of a number of different protocol layers to enhance security.

Those protocols are a set of rules that determine network dynamics and processes. They decide procedures for a given blockchain which include security, information storage, the interaction of ledgers on the network, transaction validation processes, and other rules necessary to operate the chain.

Layer zero sets the standard for the building of layers above it a lot like the foundation of a building.

Layer one, sometimes called the implementation layer, consists of the primary architecture of the blockchain network. It sets a series of rules that define the working of the network. 

Layer two protocols, often called second-layer solutions or off-chain protocols, often enhance features of a given blockchain network. They generally provide either interoperability with other chains or scalability features, providing faster transactions.

Often, altcoins or tokens are built on layer two. The Lightning Network, which allows faster Bitcoin transactions, and Plasma, an Ethereum-based product that allows other developers to build chains on Ethereum, are examples of this.

Invest in Crypto Today

Layer 3 protocols, called application layers, allow applications and other software to run on the blockchain. Examples include NBA Top Shot, an NFT platform that sells NFTs of NBA highlights, and Alien Worlds, an NFT videogame.

Blockchain is here to stay. Its efficiency as a medium of exchange combined with its  transparency and security are reasons crypto assets are likely to play an increasingly integral role in the global economy.  We believe this creates more opportunities for investors who understand blockchain technology, and the assets that utilize it, to earn real gains.

1. “Blockchain Explained”, Investopedia, 2/14/2022

2. “What is a token?”, Coinbase, 2/14/2022

3. “What are Application Layer Protocols?”, CoinMarketCap, 2/14/2022

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