ichthyoid

In this series, so far, we've looked at the basic definitions of blockchain and cryptocurrency, as well as the philosophy behind decentralization. Furthermore, we've broken down the 3 main ways blockchains verify transactions, so that we can better understand how coins and tokens are created and rewarded in any network.

You'll notice though, that at the end of the second part, I ended with a description of the Federated Byzantine Agreement in which there wasn't any way for participants who work to keep the network going to be rewarded with tokens of any kind. So how are coins then distributed in any form on such a blockchain network? Furthermore, how do people who want to participate in any system, but don't want to 'mine' any coins, obtain the currency?

And so, today, I want to discuss wallets, trading, and exchanges in the blockchain and cryptocurrency system. And then, we'll go over the different types of cryptocurrencies that presently exist, so we know what the heck we're actually getting.

Digital Analogs to the Real World

With almost everything in blockchain, because of their trust-less and decentralized nature, there are natural analogs that we can make to the real world, especially when talking about cryptocurrency. So the following are simple definitions and explanations.

Wallets

Crypto wallets are actually addresses that native coins, and the tokens developed on those platforms, are attached. So, while we use terms like “receive” and “hold” when talking about how wallets and coins interact (e.g. a wallet can hold X token), this is actually a misnomer, because wallets are just addresses that coins are then assigned to. There is no real storage space needed for any kind of crypto wallet. Instead, when a coin goes from one wallet to another, what's really happening is that the coin's address is being reassigned, and that reassigning is a transaction that is recorded on the coin's blockchain.

As an example, a Bitcoin wallet is an address that only Bitcoin tokens can attach themselves to. However, an Ethereum wallet can 'hold' both ETH tokens, as well as most ERC20 coins, which are coins that are developed on the Ethereum blockchain. Nowadays, there are both hardware and software 'wallets' that are actually a collection of wallets. For example, the Ledger Nano S, a hardware wallet developed by a company called Ledger, is able to accept a multitude of cryptos (including both Bitcoin and ETH), and the company is constantly adding support for more.

Wallets are required for almost everything we do in crypto. Thus, there's a lot of hubbub about security and privacy of wallets. For example, most wallets come with 12 or 24/25 keywords that are required for various wallet activities, including activation, as well as sending and receiving coins. A popular phrase used to be “Not your keys, not your wallet”, meaning if you don't hold the previously mentioned key-phrases for a wallet that has the coins you obtained, then the people that do have those key-phrases can technically do whatever they want to your coins. This lack of awareness of ownership has led many to have lost a lot of money from hacks and scams. While it's becoming less of a problem it's still important to be aware of these ideas going into the future.

Trading

Now that we know what wallets are, trading is a simple concept. It's simply reassigning the address of a number of the same kind of coin, and thus “moving” those coins from one wallet to the next. When we “send” or “receive”, we're just adding an immutable transaction onto a particular blockchain. No matter what kind of trading you do, whether it is crypto to crypto, or fiat to crypto, or something else, everything gets recorded on a particular blockchain.

This takes us to fees and gas prices. Like any real world trading, most blockchains have some sort of fee required for conducting transactions. This serves different purposes, depending on the type of blockchain or crypto you are using. For example, Bitcoin fees are used to compensate miners, while XRP fees are simply there to prevent spam. Furthermore, as more activity is required on a particular blockchain, typically, these fees get higher, since there are only so many transactions per second that any blockchain can handle. Fees are generally paid in the native token. So, if the fee to transfer ETH is $3.00, then an amount equal to that in ETH is (typically) taken out of the ETH I am sending (unless some service I'm sending through pays it for me).

But, what if I want to exchange Ethereum for XRP, or Bitcoin for something else? This is typically where exchanges come in.

Exchanges

Exchanges are, currently and probably into the future, where the vast majority of trading takes place. Rather than relying on sending emails or texts back and forth between two non-local people to obtain addresses for sending and receiving (that actually used to happen quite a lot in the early days!), people today tend to rely on large exchanges that automate the process for them.

There are generally two types of exchanges.

Centralized Exchanges, like Coinbase or Kraken or Binance, make up the majority of popular exchanges being used today. These exchanges are typically run by people like a real business. They function similarly to foreign exchange and brokerage companies, with users being able to conduct trades, use options, bet shorts, sell and trade on margins, and other uses besides. While the number of currencies you can trade in is controlled by the people running the exchange, they are often compelled to make as many available as possible due to competition from other exchanges. Sometimes, these exchanges offer bank-like functions (e.g. reward users interest for holding a specific coin on their platform). But, critically, these centralized exchanges hold all the keys to users wallets and accounts, and are historically the target of hacks and scams.

Decentralized Exchanges, or DEX, are a small but growing type of exchange that does away with the company aspect of the aforementioned type of exchange. Instead, DEXs usually run on particular blockchains. Users connect their personal wallets to these DEXs, and do peer-to-peer exchange themselves. There is more manual work for traders, but DEXs are (for the most part) much more secure.

The downside of DEXs, of course, is that most of them function only on a single blockchain, namely Ethereum. All the most popular ones being used today, from Uniswap to Compound to AAVE, function only for Ethereum or ERC20 tokens. There are ways around this, such as using an Ethereum representation of a particular coin. For example, WBTC is an Ethereum version of Bitcoin. But this is a slow process, and restricted by popularity (e.g. unpopular coins will probably never have an Ethereum version), and thus most non-Ethereum coins are not represented. And there are certain blockchains—such as XRP, Binance Chain, and Cosmos—that are developing interoperability between blockchains. But, at least currently, these are mostly embryonic and not popularly used.

So now we know what blockchain and cryptocurrency are, and the different kinds as well as how to obtain them. The next, almost inevitable, question is often: so which one should I get?

And...I'm not going to tell you, haha. This series is not financial advice in any way. Instead, I'll talk about the different types of cryptocurrencies there are, and what they're useful for.

Tokenization: Digitizing Real World Assets

Knowing the tokens in which one would want to invest starts, in my opinion, with understanding what different types are out there. Theoretically, and again because of how well blockchain represents the real world in a digital space, there is potential for almost anything in the real world to have a digital asset to represent it. But, because blockchain is still an incredibly new technology, that potential is still a far away dream. I will be calling all of these “tokens”, but as before, tokens and coins are basically the same thing.

That being said, here are the most popular types currently:

Transactional Tokens

This is actually my own name for this type of crypto. I've searched around, and for some reason, most cryptocurrency websites list “Bitcoin” as its own type, despite its similarity in design and usage with others. And rather than calling this whole section “Bitcoin”, which just seems extremely un-informed to me, I'm going to call this type “transactional”.

Transactional cryptocurrencies are exactly that—coins that were designed to be the medium by which transactions happen. These coins have no other popular use-cases, and weren't designed to have any other either. In many ways, they are meant to replace physical fiat and be used as a medium of exchange. This comes in the form of speculative cryptocurrencies as well as stablecoins. The former, with the likes of Bitcoin, Litecoin, and others, have a volatile price, due to not being tied or backed by anything. Stablecoins, on the other hand, are transactional currencies that are either backed by an asset (e.g. USDC is backed by US Dollars), or soft-pegged to currencies through different collateral methods (e.g. MCD DAI is soft-pegged to the US Dollar). Whether one buys speculative cryptos or stablecoins, everyone should understand that all these cryptos purport to do is replace cash with a digital way of making transactions happen.

Utility Tokens

Utility tokens are cryptocurrencies that offer some functionality besides simple transactions. For example, the Ethereum blockchain is built on the ETH token, which is the foundational coin that serves to make decentralized applications, or DApps, work on the Ethereum platform. ATOM, on the other hand, is a currency that works on the Cosmos blockchain, which is a chain designed to allow different blockchains to speak to and transact with each other.

These utility tokens often come with tools that allow developers to build on the chain. Again, Ethereum is probably the best example of this, as its tools allow developers to create many different things, including smart contracts which automate conditional transactions (e.g. escrow contracts).

In my opinion, it's important to understand that the value in these tokens is not based on transactions, but rather on the ecosystem(s) they purport to bring. In other words, if the ecosystem being developed around a certain utility token is popular and/or robust, then the value of that token is probably pretty high. On the other hand, if a utility token is not being used much, and there's no one really building around it, then even if it is technologically superior, then it probably isn't very valuable.

Security Tokens

Security tokens are probably the easiest to explain, but are technologically still in their infancy. Security tokens represent securities in the real world. From stocks and commodities to real estate, security tokens are meant to represent this class of assets in the real world.

Security tokens, and the blockchains for them (e.g. Polymath, Securitize, etc.), are still being developed. They could certainly be the next wave of where crypto is going, but because it's so early, and with the current halt in the world today, it's difficult to predict when and how the space will mature.

And that's it! If you haven't read the previous parts in the series, check out Part 1 and Part 2! I'm not sure I'll be adding any more to this series anymore, as I believe these posts have given a pretty solid foundation for most people new to the whole concept to understand what this new technology is all about, and anything else out there to do with the subject can be much more easily understood with these (hopefully helpful) explanations.

Have a good one!