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Cryptocurrencies – Why so many and what is the difference (My zero-to-expert journey, Part 2)

If you happened to have missed my earlier post and want a quick primer before diving in more, I recommend you go back and give a quick read to Part 1:

In this Part 2 post, I’m diving down into why we are seeing so many cryptocurrencies get launched and what we might expect going forward.

Fair warning, I’ll first need to touch on some of the underlying mechanics of crypto before jumping into the “why so many?”, but if you stick with me, I’m confident you’ll start seeing around some of the same corners that I am.

In this post:

  • Mechanics of Cryptocurrency – how it actually works
  • Popular Cryptocurrency Efforts – the problems being solved
  • What Might Come Next – the next corner to be turned

Mechanics of Cryptocurrency: how does it all work?

As a brief foundational concept for understanding why there are so many different cryptocurrencies seemingly springing up out the ethosphere, it’s helpful to appreciate what a “cryptocurrency” actually is.

If you’ve been hearing all about popular “cryptocurrencies” such as Bitcoin, Ethereum, and Dogecoin, keep in mind that these are really cryptocurrency projects. In some ways its helpful to think about crypto projects as start-up companies or even smartphone apps (like Facebook, Google, etc.); in other ways the parallel to be drawn is between crypto projects and networks or operating systems (such as iOS, Windows or Linux). This framing somewhat depends on what the particular crypto project has been stood up to do, but just keep these two concepts in mind (crypto project as a start-up and/or as an operating system).

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At the end of the day, It’s all just code.

At their hearts, these crypto projects are simply just computer code. Some of the code may be to define the language and rules that the crypto project will adhere to (the syntax, semantics, and protocols); some of the code is to actually execute specific actions (transactions).

The portion of the code that establishes the language and rules, in essence, sets the condition… or rather, creates the environment, in which the crypto project will operate. Again, think of this the same way you’d think of a computer operating system. The execution part of the code (the instructions for actions to be taken) enables cryptocurrency tokens (the value or the data) to be transferred from one owner to another.

This may be as straightforward as executing a change in token ownership – i.e., I want to transfer some of my bitcoin to Mark so that Mark will be identified as the owner of that bitcoin within the Bitcoin environment, rather than me. (Sidebar, Mark must be pretty awesome to get some BTC action from me … just saying.)

It may also be a bit more complex, comprising of a transaction with several preconditions that must be met before the network (environment) will allow the transfer to take place. For example, consider this set of transaction instructions:

  1. if the Ethereum network can find a valid agreement between me and Mark, and
  2. if Mark meets all of the conditions of the agreement, including satisfactorily mowing my lawn, washing my windows and cleaning out my gutters,
  3. then transfer ownership of 0.02 ETH (Ethereum’s unit of value worth about $90 USD) from me to Mark.

The latter type of transaction (the one with the honey-do list) is known as a “smart contract”. The cryptocurrency transaction is contingent on the conditions of the contract being met … and those conditions are programed into the money! Talk about no PODs (you 80’s babies remember all those infomercials) and no negotiations required!

While all cryptocurrencies support basic token transactions, not all blockchain networks support the more sophisticated transactions such as smart contracts. Increasingly, those that do not are upgrading or partnering with entities to enable smart contract functionality on their platforms.

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Tradeoffs are inevitable.

In addition to the types of transactions that a cryptocurrency can support, a cryptocurrency may be designed to optimize a certain attribute, such as security, scalability, or degree of decentralization. In fact, the Ethereum project (or just Ethereum), was developed to address some key limitations that the crypto community saw with the original cryptocurrency project, Bitcoin.

In the concept whitepaper that laid out the case for how to improve cryptocurrency, Ethereum was framed as an alternative that could offer a new blockchain network that provided much of the same cryptocurrency utility as Bitcoin (secure peer-to-peer decentralized transactions); however, unlike Bitcoin, Ethereum was designed not just to support validation and transfer of token ownership, but rather to be a platform for applications. Ethereum, this novel second-generation cryptocurrency, was developed with functionality similar to common programming languages (e.g., C++ or Java script), which meant that the Ethereum network could support both token ownership transfer transactions and would set the stage for a whole world of “programable” cryptocurrency tokens.

The intent of Ethereum is to create an alternative protocol for building decentralized applications, providing a different set of tradeoffs that we believe will be very useful for a large class of decentralized applications, with particular emphasis on situations where rapid development time, security for small and rarely used applications, and the ability of different applications to very efficiently interact, are important. Ethereum does this by building what is essentially the ultimate abstract foundational layer: a blockchain with a built-in Turing-complete programming language, allowing anyone to write smart contracts and decentralized applications where they can create their own arbitrary rules for ownership, transaction formats and state transition functions.

[…] Smart contracts, cryptographic “boxes” that contain value and only unlock it if certain conditions are met, can also be built on top of the platform, with vastly more power than that offered by Bitcoin scripting because of the added powers of Turing-completeness, value-awareness, blockchain-awareness and state.

–      Excerpt from Ethereum’s Whitepaper

THISgets into the heart of why we are seeing so many cryptocurrencies today. Developers are rapidly discovering all of the different use cases for these blockchain networks that use cryptocurrency tokens as a highly secure, decentralized, and autonomous store, validation, and “trustless” transfer of data and/or value.

So now, let me to come back up to the surface and shift focus to the range of different cryptocurrencies we are seeing grow in popularity today.

Popular Crypto Efforts: who’s doing what and why?

There are two main categories of crypto projects (possibly more, but conceptually understanding the distinction between these two is definitely sufficient for our purposes): layer 1 crypto projects and layer 2 crypto projects.

Think of layer 1 projects as those massive projects stood up to develop entire crypto environments or networks – establishing the language, the rules, protocols, etc. (i.e., the project that resulted in Apple’s iOS or Microsoft’s Windows operating systems). Think of the layer 2 projects like those projects stood up to create application layers or smartphone apps (e.g., Adobe Reader or the Robinhood app).

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Layer 1 Cryptocurrencies

By far, the most popular cryptocurrencies today are the large, established layer 1 projects. This includes Bitcoin (BTC) and Ethereum (ETH). Makes sense given their strong user communities and big financial backing. Other common Top 10 layer 1 crypto projects (in no particular order) include Algorand (ALGO), Solana (SOL), Cardano (ADA), Polkadot (DOT) and Ripple (XRP) [I have linked their respective “whitepapers” for those who would like to learn more about these projects].

As discussed, bitcoin (note “bitcoin” is used when referring to the token, also referred to as “BTC”, and “Bitcoin” is used to refer to the project or network … not confusing at all, right?) was the first cryptocurrency to go into circulation. It was positioned as a digital alternative to paper money (or a decentralized, peer-to-peer alternative to the kind of electronic fund transfers that would typically occur between two financial institutions). Bitcoin consists of the Bitcoin network, that is the “database” of bitcoin transactions (the Bitcoin blockchain) and the decentralized system of “nodes” that process and validate all of the BTC transactions (bitcoin miners and validators). Bitcoin was, at its heart, designed to be both decentralized (free of intermediaries and institutional influence) and very secure (based in cryptography); however, as a means of supporting the future of global financial transactions, its relatively slow – processing a mere 3 to 4 transactions per second (as of October 31, 2021). By comparison, global payment processing company, Visa, is reportedly capable of handling 24,000 transactions per second.

Because of Bitcoin’s scalability limitations, alternative layer 1 networks have been developed to support faster transaction speeds or to provide other types of functionality. Each new layer 1 project promises the same Bitcoin-level security while solving the limitations of its competitors: faster (more scalable), lower transaction cost, etc. Meanwhile, existing layer 1 crypto projects are also continuing to roll out upgrades to address their own limitations and offer even better improvements (case in point, Ethereum quietly rolled out ETH 2.0 in October 2021).

Developers of layer 1 project Solana have marketed their network as the fastest and most scalable with a processing throughput of 710,000 transactions per second (far faster than even that noted by Visa). Another popular layer 1 project, Cardano, highlights its inclusive and sustainable values and the rigor of its development process, even offering its user community a well-defined roadmap of where the project is heading.

In my humble opinion, it is very doubtful that we will converge to one single “clear winner”, any time soon, but rather, we will see a handful of dominant blockchain ecosystems, like Bitcoin, Ethereum, Solana, and Cardano, adopted by different users in order to meet specific needs or align with a specific set of set of core values.

Layer 2 Cryptocurrencies

Much of the recent growth of the cryptocurrency market has been in the layer 2 space – synonymous with the explosion of new app store apps. Each layer 2 crypto project is meant to offer specific functions or solutions to its token holders (users). Many cryptocurrency tokens are simply the “currency” of a crypto application. Think: customer loyalty points of a hotel or airline, shares of a publicly held company or even tokens within online gaming (e.g., Minecraft, Roblox, and Fortnight). Some tokens are utility tokens (to improve layer 1 functionality). Some tokens may represent voting rights (similar to voting rights offered to shareholders of publicly traded companies). Still other tokens may represent ownership of a unique digital asset (as in a nonfungible token or NFT). Finally, we can’t leave out those layer 2 projects established simply to offer light-hearted fun (as projects like Dogecoin and Shiba Inu originally set out to do).

Layer 2 projects offer far more variety in what they have been developed to provide their token holders than we see with the layer 1 projects.

The table below offers a few common categories of layer 2 projects.

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Notably, nearly all of these projects have been built on the Ethereum network, however many layer 2 projects have been developed to run on a variety of blockchain networks, such as Solana and Ripple, as these blockchain platforms grow in popularity. (For smartphone users, this should feel very familiar as this mimics the plight of smartphone apps designed to work on both iOS and Android devices).

What Comes Next: what’s the future likely to hold?

If you live on this planet, you will have likely taken note of the firestorm of news stories around Facebook’s recent name change and the high-priced purchases of nonfungible tokens (NFTs) – a specific types of cryptocurrency token. While many wave away this NFT phenomenon, I see NFTs as what will very likely bring the greatest value to and from all of this crypto technology. It is NFT and blockchain technology that will offer the next generation solutions to supply chain challenges, identify theft protection and the sharing economy.

While I do see a potential crypto crash coming – and not just crypto, but in our entire U.S. financial sector (bull runs can’t last forever), I also see crypto as a clear victor, coming out of that dip stronger than ever. The crypto craze is NOT going away, and I submit that it will become commonplace faster than you went from zero to five smart speakers in your home … or maybe that’s just me. At any rate, in the same vein that companies raced to offer apps and online digital experiences to their customers once they recognized that apps represented the engagement medium of the future, companies will too clamor to use this blockchain-based technology as a competitive advantage for their businesses. And, I assure you, these options will soon be plentiful and beyond our 2021 imaginations.

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Be on the lookout for more from me as I share more from deep inside the crypto rabbit hole.

WDY think? Feeling better rounded about this whole shift to Web 3? (Will get into this in a future post). Did you learn something? Did I miss something? What’s your take on the token explosion? Feel free to comment if you have adds or corrections, message me if you have questions, or feel free to share with others if you find this informative.

Also be on the lookout for more zero-to-expert postings from this series as I share more from deep inside the rabbit hole.

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Coming up:

  • Crypto, an ecosystem (web3 and dApp stuff)
  • Crypto, a disruption (policy, geopolitical and defi stuff)   
  • Crypto, a brave new world (NFT and metaverse stuff)
  • Crypto, a solution (equity and wealth redistribution stuff)
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