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What is cryptocurrency and how does it work in the digital world?

Toni Hetherington and David Swan, May 8, 2019 6:45PM The Australian

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Cryptocurrencies including Bitcoin, Litecoin, Ethereum and Dogecoin. Picture: iStock media_cameraCryptocurrencies including Bitcoin, Litecoin, Ethereum and Dogecoin. Picture: iStock

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The digital world is ever growing and ever-changing — and now new ways of paying for things in the digital world are expanding, too.

Here we look at cryptocurrencies* — what they are, if they are legal, if they are here to stay, and how you can use them.

What are cryptocurrencies?
Cryptocurrencies are digital tokens, they are not physical coins or cash. They are a type of digital money that allows people to make payments directly to each other through an online system. They were set up to allow person-to-person transactions without the need for banks.

Cryptocurrencies have no value set by law. They are simply worth what people are willing to pay for them in the market*.

How many cryptocurrencies are there?
Just as there are many different traditional currencies in the world (Australian dollar, Euro, Japanese yen), there are many different cryptocurrencies. In fact, there are more than 1300 with the most well-known of these is Bitcoin.

A new cryptocurrency can be created at any time. Bitcoin is the world’s largest cryptocurrency followed by Ethereum, Ripple, Bitcoin Cash, Cardano, and Litecoin.

Activity in cryptocurrency markets has increased a lot and prices of cryptocurrencies have risen quickly.

The fascination with these currencies appears to have been more about making money (buying them to make a profit*) rather than their use as a new and unique system for making payments.

media_cameraA visual representation of the digital cryptocurrency Bitcoin. Picture: AFP

Ups and downs of cryptocurrency.
The prices of many cryptocurrencies have been like a rollercoaster. Up and down, up and down.

For example, the price of Bitcoin increased from around US$1000 at the start of 2017 to around US$20,000 at the end of 2017 before falling to around US$7000 in early 2018.

Who invented cryptocurrency?
No one knows.

In October 2008, a group of geniuses named Satoshi Nakamoto officially unveiled a report detailing the workings of a new form of currency: Bitcoin.

Nakamoto, who was once rumoured to be Australian academic* Craig Wright, claimed to be a 37-year-old man living in Japan, but some say he’s unlikely to be Japanese given his perfect English.

Will there be an Aussie cryptocurrency soon?
The Governor of the Reserve Bank Philip Lowe noted in a 2017 speech that “there are: … no immediate plans to issue an electronic form of Australian dollar banknotes, but that the Reserve Bank is continuing to look at the pros and cons”.

Most industry experts and observers are fairly sceptical *about whether cryptocurrencies will replace more traditional payment methods or national currencies.
The future use of cryptocurrencies will likely depend on how well they can meet the needs of users compared with other electronic payments, such as electronic bank transfers.

Person looking at blockchain concept on screen, cryptocurrency, business, fintech media_cameraA businessman looks at a blockchain concept on screen.

Are cryptocurrencies here to stay?
The foundations* of the technology — known as blockchain — are here to stay.

Blockchain, a way of recording transactions*, is still very new and is being compared to the way the internet was in 1994.

Social media giant Facebook is currently recruiting dozens of financial businesses and online experts to help launch a cryptocurrency-based payments system.

If it succeeds, it is likely to become the most recognised use of cryptocurrency.

VIDEO: Understanding cryptocurrencies

The Bitcoin System
Bitcoin was launched in 2009 and was designed to electronically copy features of a cash transaction. It was designed to allow person-to-person transactions, without the need to know or trust the other person in the transaction, and to occur without the need for a central party (such as a bank).

The Bitcoin system uses blockchain technology to record transactions and the ownership of bitcoins. This is basically technology that connects groups of transactions (blocks) together over time (in a chain). Each time a transaction occurs, it forms part of a new block that is added to the chain. As a result, the blockchain provides a record (or database) of every Bitcoin transaction that has ever happened, and it is available for anyone to see and update on a public network (this is often referred to as a ‘distributed ledger’).

The Bitcoin system is protected by cryptography, which is a method of checking and securing data using extremely difficult mathematical codes. This makes the system very hard to hack or destroy.

Bitcoin transactions are confirmed as real by other users of the network, and the process of checking and confirming transactions is often referred to as “mining”.

The Bitcoin system increases the difficulty of these codes as more computing power is used to solve them. A new block of transactions is created about every 10 minutes. “Miners” want to solve the codes and process transactions because they are rewarded with new Bitcoins (about 12.5 new Bitcoins per block).

media_cameraA technician inspects the backside of bitcoin mining at Bitfarms in Saint Hyacinthe, Quebec. Picture: AFP

An example of a Bitcoin transaction
Suppose Alice wants to transfer one Bitcoin to Bob. Alice starts the transaction by sending an electronic message with her instructions to the network, where all users can see the message. Alice’s transaction is one of several transactions that have recently been sent. Since the system is not immediate, the transaction sits with a group of other recent transactions waiting to be compiled into a block (which is just a group of the most recent transactions). The information from the block is turned into a cryptographic code and “miners” compete to solve the code to add the new block of transactions to the blockchain.

Once a miner successfully solves the code, other users of the network check the solution and reach an agreement that it is correct. The new block of transactions is added to the end of the blockchain, and Alice’s transaction is confirmed.

It can take up to 60 minutes for users to be certain that their transaction has been successful.

There is not an endless supply of Bitcoins
There are only 21 million Bitcoins in total that can be mined. The number of new Bitcoins created each year is automatically halved over time, until the number mined hits 21 million, which is estimated to happen in 2024.

Right now, more than three out of every four Bitcoins that will ever exist have already been mined, while an unknown number have been lost forever due to discarded* hard drives or websites closing down.

Bitcoin uses a huge amount of energy
Bitcoin mining uses an incredible number of computers and, therefore, an incredible amount of power. So much so that in Iceland, which relies largely on cheap hydro-electric* power, more energy is used mining Bitcoin than for combined household use. Bitcoin uses so much energy to mine that some experts are warning it could lead to eventual environmental disaster. Despite a recent government crackdown, a large portion of Bitcoin mining is concentrated in China, which relies heavily on coalmining to generate its electricity.


GLOSSARY

  • cryptocurrencies: a type of digital money
  • market: an area where financial dealings are done
  • profit: gaining money
  • academic: relating to education
  • sceptical: having doubts
  • foundations: what it is built on
  • transactions: buying or selling
  • discarded: thrown away
  • hydro-electric: making electricity using flowing water

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QUICK QUIZ

  1. Name two types of cryptocurrency.
  2. When did Bitcoin first start?
  3. Is cryptocurrency real money?
  4. What is the name of the technology that is the foundation of cryptocurrency?
  5. What is the highest number of Bitcoins that can be mined?

LISTEN TO THIS STORY

CLASSROOM ACTIVITIES
1. Good or bad?
Think about the benefits (the good things) and the disadvantages (the bad things) of cryptocurrencies like Bitcoin. Draw up a table listing all of the benefits on one side and the disadvantages on the other.

Do you think that Australia should create its own cryptocurrency? Use points in your list to help you to write a paragraph explaining your opinion.

Time: allow 30 minutes to complete this activity
Curriculum Links: English, Economics and Business

2. Extension
Create a storyboard or series of pictures that will help another student understand how bitcoin mining works.

Time: allow 40 minutes to complete this activity
Curriculum Links: English, Economics and Business, Visual Communication Design

VCOP ACTIVITY
Cryptocurrency seems like something out of a sci-fi movie, but mind you can you believe next year is 2020! That sounds out there too.

Can you imagine what’s next? A world where we work for tokens that we never see, paid with the swipe of our Garmins or will our fingerprints have chip technology imprinted into them?

Imagine it is the year 2050, you are all grown up and out in the workforce. What will your job be? Has it been invented yet? How have things changed with technology, money (or lack of it), transport, and how we live?

Write a letter from the “future you”, sent back in time to the “2019 you” — like a reverse time capsule.
Tell yourself about the world in 2050 … has cryptocurrency replaced physical money, or is there another version yet again?

Don’t forget to re-read to edit, and up-level with your VCOP


HAVE YOUR SAY: Do you think cryptocurrencies will be used instead of cash and coins in the future? Why or why not?
No one-word answers. Use full sentences to explain your thinking. Comments will not show until approved by editors.

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