Cryptocurrency - main types, how to use each of them

Cryptocurrency

Cryptocurrency is a type of digital currency (electronic money) that can be used as an alternative or additional currency. Satoshi Nakamoto used the term "electronic cash." The term "cryptocurrency" began to spread after Forbes magazine published Andy Greenberg's article "Crypto Currency."

The idea of digital money began to take shape in the 1980s on exchanges and was driven by the need for faster transactions in financial instruments.

Several commercial projects based on the development and implementation of the digital version of money were launched.

DIGICASH

In 1990, DigiCash was created with its eCash money system. The system included a feature that supported the confidentiality of electronic payments and included cryptographic data protection. The eCash system was fully centralized. This company existed for 8 years, and in the year 1998, it was successfully bankrupted. Nevertheless, the idea of anonymous payments was noticed by other enthusiasts.

HASHCASH

In 1997, British businessman and cryptographer Adam Beck developed the Hashcash system. This system was used as part of the data analysis algorithm in both bitcoin and other cryptocurrencies. The improvement of Hashcash was handled by Harold Finney, the same one who was a participant in the very first bitcoin transaction.

Then two independent projects based on the Hashcash technology appeared: B-money and Bit-Gold. Both used a decentralized data registry. These are the projects that can be considered cryptocurrency prototypes.

B-MONEY

The B-money project is explicitly listed as #1 in the list of references, as a source in Satoshi Nakamoto's "Bitcoin: a peer-to-peer electronic cash system".

Therefore, we can consider that the founder of Bitcoin realized a very important and conceptually breakthrough project. But this project is the final step in a long chain of research.

Altcoins

The word "altcoin" has two parts. "Alt" is short for "alternative" and "coin" for "coin". All of these are alternative cryptocurrencies, except for bitcoin. The best known is ETH, the Ethereum digital currency.

Why do altcoins arise? Various blockchains or projects based on them (protocols) arise to address the shortcomings inherent in the Bitcoin network or to offer new solutions.

Despite its popularity, bitcoin is primarily used for value accumulation and preservation. The altcoin market has increased the number of cryptocurrency users by an order of magnitude. And it happened largely because many altcoins have a practical use within the project.

It is worth clarifying a few concepts that cryptocurrency includes. Cryptocurrencies are monetary units issued on their blockchain. Crypto-tokens are digital assets issued by a project that has been launched on a third-party blockchain.

Read more about why a project might need its cryptocurrency.

Service tokens

These are a digital representation of the right to certain actions on the platform that issued them. They have value, but they don't work like money in the usual sense. Instead, they provide access to products, services, or actions. All token functionality is limited to a specific ecosystem. Examples of utility tokens are tokens backed by exchanges: BNB (Binance), HT (Huobi), and FTT (FTX). When making a transaction, the holder of this type of asset receives a discount on trading commissions. Although this type of cryptocurrency was originally intended for use within its ecosystem, it very often becomes an object of speculation outside the system of intended use.

Management tokens

They allow holders to participate in the development of the project by voting. Each token equates to one vote. Any token holder can propose any changes. If the right number of votes are cast, the change is implemented. Token voting governance is inherent in a new form of organization, the DAO. It is a decentralized autonomous organization, a kind of digital analog of a corporation, but created on the blockchain, decentralized, and managed by governance tokens.

Liquidity tokens 

DeFi, or decentralized finance, employs this mechanism. There are special platforms, such as Uniswap, and Curve. They create liquidity pools - trading pairs of coins or tokens with blocked funds in smart contracts. When a user deposits his assets into the liquidity pool, he receives a liquidity provider token, the so-called LP-token, in return. This token represents the user's stake in the pool and can be used in other DeFi projects as a valuable asset. Such, and some other financial mechanisms, have led to DeFi accumulating significant funds. As of March 5, 2022, the total value of blocked funds in decentralized finance is $251.7 billion.

Scam projects 

Fraud among crypto projects is also not uncommon. Crypto-tokens are also used to commit fraud. Different schemes are used, but often the main goal of fraudsters is to advertise a new token, increase its price as quickly as possible, and sell it. In the fall of 2021, the Squid Game token, allegedly based on the "Squid Game" series, rose by 2,280%. After that, the organizers of the scam pulled out of the project, defrauding gullible users of $3 million.

Wrapped tokens

Since there are different blockchains with their technical characteristics, the cryptocurrency of each of them is created according to certain standards. Therefore, it is not possible to transfer a coin or token from one blockchain to another directly; doing so will result in the loss of transferred funds. One solution to move assets between blockchains is the use of wrapped tokens.

The question may arise - why transfer cryptocurrency between different blockchains at all? Today's DeFi tools can offer different scenarios in which this might be interesting. For example, in a decentralized application (dApp) running on another blockchain, you can get a profit percentage for storing the asset.

To better understand how this transfer happens, let's look at a concrete example. We need to transfer 1 BTC from the Bitcoin blockchain to the Dapp, which is on the Ethereum blockchain. By the way, Ethereum is the most developed ecosystem of DeFi-applications so far.

The user needs to send 1 BTC to the bitcoin address generated by Dapp. At the same time, you need to specify your address on the Ethereum blockchain. The sent 1BTC will be blocked at the specified bitcoin address, instead, the user will receive 1 WBTC token, wrapped in BTC, to the Ethereum address. This is an ERC-20 standard token; it is this standard that all cryptocurrencies on the Ethereum blockchain comply with. The exchange rate for tokens will be the same: 1 BTC = 1 WBTC.

The mechanism of wrapped tokens significantly expands the scope of the use of cryptocurrencies. Thanks to it, liquidity in various protocols and the speed of transactions increase, and commissions for transactions decrease. WBTC alone is worth $ 10.65 billion on the Ethereum network in various DeFi applications as of March 5, 2022.

Stablecoins

Stablecoins are a separate type of altcoin. The term means "stablecoins." The rate of stablecoins is most often pegged to a real asset, such as the US dollar.

Therefore, the volatility of the exchange rate for this type of cryptocurrency is extremely low. This is a monetary unit that is more understandable for a crypto-investor, with which you can compare the rate of other cryptocurrencies, fix profits in a transaction, and store funds between transactions.

There are stablecoins backed by real money. That is, an organization issuing such a cryptocurrency has a reserve asset for the same amount for each issued monetary unit. For example, the Center consortium issues USDC stablecoins, each of which is backed by the US dollar.

Some stablecoins are backed by another cryptocurrency. Since crypto assets are inherently volatile, the value of the collateral should significantly exceed the value of the stablecoin being issued.

The DAI token of the MakerDAO protocol is generated after the user deposits a certain amount of collateral cryptocurrency into the smart contract. The system is governed by a liquidation mechanism. When the value of the collateral falls below the liquidation ratio, the position is liquidated.

The third type of stablecoins is those whose rate is regulated by mathematical means. That is why they are called algorithmic. A similar model is used to create the UST stablecoin on the Terra blockchain. This burns an equivalent amount of the native Luna coin.

Stablecoins account for 10.8% of the capitalization of all cryptocurrencies. Stablecoins play the role of working capital when working with crypto assets since their share in the daily turnover is 50%. This asset class plays an important role in the cryptocurrency market by providing huge liquidity.