The Real Relationship Between Cryptocurrencies, Blockchains and Initial Coin Offering (ICO)

This article has been cross-posted on armelnene.co.uk.

As any other hot technologies of the past, there’s a number of buzzwords plaguing the distributed ledger world that we cannot avoid. This creates a mist over the real goal of the technologies. The focus of this article is to try to demystify the world of cryptocurrencies, Blockchains and initial coins offering (ICO).

This all started with the whitepaper written by Satoshi Nakamoto about a peer-to-peer Electronic Cash System called Bitcoin. According to Wikipedia

In economics, cash is money in the physical form of currency, such as banknotes and coins. In bookkeeping and finance, cash is current assets comprising currency or currency equivalents that can be accessed immediately or near-immediately (as in the case of money market accounts). Cash is seen either as a reserve for payments, in case of a structural or incidental negative cash flow or as a way to avoid a downturn on financial markets.

Thus, this new cash system would be electronic in nature. The fact that the cash was electronic did not automatically make Bitcoin a cryptocurrency. Electronic cash has been around since the idea of digital cash was introduced by a research paper of David Chaum in 1983. He then later founded DigiCash. So what makes Bitcoin different to the electronic cash of yestertimes, you may ask? The answer is actually well documented in the Satoshi’s whitepaper. In a normal transaction involving multiple parties, a system of trust will need to be put in place to ensure that the promises are fulfilled. This trust factor would require a centralised body such as a central bank. The centralised body becomes the mediator and has the power of reversal. This is the case today with how Paypal Inc works. Paypal can easily implement their own centralised electronic cash which can be later on converted to physical cash also known as fiat currency. Bitcoin, defined as a peer-to-peer electronic cash, needed a way to create trust among its participants. Peers which are taking part in the network have to understand that there is no power of reversal once a transaction has been accepted and put through the network. For this reason, what is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party. This gave birth to the first cryptocurrency or cryptocash; Bitcoin – an electronic coin as a chain of digital signatures.

At this point, the cryptocurrency was created in a peer-to-peer network where participants can transact directly with one another without the need of going through a centralised entity. The peer-to-peer network introduced another problem; double spending. In the peer-to-peer network, parties involved in a transaction cannot verify if the electronic cash has not already been spent elsewhere. Unless the problem of “double spending” was resolved, the system would not be attractive for conducting electronic cash based transations. Therefore the solution here is to record the chain of ownership of the electronic cash (or coin). If a buyer spends a cash, the buyer will be recorded as the previous owner and the payee (or seller who accepted the cash) will be recorded as the new owner of that cash. A payee can verify the chain of ownership of the electronic cash so to ensure that the buyer has not already spent it elsewhere.

It is a good thing that the ownership history can be traced back to when it was first minted but there is no guarantee to the participants on the network that the history has not been tampered in any ways.

Another requirement emerged; the system needs a way to record transactions in a chronological order. The Bitcoin whitepaper proposed a Timestamp Server:

A timestamp server works by taking a hash of a block of items to be timestamped and widely publishing the hash, such as in a newspaper or Usenet post [2-5]. The timestamp proves that the data must have existed at the time, obviously, in order to get into the hash. Each timestamp includes the previous timestamp in its hash, forming a chain, with each additional timestamp reinforcing the ones before it.

As Bitcoin is a financial instrument, therefore the chronological recording of its transactions are similar to bookkeeping and the Timestamp Server is the bookkeeper, the analogy. Now that our bookkeeper is carrying out in bookkeeping duties, the system still needed a way to tell others what our bookkeeper recorded. The only solution is to make our books publicly available to all but let’s not stop there. Let others use our books for their own bookkeeping but let’s put some guideline in place about the information should be recorded in our books. Marketers have sexed up names of bookkeeping books to Blockchain and distributed ledgers.

The Blockchain is a by-product of Bitcoin, it was created in need to provide a trust less environment where peer-to-peer transactions can be executed without fraud.

The Blockchain is an innovative technology on its own and its application can be generalised. Cryptocurrency is represented as data on the Blockchain, therefore data, in its generalised definition, can be anything with a digital representation. The original Bitcoin Timestamp Server had minimal scripting capabilities but nonetheless the functionality was built-in. Those scripting capabilities are now referred to as smart contracts, scripts which can be executed on the Blockchain.

It is now clear what cryptocurrencies, in context of Bitcoin, and Blockchains are. We will go as far as saying that you cannot have a cryptocurrency without its own Blockchain. Blockchains can exist without cryptocurrencies but not the other way around. So, this takes us to the world of Initial Coin Offering.

Initial coins offering, also known as ICO, is a way to raise funds using cryptocurrencies. That is the only commonality. Most ICOs promises tokens which are assets built on top of various Blockchains with Ethereum being the most popular at the time of writing. Tokens are not cryptocurrencies and they are the subject of ongoing discussions of various governments. ICO projects do not have to utilised the Blockchains for development as their main goal is to raise finance similar to how investment in stocks work.

The real relationship is therefore as follow:

• Bitcoin was the first cryptocurrency as defined by Satoshi Nakamoto whitepaper
• The Blockchain is a by-product of Bitcoin which has matured to stand on its own
• Crytocurrencies need the Blockchain, or any other distributed technology
• Blockchain can be used without cryptocurrencies
• Initial coin offerings are only concerned with raising finances using cryptocurrencies which they would immediately exchange for fiat currencies

It is important to carry out one’s research as not to be overwhelmed with all the BS out there. This article was to highlight the relationship on the technology stack and as you can see; ICO are not even on the same stack.

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