What are the main concepts used under the umbrella of crypto payments? Understanding the basics of how these work and their long-term impact is crucial
Almost every crypto conference you attend, or podcast, webinar, etc. you listen to, stresses the importance of educating consumers about crypto topics to overcome some of the hurdles this industry is facing toward understanding how crypto works and adopting it. And it is true, as this space is new, a bit different from the traditional finance world, and quite technological.
Over the next lines, we will try and explain some of the crypto space key concepts (such as blockchain, Ethereum, crypto, Bitcoin, stablecoins, CBDCs, tokens, NFTs, digital assets, DeFi, Web 3.0, and the metaverse) briefly.
BLOCKCHAIN – networks where all the magic happens
A Blockchain is a way of permanently recording and accessing secure information which is very difficult to change afterward and fully auditable. This is achieved using cryptography, networking, and consensus algorithms.
A blockchain is a growing list of records, called blocks, which are linked using cryptography. Each block contains a cryptographic hash of the previous block, a timestamp, and transaction data. The digital ledger is hosted across multiple computers – or ‘nodes’ – which track activity (or the transactions happening) between various users. By design, a blockchain is resistant to modification of the data. Once recorded, the data in any given block cannot be altered retroactively without the alteration of all subsequent blocks, which requires the consensus of the network majority.
In contrast to traditional models relying on a single, centralised source of truth, the blockchain is said to be ‘trustless’ because its distributed model is not dependent on universal trust in a single entity. Different models of blockchain networks enable various degrees of contribution, permissions, and roles for participants. These models are public blockchains, private blockchains, consortium blockchains, and hybrid blockchains.
Types of blockchains
1. Public blockchains are blockchains open to the public and have no access restrictions.
Sometimes, public blockchains are referred to as ‘permissionless’ blockchains because no one grants authority to someone else to interact with the protocol. Thus, any user that has access to the internet, can send transactions to it as well as become a validator (i.e., participate in the execution of a consensus protocol). As the network needs to create value, foster cooperation among participants, and be secured, participants are incentivised (e.g. rewarded with crypto/tokens).
Because anyone can use a public blockchain to send and receive transactions (data), the network can become clogged and slow. Moreover, if there is a lot of activity on a blockchain, it can take a while for transactions to process and network fees can increase. Some of the largest, most known public blockchains are Bitcoin, Ethereum, Stellar, and Dash.
A bit of info about Ethereum
The Ethereum universe relies mainly on the Ethereum Virtual Machine or EVM (a canonical computer whose state everyone on the Ethereum network agrees on), network participants (Ethereum nodes), Ether (ETH – the native cryptocurrency of Ethereum), accounts (where ETH is stored), transactions (the formal term for a request for code execution on the EVM), smart contracts (reusable snippet of code which a developer publishes into EVM state).
Nodes keep a copy of the state of EVM and can broadcast a request for this computer to perform arbitrary computations. Whenever such a request is broadcasted, other participants on the network verify, validate, and carry out (‘execute’) the computations. This execution causes a state change in the EVM, which is committed and propagated throughout the entire network. Cryptographic mechanisms ensure that once transactions are verified as valid and added to the blockchain, they can’t be tampered with later. The same mechanisms also ensure that all transactions are signed and executed with appropriate ‘permissions’. The processing cost of the nodes is paid for by the transaction initiator, by means of ‘gas’, which is an ETH fraction (‘gwei’).
Ethereum vs. Bitcoin – what’s the difference?
Often referred to as a first-generation blockchain, Bitcoin wasn’t created as an overly complex system, and that’s a strength when it comes to security. The smart contract language in Bitcoin is extremely constrained and it doesn’t accommodate applications outside of transactions very well.
The second generation of blockchains enables a greater degree of programmability on top of financial transactions. Different from Bitcoin’s blockchain, Ethereum enables the creation of decentralised applications (dapps) that combine a smart contract (a script that, when called with certain parameters, performs some actions or computation if certain conditions are satisfied) and a frontend user interface.
2. Private blockchains are permissioned blockchains where participant and validator access are restricted and those interested to join the network must be invited by the network administrators.
Even if members of the private blockchain network are known to each other, the transaction details are private, and the central authority (the enterprise or business) decides who can read the transactions. Private blockchains offer more efficiency and faster transactions for private enterprises than public blockchains.
Transactions on both public and private blockchains are verified by consensus, but there are many ways in which consensus can be achieved. In a private blockchain, the consensus is usually achieved through a process called selective endorsement. It is based on the concept that network participants have gained permission to be there and that the participants involved in a transaction can confirm it.
The most common examples of private blockchains are Ripple (XRP) and Hyperledger.
3. Hybrid blockchains are blockchains that combine centralised and decentralised features. In an ideal world, this type of blockchain will mean controlled access and freedom at the same time.
The blockchain network is controlled by one entity that decides who can access specific data stored in the blockchain and what data will be open to the public. The hybrid blockchain protects users from privacy-related issues, however, it still allows third-party communications like shareholders and the public.
Examples of this type of blockchain include XinFin used for remittance, peer-to-peer trading platforms, blockchain-powered insurance, and online digital asset-linked identity, or the LTO Network, which focuses on decentralised identities (DIDs) and verifiable credentials (VCs) to help improve existing identification methods, replacing anonymity with privacy.
4. Consortium blockchains are blockchains controlled by several companies that are operating as nodes. These are designed by a group of multiple entities that want to use a decentralised network to collaborate.
Consortium administrators restrict users’ reading rights as they see fit and only allow a limited set of trusted nodes to execute a consensus protocol. In this blockchain, the number of participants is known and verified, and authentication is conducted to reduce the risks of data and privacy threats. However, because the development speed of this blockchain depends on the cooperation of the participants, if participants can’t reach an agreement, that will stall progress.
Examples of consortium blockchains are Quorum from ConsenSys and R3’s blockchain platform Corda.
Blockchain technology can be integrated into multiple areas. Blockchain applications are created to be used for several industry sectors to reduce cost, increase transparency and fairness, and advance a specific sector’s efficiency. Blockchain application use cases include supply chain & logistics, healthcare, retail & ecommerce, finance, property & real estate, media, NFT marketplaces, heavy industry & manufacturing, music, cross-border payments, internet of things, gaming, personal identity security, government & voting, anti-money laundering, advertising, original content creation, automotive, smart contracts. For the scope of this report, when we use the concept of blockchain we refer mostly to the financial sector.
Watch out for our next instalment, where we will be briefly explaining crypto wallets, Bitcoin, stablecoins, and CBDCs.
This editorial was initially published in our Crypto Payments and Web 3.0 For Banks, Merchants, and PSPs Report. The first edition of our report aims to provide a go-to payment resource of crypto terms and concepts for those interested to understand the basics of crypto payments and their long-term impact. Furthermore, it shares practical examples of cryptocurrency-enabled ecommerce and banking services and presents the latest developments in the regulatory landscape. Also, it reveals what are the most innovative companies in this space, that are building the crypto rails.
About Mirela Ciobanu
Mirela Ciobanu is a Lead Editor of the Banking and Fintech domain at The Paypers. She is actively involved in drafting industry reports, carrying out interviews, and writing about the digital assets industry, the regtech space, digital identity, fraud prevention, and payment innovation. Mirela is passionate about finding the latest news on crypto, blockchain, DeFi, and fincrime investigations and is an advocate of the need to keep our online data/presence protected.
As a writer, she aims to always get the best obtainable version of the truth. She can be reached at email@example.com or via LinkedIn.