How to explain cryptocurrencies to your children

Cryptocurrencies are hard to understand because they sit at the intersection of topics that are hard to understand by themselves — the banking system, cryptography, and game theory. The banking system is probably the most familiar, but the mere fact that you use a credit card or do wire transfers doesn’t enlighten you on how the whole system works. Cryptography, in short, is a branch of mathematics that study cyphers, and game theory is a branch of science that studies strategies.

We can understand something by associating it with current knowledge. We also don’t want to spend days, months, or even years merely to please our curiosity. But if the gap between what we already know and what we want to know is too large, then the understanding (in short conversation or article) is nearly impossible.

This article will explain cryptocurrencies based on the knowledge that every one of us already possesses. It omits the nomenclature used in the number theory, computation theory, or distributed systems; instead, it explains how to build cryptocurrencies in the physical world without computers.

// This task is nothing but easy because it requires a deep understanding of all of the components of cryptocurrencies and a wide range of metaphors. // // Is it my knowledge bragging?

Currency

Currency can be defined as a common medium of value exchange. Any medium to become a currency has to fulfil several requirements. The most vital is that it has to be in deficit and laborious to obtain; otherwise, if anyone could create it out of thin air, no one would consider it valuable. As a medium of exchange, it has to be easily transportable from one owner to the other. It’s also a desirable feature that the transport should be cheaper than the value of the currency being transported. The currency should be unfakeable or easy to distinguish the legitimate ones from the fake ones. Finally, as a common medium of exchange, it must be widely accepted — not only by ourselves or our family members.

Gold

Gold—among shells, cigarettes, beads, cloth, promissory notes—was one of the first currencies that satisfied these requirements. It was naturally deficit, hard to mine, impossible to falsify, relatively compact, and commonly demanded; these features made it a great candidate for a currency.

For years gold was used as a common currency. Interestingly, its prevalence came not from the practical applications but from the fact that everyone wanted it, and everyone wanted it because everyone else wanted it — similarly how Corovavirus created toilet paper demand.

Yet, gold had some flaws; it was impractical in transportation, was hardly divisible, and didn’t allow micropayments.

Bank

The banking system solved the problem by introducing handy securities — coins and banknotes. Everyone could deposit gold in exchange for a “certificate” — banknote. Banks guaranteed that for each issued banknote, a gold equivalence would always be available for exchange.

Such “paper gold” inherited all the gold’s advantages but solved all its flaws — banknotes were relatively light, easy to transport and divide. Coins made it possible to trade minor goods, like one apple, individually.

Bank guaranteed that the number of issued banknotes and the amount of gold remains equal. In other words, each banknote will always be backed by the corresponding amount of gold. The whole system worked because people trusted that indeed it was true.

It’s easy to guarantee that the amount of gold doesn’t exceed the number of banknotes. But, it’s hard to ensure that the number of banknotes doesn’t exceed the amount of backed gold. Printing banknotes is far cheaper than mining gold; therefore, “printing gold” can be very appealing.