IOTA, which trades under the ticker symbol MIOTA, is a digital currency specifically designed for the Internet of Things (IoT). This cryptocurrency is used to make transactions on IOTA's distributed ledger, which is known as the tangle.
IOTA was created with the intention of improving upon the blockchain, a more basic distributed ledger system, and solving its inherent problems. Because it eliminates fees, IOTA has been envisioned as enabling a "Machine Economy" that leverages a high number of devices.
The problem with this situation is that it gave the two groups different incentives. While users naturally benefited from low fees, miners would reap greater rewards when these fees were higher.
This created conflict between users and miners. While the Bitcoin Protocol gave miners the ability to upgrade the Bitcoin network and increase its bandwidth, doing so would have reduced the fees they collected by processing transactions.
To bring about a major change such as increasing the size of blocks in the blockchain, a hard fork would be required, which in turn could not happen unless a supermajority of miners signalled their support of such a change. Generating this kind of consensus proved difficult given the bitcoin community's decentralised nature.
As a result, bitcoin suffered from a drawn-out scaling dilemma, where different groups proposed solutions that were met with repeated failure. At the time of this writing (May 2018), bitcoin has the same 1MB blocks it had when it was first created.
To overcome these challenges, IOTA created a next-generation distributed ledger called the tangle, which gets its name from the way it links transactions. "The tangle naturally succeeds the blockchain as its next evolutionary step, and offers features that are required to establish a machine-to-machine micropayment system," the IOTA whitepaper states.
To issue a new transaction, a node must contribute toward confirming other transactions. The more approvals a transaction gets, the more assurance there is that the system accepts it. Every time a node makes a transaction, it contributes to the security of the overall IOTA system.
In order to issue a transaction, a node must confirm two other transactions, which are chosen at random using a specific algorithm. Next, the algorithm ensures that the transactions that have been selected in this manner do not conflict with one another.
Once this is verified, the node looking to issue the transaction must contribute some of its computational resources in order to solve a cryptographic puzzle. Finally, this information can be passed along to other nodes in IOTA's network as devices spread the news to their neighbor devices.
While a blockchain is deterministic and verifies a certain number of transactions per second, IOTA's tangle is probabilistic. The system's algorithm randomly selects transactions for verification, so some transactions are confirmed by the tangle more quickly than others.
IOTA's tangle does not depend on the linear addition of blocks to grow, and can instead expand in parallel. As a result, it can scale more easily in response to greater user demands than the blockchain could.
Unlike many digital currencies, which are decentralised by design, IOTA is partially centralised. It uses a special node called the Coordinator, which is in place to protect the network from the threat of one party (or a group of parties working together) from getting too much influence over the digital currency's network.
The Coordinator, which is run by the IOTA Foundation, digitally confirms transactions, as well as their location. Basically, the Coordinator is just like any other node, except that by signing both a transaction and its location, it prevents that particular transaction from then being reattached somewhere else.
Because IOTA relies on the Coordinator, it is not a trustless network like bitcoin. When leveraging IOTA, users must be willing to trust the IOTA Foundation and its staff.
IOTA represents innovative technology that could hold great potential. However, investors should keep in mind that IOTA, like many other digital currencies, is a speculative investment.
While potential investors may find this particular cryptocurrency appealing, they should be sure to conduct the proper due diligence before buying, selling or otherwise investing in this digital currency.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…