What is a protocol?
Protocols are basic sets of rules that allow data to be shared between computers. For cryptocurrencies, they establish the structure of the blockchain — the distributed database that allows digital money to be securely exchanged on the internet.
Bitcoin entered the world in the form of a white paper written by a pseudonymous person or group going by the name of Satoshi Nakamoto. The paper, which was posted to a cryptography message board in 2008, outlined a set of computational rules that established a new kind of distributed database called a blockchain. The blockchain would work like a ledger, tracking every Bitcoin transaction, and would be self-verifying — constantly checked and secured by the computing power of the entire network. “Miners,” whose computers do the heavy lifting of maintaining the chain, would be rewarded in Bitcoin. Collectively, these rules form the Bitcoin protocol — quite literally, they are Bitcoin.
Of course, protocols aren't exclusive to cryptocurrency. They’re fundamental to how the internet works, governing the transmission of data from one computer to another. Email, for instance, is based on several sets of protocols. The HTTP you see at the beginning of every URL? It stands for “hypertext transfer protocol.”
The Bitcoin protocol proved that digital money could be exchanged safely on the internet. In its wake, thousands of new forms of digital money, each with their own protocols, have followed. And over the subsequent decade-plus, fundamental breakthroughs in cryptography, and decentralized computation have continued to open up new possibilities for blockchain protocols.
Why are protocols important?
Protocols allow cryptocurrencies to be decentralized via the blockchain — which means they are spread across a network of computers with no central hub or authority.
The key advancement of the Bitcoin protocol was that it created digital money that can be traded or spent without anyone in the transaction worrying that the money has already been spent. (This is known as the double-spend problem, and it’s familiar to anyone who’s ever bought a concert ticket from a stranger only to discover that it’s already been scanned.)
Since Bitcoin protocol was born, subsequent rulesets have evolved to encompass a huge range of functions. There are thousands of cryptocurrencies, each with their own protocol.
The Ethereum protocol, for instance, is designed around “smart contracts” — in which a transaction or agreement automatically executes when certain criteria are met.
A vast new set of protocols that run on the Ethereum blockchain have emerged, allowing for a range of decentralized financial products that automate everything from lending and savings to insurance.
Ethereum isn’t the only “smart contract” protocol in the crypto universe — newer blockchain protocols like Polkadot have emerged to compete in the space.