What Is Cryptocurrency?

Andrey Sergeenkov is a freelance writer whose work has appeared in many cryptocurrency publications, including CoinDesk, Coinmarketcap, Cointelegraph and Hackermoon. He holds BTC and ETH.

Cryptocurrency is a relatively new type of money that operates in a completely different way than the traditional currency we all use every day. The most basic difference is that it’s exclusively a virtual currency, meaning there are no physical cryptocurrency coins or notes you can keep in your back pocket.

It’s also issued, or created, in a unique way. Instead of being produced by a central bank or government, like U.S. dollars, euros and other fiat currencies are, new cryptocurrency units typically enter circulation through a technological process that involves the participation of volunteers from all over the world using their computers.

That is why cryptocurrency is often described as “decentralized.” Cryptocurrencies are typically not controlled or operated by any single entity in any single country. It takes an entire network of volunteers from around the world to secure and validate transactions made with cryptocurrency.

But it isn’t just they’re digital nature and how they’re issued that sets cryptocurrencies apart from regular currencies; there are other differences:

• Regulation: The global financial system has been based on various fiat currencies for centuries and most countries have a mature set of laws and best practices to regulate their use. Cryptocurrency, however, is a largely unregulated market, and even when regulations exist they can vary by jurisdiction.

• Speed and cost: Sending and completing cross-border transactions using cryptocurrency is much faster than using the legacy banking system. Instead of taking several business days, transactions can occur within minutes, often at a fraction of the cost, when compared with using fiat currency.

• Supply: Fiat money has an unlimited supply. That means governments and central banks are free to print new currency at will during times of financial crisis. Cryptocurrencies, however, usually have a predictable supply determined by an algorithm. Many cryptocurrencies are coded to include a supply limit (though some don’t). For example, bitcoin – the world’s first cryptocurrency and the largest by market capitalization – has a maximum supply of 21 million tokens that are released at a steady and predictable rate. That means once the number of bitcoin in circulation reaches 21 million, the protocol will cease releasing new coins into circulation.

• Immutable: Unlike transactions involving fiat currencies, all completed crypto transactions are permanent and final. It is virtually impossible to reverse crypto transactions once they have been added to the ledger.

What puts the ‘crypto’ in cryptocurrency?

The word “crypto” in cryptocurrency refers to the special system of encrypting and decrypting information – known as cryptography – which is used to secure all transactions sent between users. Cryptography plays a vitally important role in allowing users to freely transact tokens and coins between one another without the need for an intermediary like a bank to keep track of each person’s balance and ensure the network remains secure.

It also solves a problem that used to make middlemen like banks indispensable – the double-spend issue: when a person attempts to spend the same balance twice with two different parties.

Cryptocurrencies use cryptography to encrypt sensitive information, including the private keys – long alphanumeric strings of characters – of crypto holders. Think of private keys as the passwords that determine the ownership of cryptocurrencies. Keep in mind that cryptocurrencies cannot be stored outside of the blockchain. They are permanently based on the blockchain. Hence, when someone says they own X amount of coins, what they really mean is that their password can legitimately claim X amount of coins on the blockchain.

Cryptocurrency private key concept(Getty Images)

These private keys are what crypto holders store on their wallets, which, as you must have guessed, are special kinds of software or devices designed specifically for this purpose. In instances where a crypto holder loses access to his or her private key, the cryptocurrencies associated with such keys could be lost permanently.

With the help of a cryptographic technique, private keys are encrypted to create wallet addresses, which can be likened to bank account numbers. In essence, you need your private key to digitally sign transactions. This is essentially like broadcasting to everyone in the network, “I confirm I am sending this amount of X coin to this person.” In contrast, wallet addresses indicate the destination of transactions.

The encryptions are executed in only one direction, which makes it impossible to derive private keys from a person’s wallet addresses.

While the cryptocurrencies themselves act as a medium for exchanging or for storing value, they all rely on a special type of public ledger technology called “blockchain” to record data and to keep track of all of the transactions being sent across the network.

A blockchain is exactly what it sounds like – a virtual chain of blocks each containing a batch of transactions and other data. Once each block is added to the chain, it becomes immutable, meaning the data stored inside it cannot be changed or removed.

Because cryptocurrencies are managed by a network of volunteer contributors known as “nodes” and not by a single intermediary, a system must be in place that ensures everyone participates honestly when recording and adding new data to the blockchain ledger.

The nodes perform a variety of roles on the network, from storing a full archive of all historical transactions to validating new transaction data. By having a distributed group of people all maintaining their own copy of the ledger, blockchain technology has the following advantages over traditional finance where a master copy is maintained by a single institution:

• There is no single point of failure: If one node fails it has zero impact on the blockchain ledger.

• There is no single source of truth that can be easily corrupted.

The nodes collectively manage the database and confirm new entries are valid transactions.

Think of it as having a cluster of computers take up the roles of a bank by consistently updating the balance sheets of users. In the case of distributed ledgers, however, the balance sheets aren’t stored in a single server. Instead, there are multiple copies of the balance sheets distributed across several computers, with each node, or computer connected to the network, functioning as a separate server. Therefore, even if one of the computers go offline, it wouldn’t be as detrimental as having a single server-based database go offline as can be the case in traditional banking systems.

This infrastructural design makes it possible for cryptocurrencies to evade the security mishaps that often plague fiat. It is difficult to attack or manipulate this system because the attackers must gain control of over 50% of computers connected to the blockchain network. Depending on how big the network is, it can be prohibitively expensive to carry out a coordinated attack. If you compare the amount required to attack established cryptocurrencies like bitcoin and what the attacker stands to gain at the end of the day, pursuing such an endeavor wouldn’t be viable financially.

Also, it is worth mentioning that the distributed nature of these digital assets establishes their censorship-resistant attributes. Unlike the case with banks, which governments regulate, cryptocurrencies have their databases spread across the globe. Therefore, when a government shuts down one of these computers or all the computers within its jurisdiction, the network will continue to function because there are potentially thousands of other nodes in other countries beyond the reach of one government.

Crowd of people on network connection lines. (Getty Images)

So far in this guide, we have explained why cryptocurrencies are secure and why they are censorship-resistant. Now, let us take a look at how crypto transactions are vetted.

How are cryptocurrency transactions validated?

Recall that blockchains are distributed databases where all the transactions executed on a crypto network are recorded permanently. Every block of transactions is linked together chronologically in the order the transactions were validated.

Because it is impossible to set up a central authority or bank to manage blockchains, crypto transactions are validated by nodes (computers connected to a blockchain). So the question is: How do these networks ensure that node operators are willing to partake in the validation process?

Share :