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What Is Cryptocurrency

By July 3, 2017 No Comments

It might be 2017 and you might feel like the world is speeding up so much that you can hardly catch up.

From an almost complete transition to a digital world to 3D printing and trips to Mars. Yet, there is still one crucial thing in our lives that seems a bit stale and old school – Money.

The chances are that since you’ve landed on this page, you want to know more about virtual currency, and cryptocurrency itself. And how it has started revolutionising the entire banking system and stirred the governments around the world.

So what is cryptocurrency – money of the 21st century or another millennial unicorn?

How Was Cryptocurrency Created?

How was cryptocurrency created

Before we move on to the nitty-gritty world of cryptocurrency, let’s have a look at its history. The development of cryptocurrency explains a lot about the current lack of trust towards virtual currency and common misconception about its purpose.

Once you get the technicalities and the complexity of cryptocurrency, you will know much more than the majority of people around you. So let’s try to make it as easy as possible:

The Nineties witnessed several attempts of creating a digital cash but none of them was successful. Mainly because each founder tried to centralise it and find a legitimate institution that will accept it as means of payment.

Not many people know that, but cryptocurrency emerged as a product of another invention – Bitcoin – the first and still most important virtual currency.

The founder of Bitcoin – Satoshi Nakamoto – wanted to create something nobody has thought about before, a digital currency. All he intended was to develop a peer-to-peer electronic cash system.

Nakamoto, himself said:

A lot of people automatically dismiss e-currency as a lost cause because of all the companies that failed since the 1990’s. I hope it’s obvious it was only the centrally controlled nature of those systems that doomed them. I think this is the first time we’re trying a decentralised, non-trust-based system.

Freedomnode.com

But what does it mean?

In a centralised network system, you need a payment network with an account, balance and a transaction to be able to monetise the cash. The central server keeps track of all transactions and prevents the so-called double-spending – the same amount of money cannot be spent twice.

In a decentralised network, on the other hand, you don’t have that server. So you rely on every single entity of the network to record all the transactions and check if the future transactions are valid, without an attempt of double spending.

I know, it’s already getting complicated. Considering all entities have to keep a record of these transactions, and you can only imagine how many of them there are out there.

Usually, the central authority declares the correct state of balances. For us, casual Joes, it’s the bank that does all the hard work and the entire process is out of our sight.

Most currencies circulating around the world are controlled by a centralised government, hence their creation and value can be regulated by a third party.

In the peers’ network, designed by Nakamoto, transactions are an open source, controlled by a code and they rely purely on the network. So there is no third party that can affect the currency.

And this was a key to his invention – no entity or government can influence the value of the currency, it’s born within the network and it stays there. The only thing that affects it is people who are actually investing in it, thus members of the P2P network.

What Is Cryptocurrency Really?

Ok, so you already know what’s the biggest difference between cryptocurrency and traditional money.

But what does cryptocurrency actually mean?

A cryptocurrency is a digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of this security feature. A defining feature of a cryptocurrency and arguably its most endearing allure is its organic nature; it is not issued by any central authority, rendering it theoretically immune to government interference or manipulation.

Investopedia

Cryptocurrencies are built on cryptography. They are not secured by people or by trust, but by math. It is more probable that an asteroid falls on your house than that a cryptocurrency address is compromised.

If you look at money on your bank account and the transactions you make on an everyday basis, you will see that it all comes down to the entry in a database. Money is all about a verified entry in some sort of database, whether it’s an account, balance or transaction.

Before you make any changes to the database, there are certain conditions that have to be met – usually, you have to own the money to be able to transfer it etc.

The same theory applies for cryptocurrency as well – it’s all about limited entries to the database, that nobody can change unless there are certain conditions met.

How Does Cryptocurrency Work?

how cryptocurrency works

We already know that the mechanism behind cryptocurrency is different to how traditional money work. And that every peer of the network has a complete record of all transactions, thus knows the balance of the accounts.

The backbone of cryptocurrency is also blockchain – a technology that was created alongside Bitcoin in 2008.

But if you look at it in a simple way, the exchange and transferring of cryptocurrency is fairly similar to traditional online bank accounts. One person sends money to another, and their account balance is adjusted accordingly.

The biggest difference is in the fact that cryptocurrency is not backed up by gold, silver of government’s official currency. Rather, it’s peers’ belief in the value of the currency.

So why does it seem so difficult and people cannot get their head around it?

Well… That’s mostly because the mechanism behind sending the currency is a little bit more complicated than that.

Let’s break it into steps:

#1 To be able to send money, you have to set up a wallet. The account and the idea behind it are similar to a well-known online bank account. You can see your balance, choose an amount you want to transfer, enter the recipient’s details and click ‘Send’.

#2 After you click ‘Send’, a message with your and recipient’s details will be sent to a particular cryptocurrency network. This prevents theft, and previously mentioned, double spending.

#3 If you have an online bank account then you know that before you make a transfer or a payment, you have entered a PIN code or use a digital security key. Same thing works for cryptocurrency – underneath a message, you have to include your signature.

Except, the signature is not based on handwriting but a mathematical formula.

The math behind a signature comes from the word ‘cryptography’ – an art of hiding. Normally used to hide secret messages, but in transferring cryptocurrencies is used to prove the signature’s authenticity. Clever, right?

What’s more – each user has a private key which is used to encrypt the signature!

#4 All confirmed transactions from the beginning of cryptocurrency are stored in a public ledger. The ledger ensures the accurate spendable balance, and that each transaction uses only coins that already belong to the spender. Again, that’s all to avoid theft and double spending.

So who can become a ledger?

Surprisingly – anyone. This goes down to the original idea behind cryptocurrency and wanting to avoid having one entity, e.g. government, that can control the value of cryptocurrency.

Every time the message is sent, it’s received by so-called maintainers – people who all want to help with maintaining the ledger and the value of cryptocurrency. Each maintainer keeps a copy of a transaction and a message and updates it whenever receive a new transaction.

Ledgers are spread all over the world, so as you can imagine, there will be different versions of the ledger accordingly to whatever balance each maintainer has. This can also be affected by a potential fraud.

How can maintainers come to an agreement on what the correct ledger is? Like in every democracy, there is a voting system. In cryptocurrency world, it’s different though to a common ballot box.

Instead, maintainers try to solve a mathematical puzzle and whoever solves the puzzle, gets to decide the correct ledger.

Math allows a democratic vote in a decentralised system, and the only way to outsmart the system would be buying more electricity and computers, thus increasing the cost.

In a way, maintainers can create new money through computation, hence they can be called miners.

This brings us to another aspect of cryptocurrency: mining.

What Is Cryptocurrency Mining?

what is cryptocurrency mining

Since miners are the most important part in cryptocurrency exchange, it’s worth to look deeper at what do they actually do.

As a rule, everybody can be a miner. Because the decentralised network doesn’t have a single authority, a cryptocurrency still needs some kind of mechanism to prevent one ruling member from abusing it.

So, Nakamoto set the rule that whoever wants to be a miner, has to invest into some work of their computers to qualify for the task.

What they have to do is find a hash – a product of cryptographic function – that connects the new block with its predecessor.

In simple words, mining is the process of confirming transactions and adding them to a public ledger. To do that, a miner has to solve, a previously mentioned, extremely complex mathematical puzzle.

The mining process is what gives a value to the coins and is known as a proof-of-work system.

This function is designed to be difficult on purpose. Otherwise, it wouldn’t be able to prevent a malicious behaviour or spammers. Above all that, it also prevents a single person from having a control over which block is added to the ledger next.

I know what you must be thinking – the mining process takes forever and it involves a complicated mathematical formula, hence it takes ages to solve it.

Surprisingly, it only takes minutes and the quick process is one of the things that makes cryptocurrency so efficient.

What Are The Properties Of Cryptocurrency?

To be able to truly understand the revolutionary aspect of cryptocurrency, we have to first understand its properties and what makes it so different to traditional banks and cash.

When describing cryptocurrency properties, we have to separate between two different properties: the transactional and monetary.

Transactional Properties

Irreversible

Once the transaction has been sent and approved, there’s no way back. Nobody can reverse the transaction, even if you make a mistake or you became a scam victim, you won’t be able to get your money back.

Secure

We already spoke about the private key and the encryption that makes cryptocurrency bullet-proof secure. The extremely strong cryptography prevents from anyone being able to access the code and the signature.

Fast and global

Because cryptocurrency exists only online, the transactions are confirmed in minutes. It doesn’t matter if you’re sending your money to a neighbour or a stranger on the other side of the world, the virtual money will be deposited into your account almost instantly. Yup, no more lengthy bank transfers and painful currency exchange.

Anonymous

Now, this is a part which causes the most controversies around cryptocurrency. Neither the accounts nor the transactions are connected to the real world identities. Your name is a pseudonym and the address is a combination of 30 symbols, which are not linked to your real address at all.

Permissionless

You don’t need anyone permission to open up a wallet and buying cryptocurrency. Anyone can do that and you don’t need bank’s permission or credit checks etc. No gatekeepers are involved.

Monetary Properties

Controlled Supply

Most cryptocurrencies limit the supply control of tokens by a schedule written in a code. This means that there are no surprises and anyone can roughly estimate the amount that will be available in the future. For instance, we already know that by 2140 Bitcoin will run out of its supplies and there won’t be any more to buy.

No Debt

If you look at your current bank account balance, it will most probably be debt. So even if your account is on plus, it’s still debt. That’s how Fiat Money system functions. Cryptocurrency, on the other hand, is nothing like that. The money you have on your account represent what you actually have.

Different Types Of Cryptocurrency

examples of cryptocurrency

In this sense, cryptocurrency is similar to worldwide currencies. There isn’t just one cryptocurrency that is available.

There’s a few of them and with the demand constantly rising, the new ones will be invented.

One could write an entire book on different cryptocurrencies and the difference between them. However, these are the most popular ones and you are most likely familiar with all of them.

So let’s have a look at different types of cryptocurrency:

Bitcoin

It’s the very first, most well-known, cryptocurrency available today. What started as Nakamoto’s experiment, turned into a huge investment for some and one of the most desired currencies to purchase. The value of Bitcoin has started at zero, and it has grown ever since to a value of 2,220 Euro.

Ethereum

The same way as Bitcoin is a Nakamoto’s baby, Ethereum belongs to another crypto-genius – Vitalik Buterin. While Bitcoin is used to validate a set of accounts, Ethereum can also validate so-called states. What does it mean?

Ethereum can not only process transactions but also contracts and programmes. Meaning that besides Ethereum Classic, there are other clones of the currency that create an entire Ethereum family.

Bitcoin can fuel itself and it’s just a digital currency. Ethereum is more of a blockchain-based development platform.

Litecoin

It’s the second digital currency that emerged after Bitcoin. It’s almost four times faster, with a larger amount of tokens and minimised algorithm.

Litcoin is more expensive and more complex to produce than Bitcoin, hence it’s not as popular. Nowadays though it’s considered as a backup option for those who are aware of the slowly disappearing Bitcoin.

Monero

This algorithm was introduced with more security in mind than Bitcoin. It added extra privacy features to the chain and wasn’t considered as a currency at the beginning.

If you use Bitcoin, every transaction is documented and can be traced back to its origins. Monero introduced a cryptonite algorithm called ring-signatures. This allowed processing transactions, without them being easily released in the blockchain.

The Disadvantages of Cryptocurrency

Cryptocurrency has many benefits and most of them are reflected in its transactional properties. From security, to how quickly money can be available on your account.

But with so much bad press and reputation, you’re probably wondering what is it that made cryptocurrency such an underdog and a favourite topic of dark web.

Let’s have a look at what’s not so great about cryptocurrency:

Not Widely Accepted

There aren’t many companies or websites that accept bitcoin as a method of payment. If you really want to use it a payment, you would first have to find a service provider that accepts it and only then you can use it.

Irreversible

As mentioned before, it’s one of the cryptocurrency’s properties- you can never get your money back. If you send it to a wrong person or you put an extra zero and from 1,000 it becomes 10,000, it’s basically your problem. As harsh as it sounds, you cannot complain to anybody, not even Nakamoto could reverse the transaction for you.

Losing Your Wallet

Just like in real life, you can lose your wallet with cash and credit card inside. If you lose your login details or for some reason cannot access the platform, there’s not much you can do. There weren’t many cases in which anyone was locked out of the system completely, but still, it could happen.

And when it happens, there’s nothing you can do. Even when somebody steals your credentials or personal keys, which again, is highly unlikely, you will have to accept it and live with the loss.

Subject To Market Fluctuations

If you want to invest in cryptocurrency, you have to keep in mind its dynamic and changing market prices. While it can be used to buy and sell, it’s also a commodity like oil.

It’s best to look at it as a long-term investment, rather than a quick way of making money. So, you cannot get discouraged if the value suddenly drops and you lost quite an amount – the chances are you will recover it in the future.

Transactions Cannot Be Traced To A Real Address

I mentioned before that cryptocurrency account cannot be linked to a physical and real address as well as personal details, hence it makes it more difficult to be traced.

Yes, there’s an algorithm and unique signature but you will never be able to trace it back to the real person and the account holder.

This feature makes digital currency the perfect tool for criminal transactions and is one of the reasons for some governments to declare cryptocurrency transactions illegal in their countries.

What Is The Future Of Cryptocurrency?

what is cryptocurrency

Regardless of what anyone says – cryptocurrencies are here to stay – and to change the current banking system.

So far, cryptocurrency has been pushed down to the dark side of the web and associated with the shady side of the market.

But people all over the world are investing in cryptocurrency and use it to protect themselves against the devaluation of their national currency.

Same is with banks and governments, which are coming to an understanding that cryptocurrency is the money of the future, whether they want it or not. They just have to figure out a way to how to implement it and how to make it more legitimate.

South Korea is one of the most recent countries that have started considering legalising Bitcoin and creating proper regulations around it. This, of course, will change the nature of cryptocurrency and will impose certain laws that I think we can all agree are needed.

The revolution is already happening. You can either stand on a side and observe – or you can become a part of history in the making and learn what is cryptocurrency.

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Megan Frydel

Author Megan Frydel

Megan is a self-thought blockchain enthusiast. She enjoys combining finance with technology, from a less-techy perspective. BiteMyCoin is her most recent project underneath the umbrella of an international digital marketing agency ANCHOVY.

More posts by Megan Frydel

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