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What is Cryptocurrency?

crypto-currency

No matter where you turn to on the internet, you see articles and articles on Cryptocurrency. Even friends and family are likely pushing you to “invest” in cryptocurrency. However, given the incredibly fast rise of cryptocurrency, do many people even know what cryptocurrency really is? I decided to try to summarize what cryptocurrency is and offer you some additional high level details.

What is Cryptocurrency?

A cryptocurrency is a digital / virtual currency designed to work as your money (i.e. medium of exchange). The digital currency has no centralized government or agency that acts as the intermediary. In essence it exchanging money via peer to peer. A cryptocurrency uses cryptograph, which is defined as a database that lists transactions that no one can change without fulfilling specific conditions. This database secures and verifies transactions as well as controls the creation of new units of cryptocurrency. Cryptocurrency is created and stored electronically in the “blockchain”, using encryption techniques to control the creation of monetary units and to verify the transfer of funds. It is important to note that cryptocurrency itself has no intrinsic value, has no physical forms, and its supply is not determined by a central bank. These aspects make it a “cryptocurrency”.

In a very simple example, if I want to send a cryptocurrency, such as a bitcoin, to someone, I request a transaction, and the request is broadcast to a network of computers known as nodes. The nodes scan the entire bitcoin network to confirm (a) I have the bitcoin that I want to send, and (b) I haven’t already sent this particular bitcoin to anyone else. Once those are verified, the transaction is combined with other transactions to create a new block of data in a ledger, which is called the blockchain. The new block is added to the existing blockchain, and the transaction is complete. The transaction cannot be undone or manipulated because the entire blockchain would have to be re-done and the technology would break down completely.

History of Cryptocurrency

There were many attempts at creating other cryptocurrencies during the 1990s, but all failed. All of these failed companies verified and facilitated the transaction and many people were lost on digital currencies for a while. Bitcoin was first introduced as an open-source software by an anonymous programmer, or a group of programmers, under the alias Satoshi Nakamoto in 2009. There has been a lot of rumors about the real identity of Bitcoin’ss creator, and no one is exactly sure of the person/group behind the creation.  Satoshi Nakamoto described Bitcoin as a ‘peer-to-peer electronic cash system.’ Bitcoin was completely decentralized and there was no central controlling authority. Given most did not trust a third party to keep the records of the balances and transactions, someone had to create a new way to do this. This is where Blockchain was invented, which is a public ledger of all transaction that ever happened within the network, available to everyone. Therefore, everyone in the network can see every account’s balance (but do not know the owner of the balances). Every transaction is a file that consists of the sender’s and recipient’s public keys (wallet addresses) and the amount of coins transferred. The transaction also needs to be signed off by the sender with their private key. Eventually, the transaction is broadcasted in the network, but it needs to be confirmed first. Within a cryptocurrency network, only miners can confirm transactions by solving a cryptographic puzzle. They take transactions, mark them as legitimate and spread them across the network. Afterwards, every node of the network adds it to its database. Once the transaction is confirmed it becomes unforgeable and irreversible. In short, the network is based on complete agreement between all the participants (seller, buyer, and miner). This supports the bookkeeping of the balances and transactions.

What can you do with Cryptocurrency?

Given Cryptocurrency is a form of money, you can, in theory, buy anything with your cryptocurrency, just as you would with your physical cash. However, the reality is, cryptocurrency is still very new and not every company or person accepts cryptocurrencies. Over time there have been a lot of online and offline merchants that are beginning to accept Bitcoin (most popular cryptocurrency) as a form of payment. You can always exchange your cryptocurrency with another form of currency, such as USD as well.

As you have seen in the media, many people are investing in cryptocurrencies as well. The price of many cryptocurrencies have skyrocketed over the last few years. In fact, it has created many millionaires and even some billionaires. The most popular are Bitcoin and Ethereum. Investing in cryptocurrencies are extremely risky and the topic of this article will not go into details of how to invest. It is just very important to note that you should seek expert advice and do your research if you decide to invest in any form of cryptocurrency as we are not advising or recommending to invest in any way.

What is Mining?

You may also have heard of “mining” when people discuss cryptocurrency. As we stated above, there is no centralized network or authority to determine the supply of a certain cryptocurrency.  Given this dynamic, a cryptocurrency needs some sort of mechanism to increase the supply and maintain the bookkeeping / ledger of the cryptocurrency.

Essentially, miners are providing a bookkeeping service for their respective communities. They contribute their computing power to solving complicated cryptographic puzzles, which is necessary to confirm a transaction and record it in a distributed public ledger called the Blockchain. As an incentive to solving this puzzle, the minor has the right to add a transaction that gives him a specific number of cryptocurrencies. So mining allows the transactions to properly be maintained in the ledger and slowly increases the supply overtime. Over time the puzzles become more complex and take longer to solve, which increases the amount of computer power needed to solve the puzzle. It also decreases the increase of supply of cryptocurrency as it takes longer and longer to solve these puzzles.

Miners can make money doing this. The more computing power they manage to accumulate, the more chances they have of solving the cryptographic puzzles. Once a miner manages to solve the puzzle, they receive a reward as well as a transaction fee. As a cryptocurrency attracts more interest, mining becomes harder and the amount of coins received as a reward decrease.

What Makes Cryptocurrency So Different?

Below is a high-level summary of what makes cryptocurrency so different from the financial systems we are used to:

  • Scale: Cryptocurrencies are built to make sure that it works both in large and small scales meaning it can work with a low amount of currency or millions/billions amount of currency. Cryptocurrencies are also built to limit the supply over time to create scarcity.
  • Cryptographic: Cryptocurrency uses a system of complicating computer encryptions to control the creation of coins and to verify transactions.
  • Decentralized: Most of the cryptocurrencies have no centralized government to regulate the cryptocurrency. Instead, the creation and transactions are open source, and rely on peer-to-peer networks. 
  • No Physical Form: All cryptocurrencies are digital or virtual and have no physical form like gold or USD paper money. They are stored in digital wallets. 
  • Proof-of-work: Most cryptocurrencies use a proof-of-work system. A proof-of-work scheme uses a hard-to-compute but easy-to-verify computational puzzle to limit exploitation of cryptocurrency mining. This is where mining is so important in cryptocurrency adoption.
  • De-attached from a person’s identify: Cryptocurrencies are tied and encrypted on a Cryptocurrency wallet, and it is not attached to a person’s identity.
  • Value: Value is created by the “market”. Factors include supply, demand, and how the miners are paid as they increase the supply.

What is a Cryptocurrency Wallet?

You may have seen companies that offer a “wallet” for your cryptocurrency, but unsure what that really is. A cryptocurrency wallet is a software program that stores your special keys (unique code for your cryptocurrency). It interacts with the blockchain to allow the holder of the cryptocurrency is send and receive digital currency and monitor their balance. It is important to note these wallets don’t actually store the cryptocurrency as these currencies can’t get stored in a single location as they don’t exist in any physical form. These wallets just allow you to use and monitor your cryptocurrencies. 

There are many forms of these wallets, include desktop, online, offline, mobile, and hardware. The wallets can be secure, but depend on which kind you use, and who the service provider is. It is always important to backup your wallet and to add in extra security layers where you can. There have been many hacks recently and there are a lot of scammers out there as well. Given the structure of bitcoins, once someone has your unique private key, there is very little you can do to get your cryptocurrency back if it is stolen.

Additional Details on Cryptocurrency

Given the fast revolution and introduction of cryptocurrency, there is a ton of articles, courses, and webinars on cryptocurrency. There is a ton more to learn, and if you are interested, I would advise you to get into the details prior to venturing into cryptocurrencies.

 

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Comments 2

Wanderer on Wednesday, 28 February 2018 18:47

Really appreciate your offering all this information in one place. For me it has been so scattered I could not understand. At least now I have acquired a sense for the subject. One question remains in my mind ... why? Who really makes money and where is this an improvement on an already established foundation of monies? Appears to have a high level of risk and trust. In today's market place for scammers and hackers I sure would not venture in. However, to each his own.

Really appreciate your offering all this information in one place. For me it has been so scattered I could not understand. At least now I have acquired a sense for the subject. One question remains in my mind ... why? Who really makes money and where is this an improvement on an already established foundation of monies? Appears to have a high level of risk and trust. In today's market place for scammers and hackers I sure would not venture in. However, to each his own.
latoyairby on Wednesday, 28 February 2018 18:54

This is a great comprehensive introduction.

This is a great comprehensive introduction.
Guest
Wednesday, 20 June 2018