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What is a Cryptocurrency?

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A cryptocurrency is a payment system based on cryptography. Each unit of a cryptocurrency is only created after a certain cryptographic calculation, based on several possible algorithms.

To understand cryptocurrency, one needs to understand the usual money we spend- fiat currency. Fiat is Latin for “let it be”- so fiat currency is a payment means that is based on an agreement. We all agree that a dollar has value.

Before fiat currency, paper money was backed by a gold standard. But decades ago, the gold standard was removed and so the modern economy has an unlimited supply of fiat currencies. Central banks serve to put the brakes on an unlimited creation of money. Still, a central bank merely writes a certain sum into a central ledger and the money is brought into existence.

For a cryptocurrency, there is no such process. Each unit of the currency is created as a result of computation. In the case of Bitcoin, the computation of one block of transactions creates 25 brand-new Bitcoin every 10 minutes. But there is no central authority that issues the coins- they can be created by any miner across the globe. The coins have no physical representation, but they become a means of exchange for users of Bitcoin.

Some cryptocurrencies are not mined, but are pre-mined, or created in one go. But their spending, sending and receiving also requires the performance of cryptographic tasks. The tasks that are performed require the guessing of a certain hash value. To do this, computers of varying power generate millions or even trillions of possible codes every second- and sometimes, stumble onto the correct one. Then, a new block of transactions is generated and all the movements of a coin are recorded.

And the record is distributed over the whole network of computers. There is no central authority that holds the ledger on cryptocurrency transactions. That is why cryptocurrencies are said to use a “distributed ledger” technology.

Initially, one may be confused that cryptocurrencies resemble “virtual money”, some sort of in-game tokens, a form of electronic air miles or a bonus program. This is far from the truth. While all bonus points, air miles and game tokens are kept in a centralized server, your coin balance is verified and kept on actual hard drives that belong to thousands of semi-anonymous entities across the globe. If one of those users suffer a technical failure, your record is still open.

So cryptocurrencies are also said to be decentralized- there are no server farms, no central authority. The computing power needed to keep a cryptocurrency alive is supplied voluntarily, usually for economic gains.

A cryptocurrency is also a market-tradable asset. Currently, enough exchanges and trading platforms are open worldwide, so you can sell your cryptocurrencies and receive fiat.

Last but not least, cryptocurrencies are not stored in a bank, but in a wallet. You own the wallet, and it is also protected by cryptography. Wallets are like your personal electronic bank vault- they are very secure, and there is no password recovery. Wallets have an address and you are solely responsible for sending and receiving funds. Transactions in cryptocurrencies cannot be rolled back- once the money is sent, it is gone.

And those are cryptocurrencies in a nutshell- there are many more details, but the technology certainly challenges people’s idea of “what is money”.