What is cryptocurrency?
- A digital asset.
- A medium of exchange that uses cryptography.
- A subset of digital currencies further defined as an alternative currency.
- It secures its transactions in blockchains, controls the creation of new units, and verifies asset transfer.
You might be wondering, “What does all this mean and how can I get involved? Is it too complicated?”
While these initial concepts might seem complicated, they’re easy to understand when you relate them to everyday things in your life.
How is cryptocurrency like the money in my wallet?
Cryptocurrency can be used to buy things or be transferred to others — just like you can do with the money in your wallet. The difference is that cryptocurrencies aren’t controlled by the bank, and they do not have a physical form. They do exist in a virtual wallet — just like you hold your physical money in your physical wallet.
Are cryptocurrencies as safe as the money stored in my bank?
Cryptocurrency transactions are backed up by the blockchain. A blockchain acts as a decentralized, open-source ledger that anyone can access. When you use your cryptocurrency, it must pass through the blockchain.
The blockchain is run by miners, who use powerful computers to verify your transactions through your special public key with a special hashing algorithm. This verification ensures that your cryptocurrencies get transferred to the correct person. It also protects against double spending. This happens when someone tries to send the same, say, Bitcoin to multiple people. Just as your bank would prevent this from happening with your physical dollars, the miners prevent this from happening with your Bitcoins.
The cryptocurrencies stored in your Wallet are protected by your private key. This is sort of like the password you use to access your bank account. As long as you don’t give your private key out to anyone, your cryptocurrencies are safe.
It’s important to note that your private key is strictly your responsibility. Unlike a bank that could help you gain access to your account again if you were to lose your password, you would forfeit any cryptocurrencies you own if you lost your private key. It cannot be retrieved again once lost or stolen.
Are cryptocurrencies created just like how dollars are created?
Not exactly. Banks have control over when new money is created and issued to the public.
Cryptocurrencies are created when transactions have been approved by the miners in the Blockchain.
Pretend that Bob has 1 bitcoin, and he wants to book a flight. The flight only costs 0.2 bitcoin. Bob’s bitcoin cannot be broken down. He must send the entire 1 bitcoin to the airline. In turn, the airline will send him his change: 0.8 bitcoin.
In Bob’s case, he has one input of bitcoin. He has two outputs: the 0.2 bitcoin cost for the flight and the 0.8 bitcoin in change. A miner would need to process the input and outputs in the blockchain. It takes significant computer power and electrical energy to process this.
The miner who first approves the transaction must send his proof-of-work to the other people, called nodes, on the blockchain. If the nodes approve his work, the transaction gets added to the blockchain. The miner will be awarded with bitcoin for all his work.
This transaction approval process is how bitcoins are created. A maximum of 21 million bitcoins can be created. Due to this limit, inflation is monitored and avoided.
Are all cryptocurrencies the same?
Just like the U.S. dollar is different from the euro, so too are cryptocurrencies.
Let’s look at two popular cryptocurrencies, bitcoin and litecoin. They both have ‘coin’ in their name … so they must be similar, right?
Yes and no. Both will be processed through blockchain. The way that the miners verify the transaction would be a little bit different, though.
To make it easy to understand, miners solve complicated math problems to verify transactions. Different cryptocurrencies make miners use different formulas to solve the math problem. Bitcoin uses a formula called SHA-256; litecoin uses Scrypt.
What cryptocurrencies exist?
There are many cryptocurrencies for you to choose from. Some have existed for a longer time (like bitcoin), and some are newer.
When looking for the best cryptocurrency for you, do your research. Try reviewing some of the cryptocurrency exchanges that exist.
Once you find a cryptocurrency on the exchange that interests you, do some further research into it. You can get a small list of cryptocurrencies and their simple descriptions right here.