Table of Contents
- 1 How Does Cryptocurrency Work?
- 2 Crypto Definition
- 3 The Origin of Cryptocurrency
- 4 The Story of Bitcoin
- 5 What is Blockchain?
- 6 How Does Blockchain Work?
- 7 Cryptocurrency Mining
- 8 So, What is Cryptocurrency Mining For?
- 9 Using Cryptocurrencies
- 10 The Rise of Cryptocurrencies!
- 11 Cryptocurrency Trading
- 12 Can Cryptocurrency Save the World?
- 13 Final Thoughts: What is Cryptocurrency?
How Does Cryptocurrency Work?
EXCHANGEAn exchange is a business (usually a website) where you can buy, sell or trade cryptocurrencies.
WALLETSCryptocurrency wallets are software programs that store public and private keys and enable users to send and receive digital currency and monitor their balance.
Crypto DefinitionBelow is a list of six things that every cryptocurrency must be in order for it to be called a cryptocurrency;
- Digital: Cryptocurrency only exists on computers. There are no coins and no notes. There are no reserves for crypto in Fort Knox or the Bank of England!
- Decentralized: Cryptocurrencies don’t have a central computer or server. They are distributed across a network of (typically) thousands of computers. Networks without a central server are called decentralized networks.
- Peer-to-Peer: Cryptocurrencies are passed from person to person online. Users don’t deal with each other through banks, PayPal or Facebook. They deal with each other directly. Banks, PayPal and Facebook are all trusted third parties. There are no trusted third parties in cryptocurrency! Note: They are called trusted third parties because users have to trust them with their personal information in order to use their services. For example, we trust the bank with our money and we trust Facebook with our holiday photos!
- Pseudonymous: This means that you don’t have to give any personal information to own and use cryptocurrency. There are no rules about who can own or use cryptocurrencies. It’s like posting on a website like 4chan.
- Trustless: No trusted third parties means that users don’t have to trust the system for it to work. Users are in complete control of their money and information at all times.
- Encrypted: Each user has special codes which stop their information from being accessed by other users. This is called cryptography and it’s nearly impossible to hack. It’s also where the crypto part of the crypto definition comes from. Crypto means hidden. When information is hidden with cryptography, it is encrypted.
- Global: Countries have their own currencies called fiat currencies. Sending fiat currencies around the world is difficult. Cryptocurrencies can be sent all over the world easily. Cryptocurrencies are currencies without borders!
The Origin of CryptocurrencyIn the early 1990s, most people were still struggling to understand the internet. However, there were some very clever folks who had already realised what a powerful tool it is. Some of these clever folks, called cypher punks, thought that governments and corporations had too much power over our lives. They wanted to use the internet to give the people of the world more freedom. Using cryptography, cypher punks wanted to allow users of the internet to have more control over their money and information. As you can tell, the cypher punks didn’t like trusted third parties at all! At the top of the cypher punks to-do list was digital cash. DigiCash and Cybercash were both attempts to create a digital money system. They both had some of the six things needed to be cryptocurrencies but neither had all of them. By the end of the
nineties, both had failed.
The Story of BitcoinNo one knows who Satoshi Nakamoto is. It could be a man, a woman or even a group of people. Satoshi Nakamoto only ever spoke on crypto forums and through emails. In late 2008, Nakamoto published the Bitcoin whitepaper. This was a description of what Bitcoin is and how it works. It became the model for how other cryptocurrencies were designed in the future. On January 12, 2009, Satoshi Nakamoto made the first Bitcoin transaction. They sent 10 BTC to a coder named Hal Finney. By 2011, Satoshi Nakamoto was gone. What they left behind was the world’s first cryptocurrency.
Bitcoin became more popular amongst users who saw how important it could become. In April 2011, one Bitcoin was worth one US Dollar (USD). By December 2017, one Bitcoin was worth more than twenty thousand US Dollars! Today, the price of a single Bitcoin is 7,576.24 US Dollars. Which is still a pretty good return, right?
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So, Bitcoin has succeeded where other digital cash systems failed. But why? What is cryptocurrency doing differently? The thing that makes cryptocurrency different from fiat currencies and other attempts at digital cash is blockchain technology. Let’s find out how it works…
What is Blockchain?All cryptocurrencies use distributed ledger technology (DLT) to remove third parties from their systems. DLTs are shared databases where transaction information is recorded. The DLT that most cryptocurrencies use is called blockchain technology. The first blockchain was designed by Satoshi Nakamoto for Bitcoin. A blockchain is a database of every transaction that has ever happened using a particular cryptocurrency. Groups of information called blocks are added to the database one by one and form a very long list. So, a blockchain is a linear chain of blocks! Once information is added to the blockchain, it can’t be deleted or changed. It stays on the blockchain forever and everyone can see it. The whole database is stored on a network of thousands of computers called nodes. New information can only be added to the blockchain if more than half of the nodes agree that it is valid and correct. This is called consensus. The idea of consensus is one of the big differences between cryptocurrency and normal banking. At a normal bank, transaction data is stored inside the bank. Bank staff make sure that no invalid transactions are made. This is called verification. Let’s use an example; George owes 10 USD to both Michael and Jackson. Unfortunately, George only has 10 USD in his account. He decides to try to send 10 USD to Michael and 10 USD to Jackson at the same time. The bank’s staff notice that George is trying to send money that he doesn’t have. They stop the transaction from happening. The bank stopped George from double spending which is a kind of fraud. Banks spend millions of dollars to stop double spending from happening. What is cryptocurrency doing about double spending and how do cryptocurrencies verify transactions? Remember, they don’t have staff like the bank does!
How Does Blockchain Work?
Cryptocurrency MiningCryptocurrency mining might sound like something you do with a shovel and a hard hat but it’s actually more like accounting. Miners are nodes that perform a special task that makes transactions possible. I’ll use an example to show you how it works using the Bitcoin network.
- George owes Michael 10 BTC. George announces that he is sending Michael 10 BTC to the Bitcoin network.
- Miners take the information and encrypt it. This is called hashing. To this information, they add other transaction information and hash that too. More and more information is added and hashed until there is enough to form a block.
- The miners now race against each other to guess the encrypted code or block hash that will be given to the new block before it’s added to the blockchain. The lucky miner that guesses the right code gets to add the new block to the blockchain.
- Now, all the other nodes on the network verify the transaction information in the new block. They check the whole blockchain to make sure that the new information matches. If it does, then the new block is valid, and the winning miner can add the new block to the blockchain. This is called confirmation.
- Michael receives 10 BTC from George.
So, What is Cryptocurrency Mining For?It’s the way cryptocurrency networks like Bitcoin verify and confirm new transactions. It stops double spending without theneed to trust centralized accounting like banks do. Cryptocurrency blockchains aren’t secured by trust or people. They are secured by math done by computers! For more information, check out my Blockchain Explained guide.
Using CryptocurrenciesUsing cryptocurrencies isn’t like using a fiat currency. You can’t hold cryptocurrency in your hand and you can’t open a cryptocurrency account. Cryptocurrency only exists on the blockchain. Users access their cryptocurrency using codes called public and private keys. It’s a bit like sending emails. If you want someone to send you an email, you tell them your email address. Well, if you want someone to send you cryptocurrency, you tell them your public key. Now, if you want to read your emails or send an email, you need to enter your email password. This is how private keys work. Private keys are like passwords for cryptocurrency. Public keys can be seen by anyone, but private keys should only be seen by you. If there is one paramount detail you should learn from this What is Cryptocurrency guide, it’s that keeping your private keys safe is extremely important! Private and public keys are kept in wallets. Crypto wallets can be online, offline, software, hardware or even paper. Some can be downloaded for free or are hosted by websites. Others are more expensive. For example, hardware wallets can cost around a hundred US Dollars. You should use several different kinds of wallets when you use cryptocurrency. Whoever has the private and public keys owns the cryptocurrency, so don’t lose your wallets! Cryptocurrency is pseudonymous, remember? There is no way to prove you own cryptocurrency unless you have the keys to it. I’ve told you about how the first cryptocurrency was created and how it works. I’ve also told you about how cryptocurrency is stored and used. Now, let’s look at some other cryptocurrencies that have been created since Bitcoin…
The Rise of Cryptocurrencies!Bitcoin changed the way people think about money. Hundreds of other cryptocurrencies have been created since and they all want to change the world!
- Litecoin is a lot like Bitcoin but its transactions are processed four times faster. Litecoin mining is easier than Bitcoin mining, so users with less powerful computers can become miners.
- Ethereum uses more advanced blockchain technology than Bitcoin. It’s sometimes called Blockchain 2.0. Ethereum allows its users to design and build their own decentralized applications (dApps) on its blockchain.If Bitcoin wants to replace banks, then Ethereum wants to replace everything else. Ethereum developers can build dApp versions of centralized apps like Facebook, Amazon, Twitter or even Google! The platform is becoming bigger than just a cryptocurrency. So, what is cryptocurrency when it’s not really cryptocurrency anymore? It’s Ethereum! A platform that uses blockchain technology to build and host decentralized apps.
Would you like to know more about Ethereum? Check out my What is Ethereum guide.
INTERESTING FACTEthereum has quickly skyrocketed in value since its introduction in 2015, and it is now the 2nd most valuable cryptocurrency by market cap.It’s increased in value by 2,226% in just last year – a huge boon for early investors.
- IOTA is a pretty special cryptocurrency, it doesn’t have a blockchain! IOTA uses a DLT called the Tangle. Miners don’t confirm new transactions, users do…When a user wants to make a payment using the Tangle they have to verify and confirm two other user’s transactions first. Only then will their payment be processed. It’s like getting students to grade each other’s homework instead of the teacher doing it. The Tangle is thought to be a lot faster than Bitcoin, Litecoin and Ethereum!If you thought that was weird, check this out — IOTA isn’t even designed to be used by humans! It’s designed for the Internet of Things. That’s any machine with an internet connection. IOTA will help the IoT communicate with itself. IOTA actually means Internet of Things Application.Imagine that! In the future, your driverless car will use IOTA to go to the gas station, fill up with gas and pay. All without any humans being involved.
Cryptocurrency TradingBuying and selling cryptocurrencies has become a very big business. The total value of all the cryptocurrencies in the world is more than 350 billion US Dollars. Just under 17 billion US Dollars’ worth of cryptocurrency was bought and sold today!
You can trade online with crypto exchanges like Binance, Bitstamp and Coinbase. You can also arrange to trade cryptocurrencies in-person with peer-to-peer sites like LocalBitcoins.com. The cryptocurrency market is an exciting place. Traders can make millions and then lose it all. Cryptocurrencies are created overnight and then disappear just as fast. My advice to any newbie trader out there is to only spend what you can afford to lose. I know I sound like your Grandma, but it’s true!
INTERESTING FACTYou can trade online with crypto exchanges like Binance, Bitstamp and Coinbase. You can also arrange to trade cryptocurrencies in-person with peer-to-peer sites like LocalBitcoins.com
Since you started reading this guide, you’ve been getting closer and closer to understanding cryptocurrency. There’s just one more question I’d like to answer. What is cryptocurrency going to do for the world?
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Can Cryptocurrency Save the World?Cryptocurrency has a lot of critics. Some say that it’s all hype. Well, I have some bad news for those people. Cryptocurrency is here to stay and it’s going to make the world a better place. Centralized organizations have let us down.
- In 2008, banks cost taxpayers trillions of dollars and caused the world economy to fall apart.
- The credit checking agency, Equifax, lost more than 140,000,000 of its customers personal details in 2017.
- This year, Facebook was forced to apologize for selling its users’ personal data.