What is Cryptocurrency? The Definitive Guide to Understanding Crypto

logos of cryptocurrencies

Introduction

It seems like everyone is talking about cryptocurrency, digital coins and the blockchain these days. And while everyone is talking about it, almost no one knows what cryptocurrency actually is. In this guide, you will learn what cryptocurrency (“crypto” for short) actually is, what it is not, where its value comes from and what it is being used for.

What it is not

Cryptocurrency is not a traditional currency like the US dollar or the UK pound.

  1. It is not a paper currency.
  2. It is not backed by any government.
  3. It has no physical form. You can’t carry it in your wallet.
  4. It is not a means to get rich quick.
  5. Cryptocurrency is not backed by any real assets (like the US dollar being backed by gold).

While cryptocurrency is unlike any country’s currency, it does share many of the same qualities of a typical paper currency we use every day. We’ll discuss more of that later.

What it actually is

Cryptocurrency, in its simplest form, is just an entry in a digital ledger (aka a database). And in many ways, banks have been using a simple form of this ever since they transitioned their financial records and transactions from paper to electronic.

In fact, cryptocurrencies have been around longer than many know. During the 1990’s, a company called Digicash created the first form of electronic cash in which payments could be sent over a computer network. Unfortunately, Digicash was far ahead of its time. Neither governments nor banks were ready for such a monumental change and because of that, Digicash went bankrupt.

The birth of Bitcoin

Fast forward to 2008. A mysterious figure (or some say a group of programmers) by the name of Satoshi Nakamoto published a brilliant whitepaper titled “Bitcoin: A Peer-to-Peer Electronic Cash System”. This idea would form the basis of all cryptocurrencies that exist today.

Diagram of traditional banking system

The primary goal of cryptocurrency was the elimination of third parties in the transaction process, thereby removing central control of that transaction and removing any single point of failure.

A simple example of how a traditional currency transaction takes place would be an ever day banking transaction.

I have $200 in my bank account and I send a wire transfer to my buddy Brooks in North Carolina for $200. Since this is an electronic transfer and no actual cash is physically changing hands, a “trusted” third party needs to oversee the process. The bank reviews my request and changes their digital records which deducts my account by $200 and adds $200 to my buddy’s account.  

Now, if no central authority was monitoring my transactions, I could simultaneously send $200 to Brooks and another $200 to my friend Otto in New York, even though I only have $200 in my account. Both would get the $200 and, technically, the transaction would go through. This is what is called a “duplicate transaction” or “double spending” problem that banks step in and prevent.

Peer to Peer networks

So, if we eliminate the banks, who can be trusted to ensure fraudulent transactions aren’t approved? This is where P2P technology comes in. The meaning of P2P is Peer to Peer. A Peer to Peer network is a fairly simple concept in which a task or file is distributed across a network of peers.

Diagram of banking on blockchain

Think of this network of peers as a living organism with no need for a central brain or nervous system to receive its instructions. Rather the instructions and workload are shared among all peers in the network.

All cryptocurrency transactions take place on this peer to peer network which is made up of computers all over the world. Anyone who is sending a cryptocurrency transaction is participating in the P2P network.

A P2P network is naturally decentralized, meaning there is no central server or central authority controlling the network.

Say there are 1000 computers on the network and 400 of them go down, the network and the data on that network is still safe since every computer has the same data.

Consensus on the Blockchain and mining for digital gold

Remember how I mentioned that a cryptocurrency is simply an entry in a digital ledger. In blockchain networks such as Bitcoin, identical copies of that digital ledger are sent to every computer (or “node”) in the P2P network, creating a distributed ledger that is visible to the public.

Infographic explaining how sending a transaction on the blockchain works

Any time a new transaction is transmitted to the network, it is grouped together in encrypted blocks with other transactions that have recently occurred. Crypto Miners, which can be anyone with a powerful mining computer, then compete to validate that block of transactions by solving a complex math problem.

Consensus

Once a miner solves the problem, the other miners then check the validity of the transactions and make sure the solution to the problem is correct. If enough miners grant approval, a consensus is made, the block is timestamped and cryptographically added to the ledger.

The ledger is then distributed across the network for approval. This process greatly reduces the chances of a “duplicate transaction” going through and eliminates the need for a central source of approval like a bank.

Reward

The miner who first solved the problem is programmatically given a reward by the network (in this case Bitcoin) plus the transaction fees paid by the senders.  This incentivizes the bitcoin miners to continue validating and adding blocks to the ledger.

A question I’m often asked is who pays the miners? My favorite way to explain this is to echo the words of Vitalik Buterin (founder of Ethereum).

“A blockchain is a magic computer that anyone can upload programs to and leave the programs to self-execute…”

In other words, a piece of software on the cryptocurrency network is actually creating problems for the miners to solve and rewarding them once a block has been added. And this software also lives on the distributed network.

So to recap, a miner’s job is to validate the transactions on the blockchain and ensure consensus in the distributed ledger. For that, the software on the network rewards them with the currency of the network.

Security, Trust and Transparency

The blocks of transactions mentioned earlier are added to the ledger in chronological order. Every block is tied to the block before it. Block after block is added this way forming a chain that shows every transaction ever made on that blockchain. Here’s another fun infographic to explain:

infographic explaining how the blockchain works

And every ledger in the network is constantly updated so that they are all the same, giving every member of the network the ability to verify who owns what.

Because of this, the network is nearly impossible to hack. Unlike banks with central servers that are easily broken into, hacking into a block in the blockchain to alter a record would require hacking every proceeding block in every ledger on the network. An impossible task.

And unless every node on the network goes down, the data on the network will always be safe.

The security and robustness of a decentralized network eliminates the “single point of failure” problem we mentioned earlier that all banks face.

The term cryptocurrency comes from the fact that transactions are protected by strong cryptography.

The Value of Cryptocurrency

Why is Bitcoin worth anything? It’s a common question, and has more to do with economics than technology. The answer is simple but has a complicated explanation.

What is currency?

The dictionary definition of currency is[1]

  1. Something (such as coins, treasure notes and banknotes) that is in circulation as a medium of exchange
  2. Transmission from person to person as a medium of exchange

Digital currencies or cryptocurrencies are new concepts that governments and banks are wary of supporting. The mission of cryptocurrencies is to remove the need for central control which is threat to anyone who enjoys that control.

US Dollar Value

If asked what gives the US dollar value, most say gold, which is completely wrong. The gold standard ended in 1971[2]. The US dollar’s value is actually derived from several key factors:

Circle chart the value of the US Dollar

  1. Gov’t – The backing of the US government.
  2. Supply – The control of the money supply.
  3. Economy – The strength and value of the US economy.
  4. Faith – Our trust in the economy, government and the currency it distributes.
  5. Utility – The fact that it is a common means of exchanging value between parties.
  6. Perception – We believe it is valuable, therefore it is.

The most important factors being our faith in the currency’s controlling entity and our use of the currency as a means of holding and exchanging value.

Cryptocurrency Value

Now let’s compare the same factors from above and see where the value of cryptocurrency is derived:

Circle chart explaining the value of cryptocurrency

  1. Gov’t – Not a factor since control is decentralized.
  2. Supply – Total supply is finite and public knowledge.
  3. Economy – In essence, every cryptocurrency is its own micro-economy. The value of the currency increases as the value and size of that economy increases.
  4. Faith – Our trust in the business proposition that lies behind the cryptocurrency (ex. Bitcoin is in the business of storing and exchanging wealth. Ethereum is in the business of offering developers a platform to build and deploy decentralized applications).
  5. Utility – Is the cryptocurrency being actively used for the purpose it was created and is that usage growing.
  6. Perception – What we believe it is worth, what it is going to worth and what we are willing to pay for it. Many say that in the current crypto market, speculation is the biggest determiner of price. Similar to the stock market or traditional money, it’s only worth as much as the market is willing to pay.

The majority of cryptocurrencies are not being utilized at this point. Most crypto platforms and businesses are still being developed. Therefore, speculation has been the primary driver of crypto prices.

We think therefore it is

There is no definitive explanation as to why any currency has value. Economists to this day still argue about what actually gives the US dollar value. Some say it is the supply others even argue it is actually the national debt. Some have even argued that since paper money can be burned to generate heat, it has intrinsic value!

In the end, many say that our trust and perceived value of the dollar are the most important factors. And I agree with this.

Determining the value of crypto relies on the same principles. While not controlled by a single entity, we still have trust in it, perceive it as valuable and are willing to pay a certain price to attain it.

What it is being used for

There are numerous cryptocurrencies in existence and even more ICOs are being launched, creating new coins. Every time a new business is launched on the blockchain, a cryptocurrency is created to be used on that network.

Blockchain networks utilize their currencies in different ways. Some simply use it as a method of storing and transferring value while others use it as form of payment to utilize the processing power of the network.

Below are several examples of cryptocurrencies being used today:

Bitcoin

  • Name of currency: Bitcoin
  • Ticker symbol: BTC or XBT

The oldest digital currency and considered the digital “gold standard” for all other cryptocurrencies. Bitcoin’s purpose is to serve as a means of storing and exchanging wealth. It’s as simple as that.

Bitcoin can be used to purchase goods and services from businesses that accept it as a form of payment (just like a debit card). Or a person can transfer some of their wealth to another person just like using Paypal.

Want to get some Bitcoin? Check out our How to buy Bitcoin section to find the best exchanges for your needs.

Bitcoin Cash

  • Name of currency: Bitcoin Cash
  • Ticker symbol: BCH

A fork of Bitcoin that serves the same purpose of storing and transferring value. Bitcoin cash was created to solve the scalability and performance issues that Bitcoin has been experiencing.

Generally Bitcoin transactions can take anywhere from minutes to hours to confirm on the network. Bitcoin Cash attempts to solve that issue by increasing the amount of transactions in a block.

Want to get some Bitcoin Cash? Check out our How to buy Bitcoin Cash section to find the best exchanges for your needs.

Ethereum

  • Name of currency: Ether
  • Ticker symbol: ETH

The second largest cryptocurrency in the market. Ethereum not only offers a way of storing and transferring value but also introduces the concept of smart contracts. These contracts allow developers to build decentralized applications utilizing the blockchain network.

Want to get some Ethereum? Check out our How to buy Ethereum section to find the best exchanges for your needs.

Litecoin

  • Name of currency: Litecoin
  • Ticker symbol: LTC

Litecoin is also a fork of bitcoin. Its primary difference being there is a larger total supply and transaction times are much faster. If Bitcoin is considered digital gold then Litecoin is silver.

As Bitcoin works to solve its scalability issues, many speculate that Litecoin’s utilization and value will decrease.

Want to own some Litecoin? Check out our How to buy Litecoin section to find the best exchanges for your needs.

Monero

  • Name of Currency: Monero
  • Ticker Symbol: XMR

Monero aims to serve the same purpose as Bitcoin but with added privacy. Many don’t realize that Bitcoin isn’t completely anonymous. Anyone in the public can trace any transaction on the address back to a wallet address and while wallet addresses can be created anonymously, there’s still that traceability that reduces anonymity.

Monero solves that issue claiming that transactions on their network are 100% untraceable. This has attracted a large following due to its privacy features, including support from users of the “Dark Web”.

NEO

  • Native currency: NEO and Gas
  • Ticker Symbol: NEO & GAS

NEO is also a network built around the idea of smart contracts, very similar to Ethereum. NEO was founded in China but has many of the same goals as Ethereum.

Ripple

  • Native currency: Ripple
  • Ticker symbol: XRP

Considered the redheaded stepchild of the crypto industry. Many label them as sell outs. Why? Ripple was built to facilitate currency exchanges between banks at nearly instantaneous speeds.  They achieve this by ditching the decentralized model and using a more centralized method of control. And many consider that crypto blasphemy.

And, if they succeed, they will only strengthen the position of the “evil banks”. However, I believe Ripple is smart in realizing that banks aren’t going anywhere for the foreseeable future. And playing with them would be far more profitable than battling against them.

Want to get some Ripple? Check out our How to buy Ripple section to find the best exchanges for your needs.

Stellar

  • Native currency: Lumen
  • Ticker symbol: XLM

Stellar is very similar to Ripple in that it was created to facilitate fast currency transactions across the world. But that is where the similarities end. Ripple is a for-profit entity whose primary customer are banks while Stellar is non-profit whose primary customers are people who don’t have access to bank account.

They’re goal is the facilitate payments between the unbankable. Stellar is also more decentralized than Ripple.

Check out our How to buy Stellar section to find the best exchanges for your needs.

Dragonchain

  • Native currency: Dragon Coin
  • Ticker symbol: DRGN

Dragonchain was originally developed by Disney. Dragonchain offers similar functionality as Ethereum, allowing developers to create applications on their platform.

The difference is they are creating a more friendly, flexible and secure environment when compared to Ethereum.

Tron

  • Native currency: Tronix
  • Ticker symbol: TRX

Tron is building a content distribution platform on the blockchain. Their target customer is the entertainment industry. Tron’s goals is to directly connect creators of entertainment content (music, etc) with consumers, eliminating the middle man.

Tronix would be the method of payment between the creators and consumers.

VeChain

  • Native currency: VeChain Token
  • Ticker symbol: VEN

VeChain is often called the Ethereum for business. They are a blockchain platform focusing on supply chain management and business transparency.

Zcash

  • Native currency: Zcash
  • Ticker symbol: ZEC

Zcash is also a fork of Bitcoin and like Bitcoin there is a total supply of 21 million coins. Zcash offers the same functionality as Bitcoin with one key difference, increased privacy.

Zcash users can choose between 2 types of transactions: a transparent transaction or a private transaction. Choosing the private option ensures that the transaction is truly anonymous. So in some ways, it is similar to Monero.

Check out our How to buy Zcash section to find the best exchanges for your needs.

Conclusion

So to sum it up, cryptocurrency is a means to record transactions on a digital ledger which is both verified and stored multiple times on a decentralized network of computers (or nodes). Thereby eliminating a third party facilitator or central control.

And the price of crypto is based on several factors, the primary one being its perceived value.

In reality, cryptocurrency is not so different from the money you have in your pocket. But because it is such a new concept, it will take time to be understood and accepted.

[1] https://www.thefreedictionary.com/currency

https://www.merriam-webster.com/dictionary/currency

[2] https://www.thebalance.com/what-is-the-history-of-the-gold-standard-3306136

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What is Cryptocurrency? The Definitive Guide to Understanding Crypto
Article Name
What is Cryptocurrency? The Definitive Guide to Understanding Crypto
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Cryptocurrency, in its simplest form, is just an entry in a digital ledger (aka a database). Banks have been using a simple form of this ever since they transitioned their financial records and transactions from paper to electronic. However, by using blockchain technology, cryptocurrency transactions are stored on a decentralized network providing security and transparency.
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