What is cryptocurrency?

Cryptocurrency (or cryptocurrency) is a form of digital cash that allows individuals to transfer value in a digital environment.

You might be wondering how this kind of system differs from PayPal or the digital banking app you have on your phone. They certainly appear to serve the same use cases on the surface—paying friends, shopping on your favorite site—but under the hood, they couldn't be more different.

What makes cryptocurrency unique?

Cryptocurrency is unique for many reasons. However, its primary function is to serve as an electronic cash register system that is not owned by any party.

A good cryptocurrency will be decentralized. There is no central bank or subset of users that can change the rules without reaching consensus. Network participants (nodes) run software that connects them to other participants so they can share information with each other.

centralized vs. decentralized networks

Centralized vs. decentralized networks.

On the left is what you would expect something like a bank to use. Users must communicate through a central server. On the right, there is no hierarchy: nodes are interconnected and pass information to each other.

The decentralization of cryptocurrency networks makes them highly resistant to shutdown or censorship. In contrast, to cripple a centralized network, all you have to do is compromise the main server. If the bank wiped its database and there were no backups, it would be very difficult to determine user balances.

In cryptocurrency, nodes keep a copy of the database. Each effectively acts as its own server. Individual nodes can go offline, but their peers will still be able to get information from other nodes.

Cryptocurrencies are therefore functional 24 hours a day, 365 days a year. They enable the transfer of value anywhere in the world without the intervention of intermediaries. This is why we often refer to them as permissionless: anyone with an internet connection can transfer funds.

Why is it called cryptocurrency?

The term "cryptocurrency" is a portmanteau of cryptography and currency. This is simply because cryptocurrency makes extensive use of cryptographic techniques to secure transactions between users.

What is Public Key Cryptography?

Public key cryptography is the foundation of cryptocurrency networks. It's what users rely on to send and receive funds.

In a public key cryptographic scheme, you have a public key and a private key. A private key is basically a huge number that no one would be able to guess. It's often hard to wrap your head around just how big that number is.

With Bitcoin, guessing the private key is about as likely as correctly guessing the outcome of 256 coin flips. With current computers, you wouldn't even be able to crack someone's key before the heat death of space.

Anyway, as the name suggests, you need to keep your private key secret. But you can generate a public one from this key. The public one can be safely distributed to anyone. It is virtually impossible for them to reverse engineer your public key to get your private one.

You can also create digital signatures by signing data with your private key. It is similar to signing a document in the real world. The main difference is that anyone can tell for sure whether a signature is valid by comparing it to the corresponding public key. In this way, the user does not have to reveal his private key, but can still prove his ownership.

You can spend your funds in cryptocurrencies only if you have the corresponding private key. When you make a transaction, you are telling the network that you want to move your currency. This is announced in a message (i.e. transaction) that is signed and added to the cryptocurrency database (blockchain). As mentioned, you need your private key to create a digital signature. And since anyone can see the database, they can check if your transaction is valid by checking the signature.

Who invented cryptocurrency?

There have been several attempts at digital cash schemes over the years, but the first cryptocurrency was Bitcoin, which was released in 2009. It was created by a person or group of people using the pseudonym Satoshi Nakamoto. To this day, their true identity is unknown.

Bitcoin has spawned a huge number of subsequent cryptocurrencies – some trying to compete and others trying to integrate features not available in Bitcoin. Today, many blockchains allow users to not only send and receive funds, but also run decentralized applications using smart contracts. Ethereum is perhaps the most popular example of such a blockchain.

What is the difference between cryptocurrencies and tokens?

At first glance, cryptocurrencies and tokens seem identical. Both are traded on exchanges and can be sent between blockchain addresses.

Cryptocurrencies are intended to serve solely as money, either as a medium of exchange, a store of value, or both. Each unit is functionally fungible, meaning that one coin has the same value as another.

Bitcoin and other early cryptocurrencies were designed as currency, but later blockchains sought to do more. For example, Ethereum does not only provide monetary functions. It allows developers to run code (smart contracts) on a distributed network and generate tokens for various decentralized applications.

Tokens can be used like cryptocurrencies, but are more flexible. You can stamp millions of the same or a select few with unique features. They can serve as anything from digital receipts representing a stake in a company to loyalty points.

With a smart-contract-enabled protocol, the underlying currency (used to pay for transactions or applications) is separated from its tokens. For example, in Ethereum, the native currency is ether (ETH) and must be used to create and transfer tokens within the Ethereum network. These tokens are implemented according to standards such as ERC-20 or ERC-721.

What is a crypto wallet?

A cryptocurrency wallet is basically something that holds your private keys. It can be a dedicated device (hardware wallet), an app on your PC or smartphone, or even a piece of paper.

Wallets are the interface that most users will rely on to interact with the cryptocurrency network. Different types will offer different kinds of functionality – a paper wallet obviously cannot sign transactions or display current prices in fiat currency.

For convenience, software wallets (eg Trust Wallet) are considered better for everyday payments. In terms of security, hardware wallets are virtually unrivaled in their ability to keep private keys away from prying eyes. Cryptocurrency users tend to keep funds in both types of wallets.