What is Cryptocurrency?
A cryptocurrency can be easily defined as a digital currency. However, the concept behind the value and security of cryptocurrency is quite abstract and esoteric. Some people are confused about what makes cryptocurrency valuable and what makes it efficient as a means of storing and transferring value. Cryptocurrencies are also sometimes known as “altcoins” – short for alternative coins.
The most famous of all cryptocurrencies is Bitcoin, although there are many new contenders to the market, known as altcoins.
Cryptocurrency vs. Fiat Money
There was once a time when the world operated with the barter system. Someone looking to sell or trade their goods would need to find another person willing to take those goods in trade for the exact other goods they were looking for. This is called the double coincidence of wants. For example, imagine a farmer who wants to trade his bushels of wheat for clothing. He would need to find a tailor who is also looking for wheat to be able to trade. Fiat money solved this issue by creating a store of value. But at the time of its inception and creation, people used to the barter system were probably wondering why worthless paper would be equally or more valuable than their goods.
Cryptocurrency does to fiat money what fiat money did to the barter system. It creates an alternative store of value that lets users not only pay for goods but also pay for other currencies. If cryptocurrency is liquid to other fiat currencies, then these fiat currencies are liquid to each other. However, some people may be confused as to why cryptocurrency holds value, similarly to how barterers may have wondered why paper money holds value.
The Value of Cryptocurrency
At the root of it all, any type of currency is valuable because it is accepted as a store of value. The more people accept this, the more valuable the money becomes. Additionally, more acceptance leads to more stability in the value of the money. Additionally, both fiat money and cryptocurrencies solve the issue of the double coincidence of wants.
Furthermore, cryptocurrency runs on blockchain technology. This new and ingenious technological concept increases the security of the currency and allows for verification of transactions in the currency.
Finally, cryptocurrency is infinitely divisible. Whereas the smallest amount in US Dollars one can receive is a cent – or $0.01 – you can receive 0.00000000000001 Bitcoin if need be.
How Blockchain Supports Cryptocurrency
The blockchain network is supported by voluntary “miners”. Miners are computer systems that are offered for use in the specific networks that support each cryptocurrency. For example, the Bitcoin blockchain network is supported by thousands of individual computers that help “mine” the network.
“Mining” is the act of verifying, encrypting, and securing transactions in each block. Each miner (computer system) has a ledger of all past and current transactions operating in the network. This means that every new transaction can be recorded and verified in the ledger. If someone tries to create any counterfeit coins or steal coins from another person’s cryptocurrency wallet, this is checked against the millions of copies of the ledger. All legitimate copies of the ledger will return an invalid authentication on the fraudulent transaction, and as such, the counterfeit or stolen coins will not be recorded.
Miners are rewarded for participating in transaction verification with a small portion of coins. For example, the typical mining fee for a transaction of Ethereum may be 0.000444 ETH. This fee is split amongst all the miners who participated in the verification and authentication.
Cryptocurrency wallets can either be software (apps) or hardware (thumb drive or card) wallets. These wallets act as smaller versions of “miners” in the sense that they record and verify transactions. They store the value of your coins and let you know how many coins you have in total. When you deposit bitcoin into your wallet, for example, the wallet verifies that transaction against the mining networks ledgers to let the network know that the coins are now in your possession inside the wallet.
Each wallet, both software and hardware, has addresses that resemble hash codes. This is a long string of letters and numbers. When you deposit coins into your wallet, you use this address to let the network know where to send the coins, and where it will be stored in the meantime.
This article on cryptocurrency is just one of the hundreds of resources that CFI offers to further your education in the world of finance.