Let’s face it: these days, most people have heard of crypto. It crops up in too many news reports and conversations to miss it. But if you asked most people to explain what crypto was, they’d give you a shrug — like you’re asking how gravity works.
“I’m not one of those crypto folks. Something to do with Bitcoin?”
In this article, we’ll give you a more thorough answer, and explain exactly what cryptocurrency is — no hype, buzz or spin. We’ll also discuss some other key concepts, like Ethereum and blockchain, and where they fit in.
What is cryptocurrency?
Cryptocurrency is a digital currency. It’s different from traditional currency in that it has no physical form and it’s not issued by a central authority (like a bank or government). There’s a lot of other differences, but these are the two biggest ones.
Since it hasn’t been given any intrinsic or legislated value by an authority, it’s only worth what people are willing to pay for it. This is why cryptocurrencies are infamous for fluctuating in price. In contrast, something like the US dollar is a lot more stable, simply because a government has legislated it as legal tender. People know it’s not a fad (Unlike the Kanye West themed cryptocurrency “Coinye”).
So, if a government or bank isn’t involved, and there’s no physical assets being passed around, how does this whole thing even function?
How does cryptocurrency work?
Cryptocurrency uses a decentralized system where a public ledger is distributed across a large number of computers. This ledger records all transaction data, and is also used to validate any transactions.
This shared, immutable ledger is known as a blockchain – sound familiar? It uses cryptography to verify transactions, which is where the “crypto” part of the name comes in.
To own cryptocurrency and perform transactions, you need a digital wallet, which is a bit different from a traditional one. It’s actually a personal program that links to the blockchain ledger and keeps track of how many coins you have and what transactions you’ve made.
Your wallet is protected by cryptography as well, and comes with a public and private key.
The public key is what you give to other people so they can send you funds, like your bank account number.
The private key is what is used to authorize spending, like your bank pin number (so something not to share around!)
If you’ve got a private key, you can approve the transfer of any crypto you have in your wallet to someone else. But let’s dive into what actually happens when you transfer money.
A Standard Cryptocurrency Transaction
Let’s say you’ve got a bitcoin in your wallet and you want to send it to your friend, Bob. For the transaction, you enter your private key to confirm it’s you, Bob’s public key as the destination, and the amount of coins you want to send.
You send this message out to every participant in the network, telling it that you want to decrease the number of bitcoins in your wallet by one, and increase the number in Bob’s by one.
This is where some checking happens. Cryptocurrency is a trustless system – there’s no bank involved, after all – so everyone wants to make sure Bob’s not doing something shifty. Every network participant checks the legitimacy of the transaction using a validation method set by the creators of that blockchain network.
If the nodes validate the transaction, it is added to a block along with any other recently sent transactions (think of it as packing up a bunch of letters in a single box). The block is verified, added to the existing blockchain ledger, and this update is distributed across the network.
The transaction is complete and transparent – and everyone agrees that Bob is now one bitcoin richer.
How cryptocurrency prevents fraud
There’s no central authority at work like Visa, and the currency is digital, so what prevents people from spending the same money twice? To stop this, Cryptocurrencies use a “consensus mechanism” to determine which transactions are legitimate, and make it difficult and expensive for bad actors to commit fraud.
The two major methods used today are called Proof of Work and Proof of Stake.
Proof of Work
Proof of Work is the way most traditional cryptocurrencies work, including Bitcoin. Before a block is added to the blockchain ledger, virtual “miners” rush to solve a complex mathematical equation, which is then validated by the nodes. Whoever solves it gets to add the block to the blockchain, and gets some crypto in return for their troubles.
Unfortunately, all this processing uses power, which in turn generates carbon emissions. In fact, as the cryptocurrency gets more mature, the calculations become more intense, taking more energy and power.
To undermine this sort of network, a bad actor would need to control 51% or more of the whole blockchain network and its computing resources (this is known as a 51% attack). For a large cryptocurrency like Bitcoin, it would cost billions to acquire that much processing power. This sort of attack is limited to smaller currencies with less participation.
Proof of Stake
Proof of Stake is when validators, not miners, confirm transactions by putting up stake with coins of their own, as well as evidence of their validation history. The choice of who gets to validate the transaction is random, but weighted towards those with more stake and experience.
When the block is validated, the validator gets some crypto (just like Proof of Work) as well as their original stake back. However, if the block isn’t validated, there’s a chance their stake can be lost. This acts as a powerful disincentive to try and game the system, because your own coins are at risk.
The Proof of Stake method is a direct response to concerns about carbon emissions and power usage with the Proof of Work model. In September 2022, Ethereum – the second biggest cryptocurrency network – shifted to a Proof of Stake model, cutting carbon emissions by 99.95%.
To perform a 51% attack, a bad actor would need to own 51% of all the staked cryptocurrency on the peer to peer network, making this attack even more costly (and unlikely) for larger currencies.
However, some people have argued that proof of stake means cryptocurrency will become more centralized, because it will favor validators who have a lot of coins already, allowing them to influence the cryptocurrency as a whole.
Common questions about cryptocurrency
Let’s quickly shoot through some of the more frequently asked questions.
Is cryptocurrency even money?
Most countries don’t count it as currency, because it doesn’t have intrinsic or legislated value, which are the hallmarks of an actual currency. Every country has a different approach. Using Bitcoin as an example:
In Japan, Bitcoin is treated as property
In Canada, Bitcoin is treated as a commodity
In Australia, crypto is a financial asset with value that can be taxed
In the United States, Bitcoin is a “convertible currency” with an equivalent in real world currency
El Salvador is the only country in the world so far that considers Bitcoin to be legal tender
It would be fair to call cryptocurrency a digital token, but many people commonly refer to it as a “virtual currency” or “digital currency”. At this point, it’s likely a case of quibbling over semantics for legislative and tax purposes.
Is cryptocurrency infinite?
Depends on the cryptocurrency. Some cryptos are finite like Bitcoin, which has a supply cap of 21 million coins. This was an intentional choice by the creator to make it more valuable like gold. Other cryptos have no such cap, and can be produced infinitely.
Ethereum is one such currency, and while it has a yearly cap of 18 million, it could be mined indefinitely.
Wait, how do infinite cryptocurrencies keep value?
That’s a good question. Some are stablecoins, which means their value is tied to a real world asset. An example is USD Coin, which is tied to the U.S. Dollar.
Ethereum is infinite because it’s used for a lot of other things other than representing value like Bitcoin – for instance, decentralized projects can be built on its blockchain, including Solidity apps.
In short, no two cryptocurrencies are exactly the same, and the decision to put a cap in place is often a deliberate decision linked to the creator’s original goal of making it in the first place.
How legal is cryptocurrency?
Generally? Pretty legal. There are some notable countries with absolute bans as of the Library of Congress’s November 2021 report, listed below:
How many cryptocurrencies are there?
There are over 21,200 cryptocurrencies as of October 2022, according to coinmarketcap. The number of cryptocurrencies more than doubled from 2021 to 2022. The most popular cryptocurrencies by market cap out there are Bitcoin and Ethereum, with Tether, BNB, USD Coin and XRP in the top ten.
If you’re wondering where Dogecoin comes in – originally created as a joke based on the popular internet meme – it currently sits in the top 10 with a market cap of $9 billion (Much wow).
Can I create a cryptocurrency?
Yes, anyone can. But it takes some technical knowledge, and a lot of time, money and resources. Here are some of the methods:
Write your own code to create a new blockchain that underpins a native cryptocurrency
Use the source code of an existing bitcoin to create a new blockchain and native cryptocurrency
Establish a new cryptocurrency on an existing blockchain (like Ethereum)
Hire someone to make a new cryptocurrency for you – this is known as Blockchain-as-a-Service (BaaS)
Since Bitcoin is open source and one of the oldest cryptos out there, most of the cryptocurrencies out there are derived from it. Making one for fun is certainly possible, but maintaining and growing it is where things get tricky.
If you’re interested in learning about working with blockchain technology in general, Pluralsight offers a number of courses on everything from Blockchain fundamentals to developing blockchain applications on Ethereum Blockchain. There is also a Blockchain essentials course on A Cloud Guru.
How much money is in the cryptocurrency market?
As of October 2022, the cryptocurrency market cap is just over $900 billion USD, according to coinmarketcap. For comparison, the current number of U.S. currency in circulation is $2.10 trillion.
It’s worth noting again that the crypto market is prone to very famous fluctuations and crashes, so by the time we’re finished writing this article, those numbers could be different!