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What Is Cryptocurrency?

Cryptocurrency is a relatively new type of money that operates in a completely different way than the traditional currency we all use every day. The most basic difference is that it’s exclusively a virtual currency, meaning there are no physical cryptocurrency coins or notes you can keep in your back pocket.

It’s also issued, or created, in a unique way. Instead of being produced by a central bank or government, like U.S. dollars, euros and other fiat currencies are, new cryptocurrency units typically enter circulation through a technological process that involves the participation of volunteers from all over the world using their computers.

That is why cryptocurrency is often described as “decentralized.” Cryptocurrencies are typically not controlled or operated by any single entity in any single country. It takes an entire network of volunteers from around the world to secure and validate transactions made with cryptocurrency.

But it isn’t just they’re digital nature and how they’re issued that sets cryptocurrencies apart from regular currencies; there are other differences:

  • Regulation: The global financial system has been based on various fiat currencies for centuries and most countries have a mature set of laws and best practices to regulate their use. Cryptocurrency, however, is a largely unregulated market, and even when regulations exist they can vary by jurisdiction.
  • Speed and cost: Sending and completing cross-border transactions using cryptocurrency is much faster than using the legacy banking system. Instead of taking several business days, transactions can occur within minutes, often at a fraction of the cost, when compared with using fiat currency.
  • Supply: Fiat money has an unlimited supply. That means governments and central banks are free to print new currency at will during times of financial crisis. Cryptocurrencies, however, usually have a predictable supply determined by an algorithm. Many cryptocurrencies are coded to include a supply limit (though some don’t). For example, bitcoin – the world’s first cryptocurrency and the largest by market capitalization – has a maximum supply of 21 million tokens that are released at a steady and predictable rate. That means once the number of bitcoin in circulation reaches 21 million, the protocol will cease releasing new coins into circulation.
  • Immutable: Unlike transactions involving fiat currencies, all completed crypto transactions are permanent and final. It is virtually impossible to reverse crypto transactions once they have been added to the ledger.

What puts the ‘crypto’ in cryptocurrency?

The word “crypto” in cryptocurrency refers to the special system of encrypting and decrypting information – known as cryptography – which is used to secure all transactions sent between users. Cryptography plays a vitally important role in allowing users to freely transact tokens and coins between one another without the need for an intermediary like a bank to keep track of each person’s balance and ensure the network remains secure.

It also solves a problem that used to make middlemen like banks indispensable – the double-spend issue: when a person attempts to spend the same balance twice with two different parties.

Cryptocurrencies use cryptography to encrypt sensitive information, including the private keys – long alphanumeric strings of characters – of crypto holders. Think of private keys as the passwords that determine the ownership of cryptocurrencies. Keep in mind that cryptocurrencies cannot be stored outside of the blockchain. They are permanently based on the blockchain. Hence, when someone says they own X amount of coins, what they really mean is that their password can legitimately claim X amount of coins on the blockchain.

Cryptocurrency private key concept (Getty Images)

These private keys are what crypto holders store on their wallets, which, as you must have guessed, are special kinds of software or devices designed specifically for this purpose. In instances where a crypto holder loses access to his or her private key, the cryptocurrencies associated with such keys could be lost permanently.

With the help of a cryptographic technique, private keys are encrypted to create wallet addresses, which can be likened to bank account numbers. In essence, you need your private key to digitally sign transactions. This is essentially like broadcasting to everyone in the network, “I confirm I am sending this amount of X coin to this person.” In contrast, wallet addresses indicate the destination of transactions.

The encryptions are executed in only one direction, which makes it impossible to derive private keys from a person’s wallet addresses.

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