How does Cryptocurrency Work?

The success of cryptocurrency is primarily dependent on a system involving digital cash, a decentralized platform, and cryptography. Cryptocurrency’s main ingredients are the digital coin and the blockchain it uses.

This article explains where the “crypto” in cryptocurrency comes from, how people use cryptocurrency, and why cryptocurrency has inspired a burgeoning world of new technologies.

How does cryptocurrency work? Here it is in 6 simple steps:

1. Someone requests a transaction to pay for a product or service.
The transaction broadcasts out to the peer-to-peer network of distributed computers (or more correctly, nodes).
Using the program’s algorithm’s and the consensus rules of the specific currency, the transaction goes through the validation process by the network of nodes.
Once the transaction is verified, it goes onto a digital ledger of other transactions. Then, a new block containing the data/information of the transaction is added to a consecutive sequence of other similar transactions.
The new block is added using cryptography to the previous blocks in the blockchain. Future transactions are approved and also go onto the most recentblock in the chain, infinitely.
All of this takes place in the span of about an hour. The transaction confirmation means the digital exchange is complete.

Yup. That is pretty much how cryptocurrency works. But in case you’d like to know more or gain additional clarity about the system, let’s work through the whole story looking closely at both the crypto and the currency in cryptocurrency.

After reading this article you will better understand the following things about cryptocurrencies:

Cryptography: How digital currency work and created.
Blockchain Technology: How the immutable public ledger works. peer-to-peer networks: What is the role of a decentralized network.
Popular Cryptocurrencies: Who the major players are and what should you know about them.
Concerns and Limitations: What challenges face cryptocurrencies long-term health.

The Genesis of Digital Currency

In 2009, Satoshi Nakamoto launched Bitcoin, it was the blockchain that supported the currency making it possible to secure Bitcoin transfers without the need of a middleman. Cryptocurrency transactions process via data chunks called blocks. New blocks form about every ten minutes. In each block contains a compressed version of the previous block, and thus they connect in a digital chain.

Using cryptocurrency really is as easy as these 6 steps make it out to be. But there is still a lot that is going on behind the scenes in order for cryptocurrencies to function in a trustless, peer-to-peer digital world. The particulars behind the scenes involve complicated and impressive cryptographic algorithms. To best understand how cryptocurrency works, you need to understand the principles of the cryptography that makes these operations possible.

When we ask how cryptocurrency technology works, it is also helpful to ask “Why it works?” This article lays out what is under the hood of cryptocurrencies and explains why they have been so successful. What I mean is, what are some of the global issues, both economic and social, that make cryptocurrencies appealing? Cryptocurrencies and the blockchains they run on are not appealing just for the technology they have harnessed. A peer-to-peer system with decentralized authority is undermining many of the authoritarian regimes that have become standard practice for customary institutions.

Currently, there are over 1500 cryptocurrencies in existence. With them, people can purchase things and pay for services. Much in the way of a traditional fiat market exchange, people trade crypto for their value. Cryptocurrency trading is just trading that involves exchanging one digital currency for another, purchasing and selling coins, and exchanging fiat money for crypto.

As the influence of cryptocurrencies grows, more traditional institutions and business are adopting cryptocurrency practice. This is in large part because of the way that cryptocurrencies work. In the discussion of cryptocurrencies we often talk about disruption, and with good reason. Trustless peer-to-peer systems are a necessary part of our progression and are the result of collective dissatisfaction with institutionalized restrictions on financial freedom and security.

Disruption

In the past, when the status quo became dissatisfied with their oppression, they started wars, overthrew authoritarian leaders, or packed up and moved to a new world. Fed up with monarchical powers, Europeans of the 15th century moved to North America and established a new regime. However, there is no territory uncolonized on planet earth, and most of us are beyond the desire for war. But many of us still long for a new world. In many ways, we have already realized that new world. It is a world of information and digital access that has never before been possible.

Like the explorers of our past, many of us in the present have grown tired with the controls that financial institutions hold over their patrons. Financial institutions are the new monarchs; the world’s big banks wield unquestioned power and decide who gets access to valuable resources.

So let’s talk about cryptocurrency and why it might be the solution to many of these issues concerning power and control.

The Crypto-Revolution

Before Satoshi Nakamoto created Bitcoin in 2008, there were other attempts at making digital currencies. However, because they lacked the requisite properties of a trustless peer-to-peer system, they were unsuccessful. The success of Satoshi’s Bitcoin and cryptocurrencies that enjoy a similar success such as Ethereum, and Litecoin, is the result of effectively combining a market need with secure cryptography that uses blockchain.

Cryptocurrency debuted after the 2008 stock market crash, that not only devastated individuals around the world but highlighted the surmounting problems of our current system. The top-heavy design of traditional financial systems keeps many individuals completely powerless, and at the mercy of a few very powerful financial groups. The dream of eliminating systemic hierarchical power that North America once offered has since become mired by the debt and despotic controls that large American and Chinese banks have since acquired.

One of the reasons that large banks like Bank of America, Goldman Sachs, and Wells Fargo have been able to gain so much control over our day to day finances is because we depend on a system of trust. And better the devil you know than the one you don’t. But cryptocurrency is eliminating the need for the trusted third party. Using blockchain and cryptographic functions, exchange and trade can take place without the fear of being defrauded.

What can a cryptocurrency do that fiat currencies can’t?

Here are several things that cryptocurrencies do:

Act as a legitimate currency for the exchange of goods and services.
Make possible nearly instant peer-to-peer transactions.
Employ blockchain technology on a decentralized network that uses millions of nodes.
Crypto is a non-fiat, digital currency that works like cash, but can fulfill payments anywhere with internet access.

Satoshi Nakamoto realized a system where peer-to-peer transactions did not require trust. He did so with the creation of the program that would perform using true or false logical processes.

Bitcoin script and smart contracts basically operate like this: Alice wants to pay Bob 1 BTC for his apples, and Alice has 1 BTC in her wallet. So Alice sends Bob her Bitcoin. When the transaction receives confirmation, Alice has her apples and Bob has his new Bitcoin (or UTXO).

Basically, because cryptocurrencies operate using a program or script that fulfills if the conditions of the script are met, it operates under the rules of logic, not trust. For example, IF Alice has 1 BTC to pay Bob, THEN she will receive her apples. If she does not then she will not. It is as simple as that. What’s more, with cryptocurrencies, Alice and Bob do not even need to know one another. All Alice and Bob need to know are the address for one another’s electronic wallets for cryptocurrency.

Crypto-basics

The genius of cryptocurrencies is that the application of cryptography they have eliminated the following:

The possibility of double-spending
The need for a trusted third party, such as banks

How have cryptocurrencies made this possible? With:

Asymmetrical Cryptography
Strong Hash Functions
Blockchain’s Public Ledger and Decentralized Network

Asymmetrical Cryptography

Cryptocurrencies like Bitcoin and Ethereum are successful in large part because they rely on strong cryptographic functions. Strong cryptography means that both a public key and a private key are necessary for a transaction to be successful.

Here is how asymmetrical cryptography works: Two different but mathematically related keys are used: a public key and private key. They share a relationship because the keys come from one another using a similar data set.

Private keys and Public keys

Public-key algorithms are most often based on the computational complexity of “hard” problems. “Hardness” simply means that the computations are significant in size and number. So the algorithm must test many sequences to find the correct answer. Part of what makes asymmetrical cryptography secure is that it requires a lot of work for the computer to run through.

This is a useful procedure because, in the case of currencies like Bitcoin or Ethereum, this is going to mean that to approve a transaction you need two things:

The right equipment to process run such algorithms
Enough energy to power the computer

For example, the hardness of RSA, which is an algorithm for everyday online shopping, is related to the integer factorization problem. In RSA, the two keys rely on a process of factorization, which is computationally expensive and difficult to hack.

The security of elliptic curve cryptography is based on number theoretic problems involving elliptic curves. Elliptical curve cryptography is what Bitcoin uses for its hash function. The essence of the design is such that the sensitivity of the computation, the size of the key and the realistic chances of guessing the correct private key combine to make the probability of a successful attack very low. Basically, the public key is for encryption, while the private key is for decryption.

A public key system has the design so that the calculation of the private key is computationally infeasible with the public key. Instead, both keys generate secretly, but as an inter-relational pair. They are related so that one can unlock the encrypted script. A public key may be freely distributed, which is necessary for transactions to occur. While the paired private key must remain completely secret.

Elimination of Double-spending with SHA-256

Because of the hashing algorithms used by Bitcoin and other reliable cryptocurrencies, double-spending is not possible. Here’s why: a digital currency that relies on secure hash-functions, like SHA-256. Hash functions create alphanumeric combinations that are essentially impossible to duplicate because they are so computationally complex.

SHA-256 is a double hash function that is highly sensitive to change and a significant amount of computational power is necessary to run this function.

What that means is that a hash like SHA-256 requires a computer that is able to process the computations necessary to solve for the target-hash of a cryptocurrency transaction. However, it also needs time and energy to process these computations. That means it requires a lot of electricity to run these algorithms. To solve for a target-hash, a computer must run through all of the possible answers based on the input data it was given from the transaction.

Because the target-hash is the outcome of a very sensitive cryptographic algorithm, it is hard to solve for, both computationally and energetically. So, when networks are trying to solve these hashes to approve transactions, they must solve for a hash that is impossible to forge because it is a specific combination of inputs. You might think; couldn’t an attacker just take the hash and solve backward to get the information of the original owner? And the answer is, theoretically yes – but realistically, no.

Because of the complexity of the cryptography used, they would have to use a random guessing method, called brute force. Again, you might think, well that might be worthwhile anyway! You could get lucky, right? You’re right, you might get lucky. But you have a better chance of experiencing a lightning strike. And what’s more, as I mentioned, these computations are incredibly expensive to run correctly. So an attempt to reverse engineer the solution is computationally and energetically infeasible, and therefore it is essentially impossible to perform successfully.

Blockchain for Crypto

When we talk about cryptocurrency, the discussion of blockchain often comes up. Although blockchain does not necessarily mean cryptocurrency, any cryptocurrency worth its salt operates on a strong blockchain platform. The essence of a blockchain is a ledger of data that is cryptographically bound. So, once the data is entered, the information in the ledger cannot be altered. The data can be of anything, and it can be applied in many ways.

1991 saw the creation of the first cryptographically secured chain of blocks. Stuart Haber and W. Scott Stornetta conceptualized the theory of blockchain technology. The system enables the time stamping of documents to disable the tampering of data.

Then, in 1992, Bayer, Haber, and Stornetta incorporated Merkle trees to the design. Merkle trees improve the efficiency of blockchains. They do this by allowing for the condensing of several document certificates into one block. This is because the Merkle tree relies on ‘roots’ or ‘leaves’ rather than the entire hash. Hash trees are a generalization of hash lists and hash chains, and so they take up less space and make confirmation of the blockchain history much easier.

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Adding Cryptographic Blocks to the Chain

Blockchain is an increasing collection of blocks that is nothing more than a growing list of records. Each block is cryptographically bound to the other blocks and contains a cryptographic hash of the previous block, a timestamp, and transaction data, which is represented as a Merkle tree.

In any blockchain, whether it is for cryptocurrency or storing other data, blocks can be added but never removed. Thus an immutable ledger if formed. Each time information goes onto the blockchain it connects to the other transactions with cryptography. So, because the blockchain is public, or decentralized, anyone on the network is able to see the cryptographic information is stores. And the information is immutable because of the mathematical algorithms that link each block. To change one block would change the others, so it cannot be done successfully.

Decentralized Networks and Blockchain

So, Satoshi Nakamoto did not invent blockchain, but in 2008, he was the first to fully implement the theory. Blockchain is the realization of peer-to-peer transactions. The blockchains of Bitcoin and Ethereum run on a decentralized network, which operates without a central server or controller. Instead, these networks include millions of individual nodes that participate.

This means that instead of storing the blockchain’s information in one place, the way that typical servers do, there is a copy of the information within each node in the network.

There are many benefits to this model. One of the central benefits is that it is impossible to attack the entire server. Because the data of the blockchain is shared amongst the distributed network, an attacker would have to hold all nodes hostage simultaneously. This is impossible. So, relying on a decentralized network not only keeps the information safe because it is stored in many different locations, but it also means that the entire system will never be down all at once. Unless there is an apocalypse, and the entire world loses power and has no backup generators.

Decentralization-Optional

A central feature of cryptocurrencies is indeed the decentralized authority, which is possible because of decentralized networks that the altcoins run on. Blockchain does not need to be a decentralized system, however. There are private and public industries applying blockchain technology currently.

Estonia’s fully digital bureaucracy is a fine example of an X-Road application. While IBM and Walmart are using blockchain in an effort to fully digitize records and orders of operation.

JPMorgan has just released their own private token, and are using blockchain to make instant global transfers between institutional customers.

For bureaucracies, blockchain applications have the potential to offer a solution to maintaining vast amounts of citizen’s data safely. Using blockchain’s secure storage and encryption, citizens could easily access their private information. And because of the immutable cryptography, records will become far more reliable.

On the other hand, IBM is working to streamline order of operations. With a fully digitized blockchain, it would finally be possible to keep track of every process from initial stages of manufacturing to the final consumer experience.

Blockchain provides solutions for the layers of the food business. Issues food industries face regularly concern contamination such as E. coli outbreaks, and even factory fatalities. Nestlé and Bumble Bee Foods are turning to blockchain to secure their supply chains and reduce paperwork in an effort to improve and grow as a business.

According to Forbes: “Total corporate and government spending on blockchain should hit $2.9 billion in 2019, an increase of 89% over the previous year, and reach $12.4 billion by 2022, according to the International Data Corp.”

Blockchain Technology and Applications

Blockchain offers solutions for virtually any industry. Its cryptographically bound blocks make records available to all blockchain participants as well as presents a secure, trustless system. As a result, it reduces record and fact-checking redundancies. Consequently, the foundation of cryptocurrencies success is being applied to solve problems for traditional industries.

By eliminating many of the basic problems of record keeping, using blockchain has huge potential to save many different industries millions if not billions of dollars. Each industry has different estimated saving the predict depending on what need blockchain will fill.

Regardless of who is using it, or for what exact purpose, Hyperledger has recognized the value of blockchain. So, Hyperledger has established itself as the lead in corporate blockchain projects. Thirty companies are on board as founders, among them Cisco, CME Group, IBM, Intel, JPMorgan Chase, and Wells Fargo.

Consensus Mechanisms

This section explains what a consensus mechanism is and how consensus is maintained by a decentralized network.

As you can see, there are many working parts of a cryptocurrency. But cryptocurrencies at their most basic level are data entries that cannot be changed once the cryptographic puzzle has been solved. But to solve that puzzle the data must first be confirmed. Without confirmation from the network, a transaction is only pending. This means it can be forged or sent again to a different address – the dreaded double-spend.

Confirmation is critical to all good cryptocurrencies. It was Satoshi’s creation of a functioning decentralized confirmation that made digital currency a functioning system. But as soon as a transaction is confirmed, it is permanently a part of the digital blockchain ledger of the currency. At that point, the transaction can no longer be forgeable or reversed.

A consensus is particularly important for the decentralized networks of cryptocurrencies. For the coin to last, there must be agreement on the state of the system for block approval and how adding to the blockchain will work.

What makes up a consensus mechanism?

Consensus mechanisms are just the rules that determine how nodes can participate in the program. A consensus is a mutually enforceable agreement by the networks to achieve agreement on both a single data value, as well as a single state of the network.

In order to overcome the problem of a central authority, Satoshi built into the design that the miners need to invest work from their computers to qualify for this task. This computational work is to find the target-hash. That is the product of a cryptographic function connecting the individual blocks.

A common consensus algorithm used is Proof-of-Work. PoW is what Bitcoin and Litecoin require. For Bitcoin, it is based on the SHA 256 Hash algorithm. This means that all participant nodes must prove the work they have done. The work is what they have done to mine new coins and approve transactions. It is the computational work that qualifies them to add new transactions to the blockchain. PoW is currently the most popular form of consensus in use. Unfortunately, it consumes a large amount of energy and requires longer processing time.

The Role of Miners in Consensus Mechanisms

So these digital ledgers use the consensus mechanisms of the network. But in order for the data blocks to see approval, they must go through the mining process. Most cryptocurrencies and altcoins need to be mined, and most have a limited supply. For example, Bitcoin has a supply maximum. It is estimated that in 2140, Bitcoin will reach its maximum supply of 21 million Bitcoins. That means until then, new coins can be made available. These new coins are produced through Bitcoin mining.

Mining is not just looking for new Bitcoin, it requires approving transactions on the network. That means that in order to be rewarded with newly minted Bitcoin, a miner must solve the target-hash of a transaction. Solving for the target-hash of a transaction is not as easy as it sounds though. While the heavy math is done by a computer, to solve for the hash, the program must run through a significant amount of computations. That meant that miners can no longer use a personal computer to mine. Instead, to mine one needs specialized hardware, typically ASICs. If a miner is successful they become the owner of the valuable and newly minted Bitcoins, They are also awarded the transaction fees paid for by the currency user.

Bitcoin programming allows mining at a steady rate, which is about 1 bitcoin every 10 minutes. To maintain this difficulty rate, the program adjusts itself depending on how many competing nodes are live on the network. So when there are more miners mining, the system adjusts to respond to this increase to maintain the 10-minute process. When the difficulty increases it means that the competition to solve for the target-hash also increases.

Top Cryptocurrencies on CoinMarketCap Now

Now you should have a pretty good idea of how cryptocurrency works. But you may still be wondering, what cryptocurrencies are out there other than Bitcoin? Here we’ll go through several of the top performing cryptocurrencies on the market today and why that might be.

Note: The relative value of the following cryptocurrencies is based on the day they were sourced. For up to date information, please visit CoinMarketCap.

Bitcoin

Currently, Bitcoin’s value sits on the market at around $97,405 USD. Like most cryptocurrencies, Bitcoin’s value is volatile. Last year at this time it was worth about half of that. However, Bitcoin has staying power, and for some very good reasons.

Bitcoin was the first legitimate and successfully cryptocurrency and it is easily the most widely accepted one out there. The script and blockchain Bitcoin uses is very secure, and it is easy to use Bitcoin. Bitcoins are registered to bitcoin addresses, which is much like a very secure email address. To create a Bitcoin address you simply pick a random valid private key and compute the corresponding bitcoin address.

Then to spend their Bitcoin, the owner must know the corresponding private key and digitally sign the transaction. When you send Bitcoin to another wallet is a computation that is done nearly instantly. But, as I mentioned earlier, the reverse, computing the private key of a given Bitcoin address, is mathematically unfeasible.

Users can make a Bitcoin address public without compromising its corresponding private key. Because the number of valid private keys is so vast, it is extremely unlikely someone will compute a key-pair that is already in use.

Ethereum

Ethereum and its coin Ether are presently valued at about $150 each. But bear in mind there are much more Ether tokens in circulation than there are Bitcoins. Ether (ETH) allows others to run the application on Ethereum. To do so, you need Ether, commonly referred to as the “gas” that fuels the program.

Ethereum is an open source software platform based on blockchain technology that followed Bitcoin’s basic design. However, its primary purpose is to allow developers and tech teams to build apps on the Ethereum platform.

Applications built on Ethereum platform are often decentralized apps, or DApps. We talked about what decentralized networks were earlier on. The opposite is a centralized server, such as with Microsoft or Amazon. Smart contracts are one of the things that Ethereum is best known for. Smart contracts are self-executing, based on the basic logic that if the conditions are met, then the contract will be fulfilled.

The Ethereum platform allows startups to create DApps to exchange assets, such as content or digital money. Smart contracts make the automated exchange of assets possible. They run without the need for an intermediary who ensures that all the stipulations are met. So miners of the Ethereum Network mine Ether. They can also be earn by processing transactions for the DApp users.

Ripple’s XRP

Ripple’s altcoin XRP has a much larger circulating supply than Bitcoin and Ether. Ripple is a real-time gross settlement system that represents fiat currency, cryptocurrency, commodities, or other units of value such as frequent flier miles or mobile minutes. Released in 2012, Ripple purports to make possible nearly instant global transactions. So for now, XRP has a hand in both the crypt-world and traditional financial institutions.

The native currency the ledger uses is XRP. Since its creation, Ripple has been adopted by banks and payment networks, which use it for settlement infrastructure technology. While working with the public and private industry, Ripple relies on a common shared ledger, which is a distributed database storing information about all Ripple accounts.

Ripple has XRP, the native token. However, it is more the network to move other various exchanges, and not really the cryptocurrency itself. XRP, the currency, does not store and exchange value of its own. It is a token used to represent other transactions on the Ripple network.

Ripple is often called pre-mined because the company that runs the Ripple network distributes the token as needed. XRP is not considered as a good store of value. This is in part why traditional banks have adopted XRP readily.

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Litecoin

In 2011 Charlie Lee, a Google employee and former Engineering Director at Coinbase released Litecoin. It started as a fork of the Bitcoin Core client.

The primary difference is that Litecoin has a decreased block generation time. Litecoins are generated about every 2.5 minutes, compared to Bitcoin’s 10 minutes. It therefore also has increased maximum number of coins and relies on a different hashing algorithm than Bitcoin’s SHA-256. Litecoin however, is both more complicated and expensive to produce or mine than Bitcoin’s hashing function.

EOS

EOS is another example of a decentralized blockchain. It’s designed to host and support DApps. Blockchain-based DApps, like those of Ethereum, are used for either commercial or individual projects. DApps are similar to typical web-based apps. EOS platform’s supports all required features for developing, hosting and using DApps. In many ways, they are a full-service platform. They provide secure access and authentication, permissions, data hosting, usage management, and communication between the DApps and the Internet.

A major boon for EOS is that they have managed to effectively leverage the scalability potential of blockchain. EOS is capable of processing large numbers of transactions, a challenge many platforms have yet to effectively overcome. Rather than proof-of-work, EOS uses delegated proof-of-stake. With PoS they have the power to make high-level decisions with a majority consensus from stakeholders.

Revolutionary properties of Cryptocurrency: Transparency and Trustless Security

Hopefully, by now, it is clear what I mean by the trustlessness of cryptocurrency. When Satoshi Nakamoto released the Bitcoin whitepaper, he caused an irreversible shift in the way transparency and privacy function in the digital age. Bitcoin’s financial privacy model separates identities from their transactions.

The model of a cryptocurrency is that no one needs to verify who the person is they are dealing with. There does not need to be a relationship of trust. The only thing that matters is that the users have valid addresses and that they actually own the altcoin in exchange.

The crash of 2008 highlighted the intrinsic problem of banks. They run on credit and control the financial system. But more than that, banks can exert a lot of power because they have so much of our personal information. Satoshi’s model aimed to eliminate this.

Before the marriage of cryptography and cryptocurrency, we were entirely reliant on the trusting traditional banks to appropriately and selectively share private financial information. Privacy was therefore only possible with the facilitation of a third party.

However, by publicly announcing all transactions, the middle man is eliminated. Privacy is maintained with anonymous public keys. Via a cryptocurrency’s public ledger, the public can see that transactions are made between others on the network. The revolutionary bit is that transactional information is linked to a secure address, and not a person.

In many ways, it is similar to the information released by stock exchanges. In that case, the time and size of individual trades are public, but the parties involved are not.

When we talk about blockchain public ledgers, one of the major appeals is transparency. The reason blockchain is such an appealing platform is that it uses a ledger that maintains both the anonymity of the actual humans making transactions. Public ledgers simultaneously keep a public record of all of the transactions that occur on a given blockchain platform.

Public Ledger Transparency

The essence of crypto-transparency is the combination of anonymity and accountability through public access. Transparency is possible because while the addresses are publicly accessible, the addresses and their transactions are hidden with cryptography.

Transparency leads to accountability.

Cryptocurrencies rely on networks and public blockchains. Therefore, although information stored cryptographically is disguised, it is also available to every network participant. Obviously, not many traditional financial institutions are ready to adopt this exact open model. However, given the continued influence of the world of cryptocurrencies, it would come as no surprise if the public ledger became a necessity due to public demand.

If a company wants clients and investors, they will have to earn trust and show us what’s under the carpet. Not simply hand over a bill of goods that we are simply expected to approve of. Consumers and citizens alike deserve the basic tenets of transparency and accountability. In an ever-expanding global economy, trust needs to be earned, not just freely given. Again, this is one of the reasons that cryptocurrencies have such a strong appeal, transparency through access to records.

Potential Limitations

Digital currencies have indeed ushered in a new age. But to guess how long they will last is an impossible call to make. There is no question that technology and niches that cryptocurrencies are accessing have value. However, there is no way to tell which currencies and applications have real staying power on the market.

When the internet was invented, there were many predictions made about what products and capabilities would be either incredibly valuable or totally worthless. As it turns out we cannot see into the future. We are obviously still using the internet, but not in the way people 30 years ago had imagined. And so it is fair to say that we also do not know how cryptocurrencies and blockchain applications will be used in the next 30 years.

Just Digits

The fact that the crypto-world is completely digital poses some potential issues. Cryptocurrencies are virtual and do not have a central repository. Although being digital is the basis of their appeal when a digital cryptocurrency balance can be stolen or lost. And computers crash without a backup, at which point there is nothing that can be done. When private keys are stolen or guessed, which recently occurred with Ethereum private keys, there is little recourse.

Bad Behavior

As we talked about earlier, there are many gains from a lack of central authority. However, cryptocurrencies have given nefarious activities, like money laundering, tax evasion and selling of illegal drugs and arms, an easy way to transact. Moreover, because of the illegal activities that occur using crypto-exchanges, for better or for worse, it is likely we will only see more government and enforced policies surrounding cryptocurrencies in the future. Forensic analysis of Bitcoin transactions has already led to successful arrests and criminal prosecutions.

Volatility

Price fluctuations of cryptocurrencies have been shown to be very extreme, this is the nature of a totally free market. There is a lot of interest in identifying what drives these price fluctuations, but the investigation is new and speculative. Bitcoin is an excellent example of volatility. While it remains the most valuable cryptocurrency, in December of 2017 it was at a high of $19,000, currently, its value sits at around $5000.

There are definitely challenges to the design of cryptocurrencies that make certain economists believe it is a short-lived phenomenon. Bitcoin, as with other cryptocurrencies, is not backed by material goods. ICOs and IEOs use native tokens which are valued because they work much like an initial public offering. However, many of these ICOs are destined for certain failure.

Crypto-Fail

Although the blockchain technology and function of cryptography face few criticisms, the design of cryptocurrencies is not bullet-proof. Both Bitcoin and Ethereum have faced serious issues when it comes to maintaining security.

There have been several cryptocurrency exchange hacks. At times, millions of dollars worth of Bitcoin were stolen. And more recently, hackers have successfully guessed Ethereum’s private keys.

Mining Costs

Mining for cryptocurrencies is incredibly energetically expensive. To combat the price of energy, mining pools are set up in low-cost energy areas, such as China. However, the extraordinary energy consumption from mining is no longer overlooked by energy providers.

Summing Up Cryptocurrency

By now you should have a good understanding of what a cryptocurrency is. So let’s recap what we’ve learned.

Cryptocurrencies are digital transactions that are made with cryptographically secured data. The transaction is exchanged as a currency. This is done by exchanging altcoins or tokens via a decentralized network of computers, much like sending an email. It is built with blockchain technology, once the transaction is approved, it is cryptographically stored and bound in a permanent public ledger.

Blockchain and cryptocurrencies are two peas in a pod. Essentially, cryptocurrencies are digital entries about transactions that exist on a decentralized consensus-databases. They are named for their use of strong cryptography; hence crypto-currencies. Because it relies on cryptography, it is a trustless system secured only by computations and algorithms.

Valuable cryptocurrencies like Bitcoin and Ether are often compared to gold and silver. This is because they are strong currencies and epitomize free-market capitalism. Like the metals, there is nothing backing an altcoin. It is the currency alone that is traded on and valued. Because they are purely digital and use decentralized networks, cryptocurrencies are a fast way to make worldwide payments. And they are private and anonymous enough to serve as a means of payment for black markets and any other outlawed economic activity.

Not only are cryptocurrencies used to make payments for products and services, but they have also manifested a burgeoning market for investors and speculators. A totally free-market, these altcoins and tokens are subject to extreme volatility, which investors cannot decide if they love or hate. Either way, it is an increasingly growing market and a movement that deserves acknowledgement.

Crypto 101

This article promised to answer the question: what is cryptocurrency. But an equally important question is: why cryptocurrency.

Here is a run-down of a few of the central solutions that cryptocurrencies offer:

Transactions are irreversible. Once the transaction is sent and confirmed it is finished. Although this could be problematic, the main problem it solves is double-spending. You cannot send the same transaction twice.
Cryptocurrencies are pseudonymous. The addresses used and messages sent are all encrypted. What’s more, an address is not a human identity, and neither are the transactions made by the address. It is simply a record of transactional information. There is no personal information.
Instant global transactions. As long as you have internet access you can send money to anyone in the world. Within the span of an hour, transactions are finalized.
Cryptographic security. With public key (or asymmetric key) cryptography hacking or guessing private keys is nearly impossible.

There are many reasons to believe that cryptocurrencies are around for a while. Digital cash has filled a need in the market by resolving a slew of long-standing issues.

The crypto-world has ushered in a new world of currency and trade, as well as a techno-revolution. Understanding the value of the technology of blockchain and cryptography is central to understanding the market value of a cryptocurrency. If you're interested in learning more about how cryptocurrency works, I'd recommend a book called - 'The Basics of Bitcoins and Blockchains: An Introduction to Cryptocurrencies and the Technology That Powers Them' - it's available on Amazon here https://amzn.to/4gyPKtM