What is cryptocurrency?
Cryptocurrencies are defined by some as “money of the future”, a virtual means of payment, free from all the disadvantages of traditional currencies. Do we really have to reckon with the possibility that in a few or several years’ time cryptocurrencies will completely replace the means of payment known to us so far? What kind of forecasts do economists predict? On what basis do cryptocurrencies work?
Do cryptocurrencies pose a real threat to traditional money?
Until recently, experts did not predict a bright future for cryptocurrencies. It was commonly assumed that they have no chance to threaten the domination of traditional money. However, in the face of the growing popularity of cryptocurrencies, which have been so far marginalized by the establishment, financial specialists had to revise their beliefs. The new form of payment is gaining an increasing number of supporters. It has been noticed by the governments of several countries and has become the subject of new legal regulations. The potential of cryptocurrencies is undeniable. Perhaps in the more or less distant future, traditional currency will be replaced by monetary systems such as Bitcoin and Ethereum. This is all the more likely as cryptocurrencies are free of many of the drawbacks that characterize coins and bills in circulation. Introducing them on a massive scale could revolutionize our current payment system, and solve many problems related to the issue of money and administrative complexities.
Although cryptocurrencies seem to be a better means of payment than ordinary money, they still arouse reluctance in some parts of society. They cannot be touched or withdrawn from an ATM – their existence is completely virtual. In the era of progressive digitalization of other aspects of human life, however, it must be assumed that sooner or later physical monetary units will come out of circulation, replaced by electronic equivalents. Therefore, it is worthwhile to take an interest in the subject of cryptocurrencies and find out what Benefits and risks are currently associated with their use. What is cryptocurrency? The following article attempts to answer these important questions.
What exactly is cryptocurrency?
Cryptocurrency can be defined, in general, as a Digital (virtual) currency, which uses an encrypted communication technique – cryptography. This technique ensures security of transactions. Thanks to cryptography it is not possible to forge digital means of payment, so you can use it without fear of theft. The vast majority of new cryptocurrencies create decentralized systems, based on blockchain technology. A blockchain can be defined as a Publicly available register of transactions, constantly updated by the so-called Miners, i.e. people who attach subsequent transactions to an existing chain. Transactions are anonymous, but every network user has access to them. Virtual currency is therefore a smooth means of exchange, not inferior to regular money. Nowadays, it performs well primarily in online sales-oriented trading.
How is virtual currency different from regular money?
Someone could justifiably say that many financial operations are already done with a bank card or using BLIK. We have managed to get used to electronic banking. So how does cryptocurrency differ from this means of payment, through which we can transfer funds from one account to another with just a few clicks?
Such a question should be answered as follows: cryptocurrency is completely digital. The funds available in a bank account can be withdrawn from the ATM at any time – they have a physical aspect. Although we can use their virtual counterparts by transferring our funds online, these counterparts are only contractual representations of physical coins and banknotes. Besides, there are some costs associated with maintaining a bank account and the time of the transfer may vary (depending on the hours of incoming and outgoing sessions at a given bank).
Cryptocurrencies are 100% virtual, they do not correspond to any physical monetary units (although they are for sale, and you can buy them with regular money). Their monetary value is measured using cryptocurrency rates. They are the same means of exchange as traditional currencies, however, there are Important differences between them (such as duration of the transfer).
New, decentralised payment system
Digital currencies are divided into centralised and decentralised. The former currencies are supervised by one central point of control over their emission. The latter is supervised by many different sources. Most cryptocurrencies fall into the second category.
Decentralized digital currencies are Payment systems that are not owned by anyone. No bank has custody over them; there is no one to manage the cryptocurrency. The key to any possible change is the agreement between the network participants creating the so-called nodes.
Currencies under the supervision of a central bank require users to communicate through a single server. In case of digital currencies there is no such requirement. This entails many important advantages: cryptocurrencies are much more resistant to closure or censorship. In order to disrupt the traditional monetary system, it is enough to disorganize the main server. For example, if bank databases were removed due to a hacking attack, it would be impossible to restore customer balances without backups. Within virtual money systems, such as Bitcoin, copies of databases are located in the previously mentioned nodes. Even if some of the nodes are offline, users making transactions can retrieve data from other nodes.
Virtual cash systems can therefore be used at any time, 24 hours a day, 7 days a week. They enable money transfers with the use of special keys, without the intervention of any intermediaries (as is the case with traditional bank transfers, where the role of the intermediary is played by the bank).
Cryptocurrency: how does a blockchain work?
The principle of a cryptocurrency is, as we have already mentioned, blockchain technology. It allows for continuous updating of the Publicly available register of all transactions carried out exclusively with the use of a cryptocurrency. For a register update to be accepted by the system, most of the online nodes need to “work out a common understanding” to use an illustrative term. What does this mean?
The funds deposited in a digital wallet are files, and a file can be copied infinitely. If this were the case with cryptocurrencies, naturally there would be no decentralized system in place. What kind of a system is it if everyone can multiply their capital without limitations?
In order to exclude the possibility of copying the funds in the wallet, it is necessary to Use a chain of blocks (a blockchain). It allows to block the possibility of duplication of concluded transactions in order to smoothly distribute digital currencies. This is the only reason why the whole network works without obstacles. To put it simply: a digital means of payment is a file that cannot be copied.
Cryptocurrencies: what is cryptography?
Cryptography is a set of practical methods of keeping information secret. Just like Cryptanalysis, it is a part of Cryptology – a scientific field dealing with securing data against unauthorized access. Cryptography is about data secrecy, while Cryptanalysis is about breaking ciphers. Cryptographic methods allow to protect data against unwanted access – thanks to them the information is difficult to decipher by someone who does not know the cipher that allows to read it. Encrypted information for an unauthorized person is only an incomprehensible sequence of characters. Cryptanalysis, in turn, includes a set of practices aimed at reading encrypted data without using a deciphering key.
Symmetrical and asymmetrical cryptography
Cryptography is divided into symmetrical and asymmetrical. The former is based on the fact that the same key is used to encrypt and decrypt data. The latter allows for at least two keys: one to encrypt data, the other to decrypt it. In asymmetric cryptography there may be more of these keys. For example, Bitcoin wallets have private and public keys. The latter can be shared without the slightest risk as they do not contain any important clues that would make it easier to recreate the private key. The public key is used to encrypt data, while the private key is only used to read it.
Thus, virtual currency uses cryptographic techniques on a large scale. They are used to secure transactions made by Internet users. Each user has unique keys (private and public addresses), which allow to conclude binding transactions with other users.
Digital currency: mining (cryptomining)
In the cryptocurrency jargon, cryptomining represents a system of dispersed consensus. When a user wants to conclude a transaction using cryptocurrency, a copy of this transaction is given to every user in the system. For the transaction to be successful, all users must approve it, which excludes the possibility of fraud. This, of course, requires the involvement of many people in maintaining the network. They are known as “Miners” – their job is to confirm transactions waiting to be accepted. Once approved, the transaction enters the register.
Each such chain is subject to strict encryption rules, which are checked and approved by the network’s “Miners“. No central state institution has any influence on this process (at least as far as the most famous cryptocurrencies such as Bitcoin are concerned). This ensures that the network remains neutral and free of any abuse of power.
To explain the whole process, it is a good idea to Compare transactions made using cryptocurrencies with the traditional monetary system. When making a contactless payment in a store, the bank’s customer has to reckon with the fact that the transaction will be verified and approved by the payment card issuer (such as MasterCard For example). Within the cryptocurrency system, verification is handled by more entities (all of the “Miners“).
However, this is hard work (it was named mining for a reason – it has a lot to do with gold mining). The “Miners” are rewarded with bitcoins in return for their effort in maintaining the network, so it is a lucrative activity, and there is no shortage of those willing to mine. There are many websites and discussion forums associating such people. If you are interested in this form of earning money and are not afraid of hard work, see how others do it – you will certainly find help from more experienced Internet users. On our website you will also come across articles containing many valuable tips regarding this subject.
An online wallet – important information
In order to use a cryptocurrency, the user requires an interface (called a wallet) where he or she can interact with the network. The number of functions offered by the wallet depends on what form it adopts. It can be a Specially designed device or application. Theoretically, the wallet could be a piece of paper, but the vast majority of people use better tools. Software-based wallets are the most popular since they are the most convenient solution. Their hardware equivalents offer a higher level of security.
Virtual currency: how to use your wallet online?
Cryptocurrencies, as we have already mentioned, are completely virtual. You cannot withdraw them from an ATM. The similarity to payments made with a card is superficial. Cryptocurrencies are part of a blockchain and are accessible to internet users with encryption keys: both Public and private. For understandable reasons they are not stored in a single location, such as files.
If one were to search for analogies in known electronic mechanisms, one could compare cryptocurrencies to e-mail. In order to receive messages, an e-mail user must give his address to a possible sender who would like to contact him. The same process applies to cryptocurrencies – to make a purchase, you need to provide a public key (the same as the internet address of your wallet). To log in to your e-mail account you need a password. To enter the wallet containing cryptocurrency – a private key.
Each wallet consists of two parts: a public address, which can be shared without fear, and a private key, which should remain a Strict secret. The private key is used to encrypt transactions, the public key is used to decrypt them. The private key should therefore be kept very safe, as virtually everyone who knows it can access the wallet. The public key only allows you to identify the owner of a given address.
How were the cryptocurrencies created? The history of Bitcoin
The history of cryptocurrency begins in the first decade of the 21st century. Before Bitcoin (BTC for short), the world’s most famous cryptocurrency network, was created in 2008, there were previously unsuccessful attempts to create digital currencies. For example, we can mention B-Money or Bit Gold – the first cryptocurrencies that did not conquer the market despite reliable technical development. In August 2008, the bitcoin.org website appeared on the Internet, and a few months later a person (or organization) named Satoshi Nakamoto published an article entitled “Bitcoin: A Peer-to-peer Electronic Cash System” (available on the official Bitcoin website). The publication contained detailed information about the blockchain mechanism and showed Bitcoin as an open-source system. In other words, to put it simply, everyone could take an active part in its development. To this day, the identity of the anonymous author remains a mystery.
In 2009, the Bitcoin software was made available to a wider audience, and Satoshi Nakamoto paved the way for more “Miners“. At that time, few people were involved in the development of the project, but over time there were more people willing to work. Professional programmers saw the Bitcoin system as a breakthrough technology that could change a great deal in the financial world. New websites were created, where detailed knowledge about the mechanisms governing the Bitcoin currency was gathered (many of them still exist today). Detailed articles were published in the specialist press.
In 2010, developer Gavin Andresen bought 10,000 Bitcoins for $50 and then set up a Bitcoin Faucet website where he distributed Bitcoins to Internet users for free. It was a breakthrough year because a few months later another developer, Laszlo Hanyecza, bought two pizzas for 10 thousand Bitcoins, going down in history as the initiator of the first cryptic transaction. Following this event, an increasing number of people started to use Bitcoin. The media took up the topic and created a new advertising technology that fueled Bitcoin sales.
Not just Bitcoin
The growing popularity of the new payment system was accompanied by attempts to create alternative cryptocurrencies, e.g. Ethereum or Litecoin (some of them were accepted on the market, some of them brought too much loss to their creators). Today, we can choose from dozens of different currency systems, and each year an increasing number of them appears. On the Ripple website (a well-known currency exchange network) you can learn a lot about current trends and check the current value (rates) of Bitcoins – we encourage you to pay a visit there. If you are interested in the details of how the Bitcoin system works, check out our other articles.
On the one hand, cryptocurrencies have Many advantages, but they are far more vulnerable to hacker attacks. However, regardless of the Possible dangers associated with the use of Bitcoin and other digital currencies, attention should be paid to their potential.
Decentralization, lack of intermediation of any institution in concluding transactions, and universal access – these are important advantages that cannot be overestimated. Proof of the growing importance of digital money is the fact that it is possible to keep track of crypto rates through prestigious financial websites. Transactions concluded with the use of such systems as Bitcoin or Ethereum are as important as those made with a payment card or physical money. Therefore, there is no need to be concerned about any difficulties.
It is possible that in time, cryptocurrencies will become a legitimate means of payment, respected in all service and commercial outlets. Currently, Bitcoins can be used for payment in relatively few places. Websites such as ours are designed to change this state of affairs and help out beginners. Other important cryptographic questions will be answered in articles to follow.