A cryptocurrency is a digital asset designed to work as a medium of exchange that uses cryptography to secure its transactions, to control the creation of additional units, and to verify the transfer of assets. Cryptocurrencies are a form of digital or virtual currencies. Cryptocurrencies are different from Euros, British Pounds or U.S. Dollars. Cryptocurrencies only live online and or not backed or regulated by any government.
To be able to create a (digital) system that can be used to transfer value we normally need an account, an account balance and transactions. In this system it is important that after every transaction the account balance is updated and money can only be spent once. For this all conventional digital payment systems like internet banking and paypal use a central authority that processes and tracks transactions. Because a bank or a banks computer server is needed for storing and transferring value in this system we always have to depend on a third party.
In a decentral network (cryptocurrency) there is no central authority or third party. This means that every part of the network will have to administrate and verify all transactions by itself and will have to be able to verify if the transaction is legit and if the account balance is positive.
A payment system only works when all the parts of the network have the same information available to them. In the conventional payment system this is easy because there is a central authority that verifies this information. In a decentral payment system however this is not the case.
The first decentralized digital payment system was introduced by a person or a group of persons under the pseudo “Satoshi Nakamoto”. Yes, we are talking about Bitcoin here. In the on blockchain based Bitcoin network all the parts of the network have the same information available to them at all times. Therefore this information and transactions do not have to be verified by a central authority.
So let’s take a look at what cryptocurrency or cryptomoney is exactly.
Just like money on a bank account digital currencies are basically a number in a database that represents a certain value. For currencies like Euros or British Pounds, as well as Bitcoin, Litecoin, Zcash or Monero for instance, this means that the number in the database cannot be changed unless certain conditions are met.
Like “normal” currencies cryptocurrencies can be used to perform payments. A payment will have to be verified by multiple parts of the network. After this the transaction will have to be recorded in a ledger. This ledger is called a blockchain.
Cryptocurrencies generally have the following characteristics:
- Cryptocurrencies can be used by anybody, anytime. Because there is no third party or central authority involved anyone that has a digital wallet can store cryptocurrencies and perform payments. Banks and governments are not involved at therefore there is no so called third party risk. Cryptocurrency transactions usually work fast with a fraction of the costs involved in “normal” currency transactions.
- Payments are irreversible. After a transaction is verified the process cannot be reversed in any way.
- Funds and transactions are secured through cryptography. Funds and transactions are sent and recorded encrypted. The encryption is based on public key cryptography. The system is secure as long as you make sure your digital wallet is safe.
- Transactions through a decentralized payment system are anonymous. In a decentralized payment system transactions are not connected to your identity. What is visible will depend on the specific cryptocurrency. Bitcoin and Litecoin blockchains will show that there was a transaction, the value of the transaction and between which parties the transaction was done. Other cryptocurrencies like Monero will not show this information at all.
- Fast international payments. You can use cryptocurrencies to pay anyone anywhere in the world within seconds or minutes.