Cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend.
How Does It Work?
Cryptocurrencies work using a technology called blockchain. Blockchain is a decentralized technology spread across many computers that manages and records transactions. Part of the appeal of this technology is its security.
What is the purpose of Cryptocurrency?
The main point of cryptocurrency is to fix the problems of traditional currencies by putting the power and responsibility in the currency holders’ hands. All of the cryptocurrencies adhere to the 5 properties and 3 functions of money. They each also attempt to solve one or more real-world problems.
Why Use Cryptocurrency?
1. Cryptocurrency Is Owned By Everyone
Cryptocurrency functions similarly to any traditional, national currency with a few fundamental differences.
Current “fiat currency” is created and regulated by a governmental body, all of which now represent debt. Anyone that owns a country’s currency holds an “IOU” issued by that respective country.
Cryptocurrency does not stand for debt. It strictly represents itself, and its value is determined by what someone is willing to trade for it.
The fact that cryptocurrency is decentralized plays an essential role in how its currency value is determined.
Nobody owns or regulates a cryptocurrency. Its value is not subject to a country’s political whims or a central bank’s monetary policy.
Note: Some may view cryptocurrency’s lack of centralization as a method to avoid taxes. However, like stocks and bonds, cryptocurrency is considered an asset. In the United States, it’s subject to capital gains taxes upon a sale or exchange.
Currencies operating off a centralized ledger (meaning a single entity managing the transaction records like a national central bank) are exposed to human manipulation and corruption.
By being decentralized, cryptocurrency operates on a “distributed ledger” or a shared transaction list. This type of ledger is the heart of cryptocurrency and leads us to our next reason why it’s worth the attention.
2. Cryptocurrency Is Almost Impossible To Forge
Cryptocurrency operates on a blockchain, which is the distributed ledger we talked about above. Understanding blockchain technology helps you understand why this is the key to the power of the digital currency.
The “block” is composed of chunks of encrypted data. The “chain” is the public database in which the blocks are stored and sequentially related to each other.
Every block in the blockchain has a specific code that distinguishes itself from all other blocks in existence. This unique code is called a hash. Blocks of information being added to a blockchain are added chronologically. A new block is added directly after the last block created, which also has its own unique hash.
The ledger or database of blocks in the chain is simultaneously distributed worldwide, spread among thousands, or in Ethereum and Bitcoin’s case, millions of computers.
Suppose someone wanted to forge a single block of data on the chain. In that case, they need to manipulate all the blocks from a point in history forward AND update all the computers holding copies of the blockchain ledger.
This is theoretically possible, but the amount of power and money needed to do it successfully makes an attempt virtually impossible.
3. Cryptocurrency Transactions Are (Mostly) Confidential
With traditional currencies issued by governments, you can privately transact or pay for something in person using physical cash.
Paper, metal, cloth, and plastic currencies make up a tiny fraction of the total amount of most fiat money in circulation. Large withdrawals of physical cash are quickly flagged and reviewed by a central authority like governments and financial system regulators.
Note: Monitoring large cash transactions is a good thing. It upholds the legitimacy of the currency and deters criminal enterprises like money laundering.
Cryptocurrency is different. It depends on well-designed math to track the exchange between two people or companies. This occurs mostly anonymously. While the ledger or list of transactions is publicly viewable worldwide, the parties exchanging cryptocurrency are more private.
By definition, cryptocurrencies are held electronically in digital wallets. The owner is the holder of the private key to the wallet. The currency is exchanged digitally from mostly anonymous wallets owned by the users.
Another Note: While cryptocurrencies are intended to be anonymous, advanced forensics can uncover wallet holders’ identities. Some crypto projects like Monero are designed to be resistant to identity discovery.
4. Cryptocurrency Security Grows Through Time & Value
Earlier, we talked about how a hack or manipulation would require an enormous amount of power and money to the point that it would essentially become a worthless endeavor. To elaborate, a hacker would need to control over fifty percent of the computers making up the “consensus” network.
The consensus network is simply all the computers that receive copies of the blockchain or distributed ledger. For more established cryptos like Bitcoin or Ethereum, the cryptocurrency networks are so big that a hack undertaking is mostly impossible.
In the early days of cryptocurrency, it was easier to gain the majority of control as the cryptocurrency network itself was much smaller.
This is an important fact to remember for investors or users of newer cryptocurrencies whose networks haven’t grown to a relatively significant size. The smaller the network, the more vulnerable it is to hacking.