What is Cryptocurrency?

May 15, 2020

When the trading price of two cryptocurrencies, Bitcoin and Ethereum, rocketed to the stratosphere in 2017, the term cryptocurrency rose to global popularity. It soon became part of the world’s vocabulary when The Merriam-Webster Dictionary approved cryptocurrency as an official word in 2018.

Cryptocurrency is, of course, a combination of two words: cryptography and currency. The word currency, first used in 1624, represents a medium of exchange and money in circulation. The field of cryptography is the encoding and decoding of information across communication systems and computer networks.

Together, the two words create the noun cryptocurrency, which the Random House Unabridged Dictionary defines as a “digital currency or decentralized system of exchange that uses advanced cryptography for security.”

Although cryptocurrency may aspire to compete with traditional currency for our wallet share, it is not money or a substitute for it. Traditional currency and cryptocurrency are created, managed, and regulated in completely different ways. Let’s find out how the two compare.

How Are Traditional Currencies Managed?

Currencies like the U.S. dollar (USD) and the Japanese yen (JPY) are both traditional and officially government backed. They’re commonly referred to as fiat.

Fiat means an authoritative determination or order. It’s an appropriate name because countries rely on a government’s central banking authority, like the U.S. Federal Reserve or The Bank of Japan, to operate and manage their official currencies. This operating structure is commonly known as centralized finance.

In essence, central banks, like the U.S. Federal Reserve, act as a trusted intermediary and broker. They oversee currency printing, interest rates and distribution. They manage and manipulate supply and demand and work with member banks to approve and verify currency transactions.

How Are Cryptocurrencies Managed?

Cryptocurrencies, like Bitcoin and Ethereum, are digital assets often with no physical form. They are currently not printed or minted by government entities or central banks – instead, most are digitally created (mined) and managed by a network of computers.

In this decentralized model, Bitcoin and Ethereum are operated by peer-to-peer computing networks and powered by the blockchain, a new kind of distributed database. The blockchain enables all peers, sometimes called network participants, to approve and verify crypto coin transactions independently, without the need for a trusted intermediary. With popular cryptocurrencies, like Bitcoin and Ethereum, network participants can number in the thousands.

Most databases that maintain financial records are managed by a single financial institution. With blockchain, a ledger is shared and updated by all computers that host the specific blockchain. If any one computer holding records is hacked, the remaining computers and network participants can continue without it.

Several cryptocurrencies run on the blockchain and are maintained by network participants. Most blockchains use advanced cryptography, to provide cryptocurrency’s privacy and security.

For example, one cryptographic tool called a secure hashing algorithm computes unique codes, called hashes, for each transaction. Because all transactions on a blockchain are grouped into blocks, encoded as hashes, and linked together with sophisticated math, it’s very difficult to go back and alter any records.

Some cryptocurrencies aspire to act as a form of money and seek to offer certain advantages in privacy, security, and utility over traditional currencies. It’s important, however, to balance these benefits with the fact that a cryptocurrency’s value is affected by market sentiment and fluctuating rates of exchange for fiat currency.

Cryptocurrency offers an alternative to traditional financial models, providing new ways of creating and managing currency, and fresh opportunities for traders and investors.

Three Takeaways

  • Cryptocurrency is a digital or virtual asset. Many cryptocurrencies are decentralized and aspire to be a form of money and medium of exchange.
  • Unlike fiat currencies, most cryptocurrencies operate without government oversight or intervention.
  • Most cryptocurrencies are managed by a large group of network participants – and are secured with advanced cryptography.

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