A cryptocurrency (abbr. crypto) is a digital currency that relays on cryptographic proofs for confirmation of transactionsTransaction Exchange of value, property, or data between two parties.. Unlike fiat currency, i.e. the classic legal tender currency, cryptocurrencies are not issued by a central bank, as they use a decentralized system to record transactions and issue new units. Cryptocurrencies are the only type of currencies with the following three features: ensuring limited anonymity, independence from central authority and double spending attack protection. No other group of currencies, including fiat currencies, has this combination of features. According to Jan Lansky, a cryptocurrency is a system that satisfies six conditions:
- The system does not require a central authority, its state is maintained through distributed consensus.
- The system maintains an audit of the cryptocurrency units and their ownership.
- The system determines whether new cryptocurrency units can be created. If such units can be created, the system defines their origin and how to determine their owner.
- Ownership of a cryptocurrency can only be proven cryptographically.
- The system allows you to carry out transactions in which a change of ownership of cryptographic units occurs. Confirmation of the transactionTransaction Exchange of value, property, or data between two parties. can only be issued by an entity that can prove ownership of the cryptocurrencies involved in the transaction.
- If two different instructions for changing ownership of the same cryptographic units are given simultaneously, the system executes at most one of the two.
(Jan Lansky currently works at the Department of Computer Science and Mathematics, The University of Finance and Administration. Jan does research in Cryptocurrencies, Databases, and Software Engineering).
Cryptocurrency payments exist solely in the form of digital coins, and transactions are recorded on a distributed ledger implemented using blockchain technology. Blockchain technology was invented in 2008 by Satoshi Nakamoto, the creator of the first cryptocurrency, Bitcoin. Bitcoin aimed to be a viable alternative to fiat currency: that is a secure, decentralised, global currency that could be used as a medium of exchange. In the first year, the currency was worth $0. Today its value is above $40,000. From the creation of Bitcoin to today, the number of cryptocurrencies has increased dramatically. Today there are over 24,000 cryptocurrencies in the world, although many of these are no longer active. Right now CoinMarketCap lists 8943 different active cryptocurrencies but this is a number that is expected to change very quickly.
How do cryptocurrencies work?
Cryptocurrencies are decentralized digital currencies. Decentralization is achieved through peer-to-peer architecture. Peer-to-peer (P2PP2P P2P stands for Peer to Peer. A peer-to-peer network allows users to exchange data without intermediaries.) is a logical architecture model of a computer networkNetwork The set of computers connected to each other, called nodes, on which the blockchain of a specific cryptocurrency is based. in which the nodesNode Device connected to a blockchain, which makes up the network. are not hierarchized in the form of clients or servers, but in the form of equivalent or ‘equal’ nodes (peers), being able to act at the same time as client and server towards the other terminal nodes (hosts) of the network. Using this configuration, any nodeNode Device connected to a blockchain, which makes up the network. is able to initiate or complete a transaction. Peer-to-peer (P2P) computing or networking is therefore a distributed application architecture that divides tasks or workloads between peers.
Cryptocurrencies and transactions are stored on a decentralized ledger called a blockchain. A blockchain is a databaseDatabase A set of data stored in a structured way. that stores data in blocksBlock A set of encrypted transactions that, in sequence with other blocks, constitutes a blockchain. that are linked together and protected using cryptography. Each blockBlock A set of encrypted transactions that, in sequence with other blocks, constitutes a blockchain. typically contains a link to a previous block, a timestamp, and transaction data. A copy of the blockchain is stored on multiple nodes within a P2P network.
Cryptography is used for decentralized confirmation of transactions. New cryptocurrency units are usually (but not always) put into circulation as a reward for using computer computing power to solve complicated mathematical problems that are used by system participants to confirm new transactions between participants. This validation of transactions is called mining.
This type of transaction confirmation mechanism using complicated mathematical problems is called Proof of Work (PoW). However, Proof of Work is only one of many mechanisms used to confirm transactions. Other examples of mechanisms to confirm transactions are Proof of Stake (PoS), Delegation Proof of Stake (DPoS), Byzantine Fault Tolerance (BFT), etc. All these mechanisms are called consensus mechanisms.
Cryptocurrency wallets
Since cryptocurrencies are not physical objects but rather information stored in a distributed database (blockchain), how do people make transactions? How do people keep track of the cryptocurrencies they own? As mentioned above, transactions take place on the blockchain using cryptography. The type of cryptography used to make transactions is asymmetric. Asymmetric encryption uses a pair of keys: one public (known to everyone) and one private (known only to the owner). People store the cryptocurrencies they own, inside special cryptocurrency wallets. A cryptocurrency wallet is a means of storing the public and private keys needed to receive or spend cryptocurrency. With the private key it is possible to write to the public ledger, effectively spending the associated cryptocurrency. With the public key it is possible for others to send currency to the wallet.
Anonymity of cryptocurrencies
Most cryptocurrencies are not anonymous but are pseudonymous, as the cryptocurrency within a virtual wallet is not tied to people, but rather to one or more specific keys (or “addresses”). Thus, cryptocurrency owners are not identifiable, but all transactions are publicly available in the blockchain. Some currencies called “privacy coins”, such as Monero, aim to solve this problem by using transaction obfuscation techniques.
Regulation of cryptocurrencies
The rise in popularity of cryptocurrencies and their adoption by financial institutions has led some governments to consider whether regulation is needed to protect users. The Financial Action Task Force (FATF) has defined cryptocurrency-related services as “virtual assetAsset An economic resource with value that an individual or organization owns, controls, or expects future benefits from. Examples of assets: gold, stocks, cryptocurrencies, etc. service providers” (VASPs) and recommended that they be regulated under the Anti-Money Laundering Act (AML) and understand customer requirements ( KYC) of financial institutions.
Alternative cryptocurrencies
All cryptocurrencies created after Bitcoin (the first cryptocurrency ever created) are called alternative cryptocurrencies or, using an abbreviated term, altcoins (short for alternative coins). The second most important cryptocurrency in terms of market capitalization and best known overall is Ethereum. Ethereum is more exactly a decentralized platform that uses Ether as its cryptocurrency. Examples of alternative cryptocurrencies are Ethereum, Litecoin, Solana and Cardano.