What are Cryptocurrencies?

Cryptocurrency is quickly becoming a household term, but what are they and why are they being discussed with growing frequency? To grasp the concept, we can begin by examining the word itself.

Crypto refers to cryptography, a system of encoding information to secure the contents from outside tampering. Techniques have been implemented throughout history, dating back to Ancient Egypt and Greece. A popular example is from WWI, where troop orders were encrypted in what became known as trench codes and required field codebooks to decipher. The US Army employed Native American “code talkers” as seen in the movie Windtalkers. The methods used in the early 20th century were basic replacement means (A = 1, B = 2, etc.) with some mathematical formulas for securing more sensitive information.

cryptography flow chart

Today, we use digital algorithms and complex sequences to encrypt everything from a simple email to highly classified state secrets. Cryptocurrencies typically use a secured hash algorithm (SHA) which converts data into a 32 or 64 character “hash” – think of this an ID number. Each hash is created based on the characters in the data set, and even the smallest change in characters will create a different hash. This ensures that information contained within a hash will remain unaltered.

Public-key encryption systems, developed in the 1970s, are now used by blockchains to sign and verify transfers of data. Public-keys are made available to anyone and serve as a receiving address. Private-keys authorize transactions by acting as a signature, much like signing a check, and must be kept secret. The combination of SHA and public-key systems allows blockchains to hold, secure and transfer data across wide networks, without requiring trust in the network users. This opens a market opportunity for businesses and individuals to create and operate a blockchain, utilizing the processing power of computers spread across the globe.

The electricity and computational work needed to run a cryptographically secured network require compensation, which gives each block a particular valuation metric. This value can be transferred like a currency.

 

Currency is defined as any means of exchanging goods and services. Coins, metal disks, shells, rocks, food, animals and other commodities have been used for exchange throughout history. Even the integrity of someone’s word can be considered valuable. Here are the commonly accepted rules for calling something a currency:

  1. Acceptability – people have to want it
  2. Mobility – must be easy to carry
  3. Durability – hard to destroy
  4. Homogeneity – made of the same commodity (i.e. silver dollars vs. silver rounds)
  5. Divisibility – denominations of larger and smaller amounts
  6. Malleability – can take many forms; easily minted
  7. Stability – holds intrinsic value
  8. Discernible – recognizable and unique

Today, governments control currencies within their borders. For example, in America the legal tender is USD. These notes were formerly backed by precious metals, such as gold and silver, but this practice was abandoned decades ago. Fiat (which means “by decree”) currencies are based on faith that the issuing governments economy is stable. Given the level of corruption and collusion surrounding governments across the globe, trustworthiness is lacking in international economies. The blockchain solves this problem with establishing a network that does not require trust, making the transfer of data a viable monetary alternative.

 

Cryptocurrencies are encrypted digital assets used (a)to facilitate the transfer of goods and services, or (b)as a means to store value. How do they do this?

The blockchain technology that cryptocurrencies are built upon uses a computational method that writes and rewrites a digital ledger where each transaction is stored immutably (unable to be changed). Ledger data is then converted to a hash and encrypted. Hashes are compiled into blocks of data that can be verified by the network. The activity of each block is public, but the contents can only be accessed using the digital keys. This technology is in developmental infancy, a relatively small number of companies have introduced platforms to utilize and expand the functionality of digital assets.

The methods used to authenticate existing blocks and create new ones differ from chain to chain, and companies offer different rewarding mechanisms to encourage network participation . Some give bonuses to users who hold a certain amount of coins, Proof-of-Stake (PoS). Others base payout on how much processing power each user contributes, Proof-of-Work (PoW). Proofs and other network-consensus algorithms ensure that no block is duplicated in the chain. This prevents “double-spending,” an issue that halted the development of digital currencies in the 90s. It can also set limits on how many blocks can be created, thereby limiting the number of coins available. These features, double-spending prevention and quantity limits, make cryptocurrencies more appealing than fiat money. In addition, the blockchain provides a new resource to build secure technology upon.

In short, cryptocurrencies are revolutionizing how assets and data are transferred, all the while changing the long-held perception of money and value.

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