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Simply put, a cryptocurrency is a form of digital currency that enables individuals to transmit value in a digital setting. In a broader sense, a cryptocurrency is a digital currency in which transactions are verified and records maintained by a decentralized system, rather than by a centralized authority.
The term “cryptocurrency” is a portmanteau of cryptography and currency. This is simply because cryptocurrency makes extensive use of cryptographic techniques to secure transactions between users within a decentralized system.
While cryptocurrencies look similar to other digital payment methods you use daily - on the surface - under the hood, they are vastly different.
Cryptocurrency is unique for many reasons. Its primary function, though, is to serve as an electronic cash system that isn’t owned by anyone party.
A good cryptocurrency will be decentralized. There isn’t a central bank or subset of users that can change the rules without reaching a consensus. The network participants run software that connects them to other participants so that they can share information between themselves.
Centralized vs. Decentralized Networks.
The decentralization of cryptocurrency networks makes them highly resistant to shutdown or censorship. In contrast, to cripple a centralized network, you just need to disrupt the main server. If a bank had its database wiped and there were no backups, it would be very difficult to determine users’ balances.
In cryptocurrency, nodes keep a copy of the database. Everyone effectively acts as their own server. Individual nodes can go offline, but their peers will still be able to get information off of other nodes.
Cryptocurrencies are therefore functional 24 hours a day, 365 days a year. They allow for the transfer of value anywhere around the globe without the intervention of intermediaries. This is why we often refer to them as permissionless: anyone with an Internet connection can transmit funds.
Public-key cryptography underpins cryptocurrency networks. It’s what users rely on to send and receive funds.
In a public-key cryptography scheme, you have a public key and a private key. A private key is essentially a massive number that would be impossible for anyone to guess. It’s often hard to wrap your head around just how big this number is.
As the name might suggest, you need to keep your private key secret. But from this key, you can generate a public one. The public one can safely be handed out to anyone. It’s feasibly impossible for them to reverse-engineer the public key to get your private one.
You can also create digital signatures by signing data with your private key. It’s analogous to signing a document in the real world. The main difference is that anyone can say with certainty whether a signature is valid by comparing it with the matching public key. This way, the user doesn’t need to reveal their private key, but can still prove their ownership of it.
In cryptocurrencies, you can only spend your funds if you’ve got the corresponding private key. When you make a transaction, you’re announcing to the network that you want to move your currency. This is announced in a message (i.e., transaction), which is signed and added to the cryptocurrency’s database (the blockchain). As mentioned, you need your private key to create the digital signature. And since anyone can see the database, they can check that your transaction is valid by checking the signature.
The first cryptocurrency was Bitcoin released in 2009. It was created by a person or group of people using the pseudonym Satoshi Nakamoto. Their true identity remains unknown to this day.
From Bitcoin spawned a huge number of subsequent cryptocurrencies – these are called altcoins. Some of these coins aim to compete with Bitcoin while others seek to integrate features not available in Bitcoin. Nowadays, many blockchains – like Ethereum – do not just allow users to send and receive funds, but to run decentralized applications using smart contracts.
Because both cryptocurrencies and tokens are traded on exchanges and can be withdrawn to blockchain addresses, they are thought to be one and the same. But they are not.
Cryptocurrencies are exclusively meant to serve as money; whether as a medium of exchange, store of value, or both. Each unit is fungible, meaning that one coin is worth as much as another.
On the other hand, while tokens can be used like cryptocurrencies, but they’re more flexible. You can mint millions of identical tokens or a select few with unique properties. Tokens can be anything from digital receipts representing a stake in a company to loyalty points.
A crypto wallet is something that holds your private keys. It can be a purpose-built device (a hardware wallet), an application on your PC or smartphone (software wallet), or even a piece of paper (paper wallet).
Users rely on crypto wallets to interact with a cryptocurrency network. Different types of wallets offer different kinds of functionality. For example, a paper wallet cannot sign transactions or display current prices in fiat currency like a software wallet would do.
Furthermore, software wallets are considered more convenient for day-to-day cryptocurrency transactions. Hardware wallets are better for security because they keep private keys away from prying eyes.