What is Cryptocurrency and Blockchain?

This month, we’re discussing two terms that go hand in hand: cryptocurrency and blockchain.

Cryptocurrency

A cryptocurrency is a digital currency that is secured and maintained by a decentralized system using cryptography rather than by a centralized authority like a central bank. Cryptocurrencies allow for secure online payments that are made by means of virtual tokens, and the innate nature of a cryptocurrency being secured by cryptography – the practice of encoding and decoding data – means a cryptocurrency is nearly impossible to counterfeit or double spend. Cryptocurrencies are software, as they are created by algorithms that rely on cryptography, and every function, including how transactions are recorded and how data is stored, is dictated by code. The main database for these currencies is blockchain, and blockchain-based cryptocurrencies rely on cryptography to maintain security and reliability, hence the “crypto” in its name. All transactions for a specific cryptocurrency relate back to unique codes that secure the currency’s network. Because of their decentralized systems, cryptocurrencies are essentially immune from government interference.

The first blockchain-based cryptocurrency was Bitcoin, which was launched in 2009 by a group or individual known as Satoshi Nakamoto, and the identity of the creator(s) still remains unknown. Bitcoin is the most widely recognized, valuable, and popular cryptocurrency, and there are now thousands of alternative cryptocurrencies with various specifications and purposes. Most cryptocurrencies are clones or pivots of Bitcoin, built upon the same basic framework as the original crypto, but each system can differ from its peers, as all cryptocurrencies are created to be self-supporting. Several of the main Bitcoin peers include Litecoin, Ethereum, Cardano, Stellar, and USD Coin, to name a few. All cryptocurrencies aside from Bitcoin are known as “altcoins” or “alternative coins,” and stablecoins are a subset of altcoins whose value is pegged to another asset to reduce volatility. USD Coin is an example of a stablecoin, as it is pegged to the U.S. dollar.

The main point of cryptocurrencies is to offer an alternative to traditional currencies by putting the power and responsibility in the currency holders’ hands. There is no central authority, government, or corporation that has access to a user’s funds or personal information. Any person can purchase cryptocurrencies through exchanges that offer the buying and selling of cryptocurrencies. Some of the most widely used platforms for buying and selling crypto include eToro, Binance, Coinbase, Kraken, Gemini, and BlockFi.  

Blockchain

Essential to the appeal and functionality of cryptocurrencies is blockchain technology, the record-keeping system behind Bitcoin and most cryptocurrencies. Blockchain seems complicated, but its core concept is actually fairly simple. A blockchain is a type of database, meaning it is a collection of information that is stored electronically and can be easily accessed by many different users at once. Large databases accomplish this by housing data on servers that comprise powerful computers. A blockchain collects information in groups, known as blocks, that hold sets of information. These blocks have specific storage capacities and abilities, and when these blocks are filled, they are chained onto the previously filled block and so on, forming a chain of data referred to as a blockchain. This process means the blockchain system innately makes an irreversible timeline of data – when a block is filled, it permanently becomes a part of that blockchain timeline in chronological order.

A variety of information can be stored on a blockchain, and with cryptocurrencies, the most common use is for the blockchain to be used as a ledger for transactions. In cryptocurrencies like Bitcoin, blockchain technology is used in a decentralized way, meaning that no individual or group has control in favor of all users collectively retaining control. Decentralized blockchains used in cryptocurrencies are indisputable, meaning the data entered is irreversible. This provides an innately secure ledger, as every new block generated in the blockchain must be verified by a node, typically a computer or large server that serves as the infrastructure of the blockchain, and this makes it essentially impossible to forge transaction histories.

Bringing the Two Together  

The primary goal of a blockchain is to allow digital information to be recorded and distributed but not edited, which makes the blockchain system a perfect fit for cryptocurrency needs. Blockchain technology was created thirty years ago with the intention of creating a system in which timestamps could not be tampered with, and Bitcoin was the first real-world adoption of blockchain, back in 2009. Bitcoin’s creator identified Bitcoin as, “a new electronic cash system that is fully peer-to-peer, with no trusted third party,” which made the cryptocurrency align seamlessly with blockchain technology. Although cryptocurrencies primarily use blockchain to transparently record transactions, blockchain can be used in many other instances to record data and is considered to have future potential for processes like online voting, product inventories, and estate planning, to name a few. Additionally, major financial institutions view the blockchain technology behind cryptocurrencies as having the potential to lower transaction costs by streamlining payments. Currently, about 15,000 companies worldwide accept Bitcoin.

Final Points

Because market prices for cryptocurrencies are based on supply and demand, extreme surges in either direction of value are common for cryptocurrencies. If you make the decision to invest in cryptocurrencies, be aware of the risks and volatility innate to these investments. Although cryptocurrency blockchains are highly secure, there is the possibility of hacking when it comes to crypto wallets and exchanges of crypto. However, many see the potential advantages of cryptocurrencies to outweigh the risks, with people in favor of having a currency operated sans the influence of central banks and governments. Today, the aggregate value of all cryptocurrencies in existence is around $1.5 trillion, showing that cryptocurrencies are on the rise and something we should all familiarize ourselves with.

Monthly Financial Jargon: The world of finance and investments is notorious for its extensive use of jargon. With a goal to enhance financial literacy and make the world of money more transparent, we have our “monthly jargon” articles that focus on debunking financial terms that are often used sans explanation.

Questions and/or interested in how this applies to your financial life?

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