If you’ve ever had a company or friend offer to pay you with Bitcoins or another type of digital money, you’ve encountered cryptocurrency, also called crypto-money or cryptoassets.
Cryptocurrency is a digital currency that is created through the use of encryption software. This approach is a solution to security and control issues that prevented a purely digital currency from being successfully developed in the past. If you hear someone talking about one of these currencies, it’s almost certainly in a cryptocurrency format. This type of digitally created and secured money is currently in a period of very cool experimentation, so let’s take a look at how it work, why it’s popular, and where cryptocurrency is heading in the future.
How does cryptocurrency work?
How does a currency exist in a totally digital format? What is it based on? While the process varies a little between different cryptocurrencies, they all follow the same general system.
First, cryptocurrency chooses a base unit and how much that particular unit is worth when compared to other currencies (often, the U.S. dollar is used as a baseline). Some cryptocurrencies are more imaginative than others at this point. They try to represent debt registries, contracts, or the act of currency exchange itself. It can get a little weird, but ultimately the unit in some way relates to the value of other currency, as is true of all currencies in the world.
Units of cryptocurrency are then created, typically when a transaction occurs. The units are carefully formed and preserved through algorithmic encryption, then linked together in vast chains of data, where the currency can be tracked and exchanged.
However, at this point, cryptocurrency is still too vulnerable and too easy to fake. The currency units need to be timestamped and processed to make them more concrete and harder to copy. A third party developer can do this, but most cryptocurrencies prefer to crowdsource the process to those with the right hardware and software to “mine” the currency.
Mining uses algorithms to go through each transaction, encrypt the cryptocurrency, and add it to a digital ledger, essentially verifying it and cementing its position online. This process may also be referred to as “consensus protocols” or “consensus platforms,” depending on the currency. This process is meant to make the currency impossible to duplicate, though whether it’s successful is up for some debate.
Some cryptocurrencies are highly centralized, with someone — usually the organization that created the process/software — making decisions about how much currency is created and how it is used. Other types are very decentralized, controlled only by how and where people are willing to use them.