What Are Cryptocurrencies?
This is not an easy question to answer in simple terms. We’ll do our best, though. Let’s start with a formal definition, courtesy of Merriam-Webster.
Any form of currency that only exists digitally, that usually has no central issuing or regulating authority but instead uses a decentralized system to record transactions and manage the issuance of new units, and that relies on cryptography to prevent counterfeiting and fraudulent transactions.
Source – www.merriam-webster.com/dictionary/cryptocurrency
So, now you know what cryptocurrencies are. Okay, maybe not. As accurate as this definition is, it doesn’t exactly tell you EVERYTHING you need to know. We’ll try to explain more clearly by breaking things down.
There are three key points to take away from the above definition. These are as follows:
- Cryptocurrencies only exist digitally (or virtually)
- They are decentralized and not issued or regulated by a single authority or organization
- They use cryptography to secure transactions.
Let’s look at each of these points in a little more detail.
Cryptocurrencies Are Digital Currency
A digital or virtual currency is one that does not exist in any tangible form. There are no physical bank notes or coins. The currency exists solely in digital form (essentially a string of numbers) and is stored on computers.
This doesn’t mean that a digital currency isn’t “real.” You can’t actually touch it or hold it, but it’s still there. A good way to think of it is like money stored in a PayPal account.
There’s nothing physically in a PayPal account per se – it’s just a RECORD of how much money is associated with the account.
Although this analogy may help you to understand the basic concept of cryptos, it’s important to recognize a key difference. Money in a PayPal account is always backed up by some form of traditional currency, so it has a real and inherent value. Cryptocurrencies are not backed up by anything, though.
Their value is based solely on what the open market thinks they are worth and what people are prepared to pay for them.
Note that cryptocurrencies can be used as a “medium for exchange.” This means that they can be used for buying goods and services, providing the seller is prepared to accept a cryptocurrency as a means of payment.
As such, they can legitimately be considered a currency in their own right – albeit a different type of currency than the ones we are used to.
Cryptocurrencies Are Decentralized
Most of us are familiar with traditional currencies such the United States Dollar, the British Pound, and the Euro. These are known as “fiat currencies,” and they are backed by a government and considered to be legal tender. Each currency is managed either directly by the government or by a government-appointed authority.
The relevant authority is responsible for controlling the supply of currency and can affect its value by creating more of it and/or adjusting the interest rates associated with the currency.
The Bank of England, for example, can choose when to print more British Pounds. This typically reduces the value of the currency, as there is more of it in supply.
Cryptocurrencies are classified as decentralized because they have no such authority associated with them.
No single individual or organization has control of them, and their supply is determined by the rate at which they are created. They are all created in slightly different ways, but the most of them rely on a process known as “mining.” We’ll explain more about that a little later.
Cryptocurrencies Use Cryptography
Cryptography is a form of digital encryption. It’s used to secure cryptocurrencies and also to verify and record associated transactions. This is where things start to get a little technical, but you don’t actually HAVE to understand cryptography in order to buy or use cryptos.
If you’re interested in learning more, however, we explain everything in more detail in the following page.