A cryptocurrency is a medium of exchange, that is designed to work like a currency. Usually, cryptocurrencies use features found in strong cryptography, such as digital signatures to secure financial transactions, control the creation of additional units, and verify the transfer of assets. The first of them were created to be independent of a government-issued currency.
Cryptocurrencies use decentralized control as opposed to centralized electronic money and central banking systems. The decentralized control of each cryptocurrency works through distributed ledger technology, typically a blockchain , that serves as a public financial transaction database.Bitcoin, first released as open-source software in 2009, is generally considered the first decentralized cryptocurrency. Since then, over 4,000 altcoin (alternative coin) variants of bitcoin have been created.
The value problem[change | change source]
In many cases, cryptocurrencies cannot be converted to real currencies; it is only possible to convert them to other cryptocurrencies, or to use them to buy things. Some cryptocurrencies can be converted to real currrencies: They usually have a high volatility, and using them carries a high risk. They are also a target for so-called Pump-and-Dump-Attacks. They act like a big distributed economic system: As they are not issued or controlled by central banks, their value is difficult to influence: For this reason, they cannot really take the place of a stable currency.
Due to cryptocurrency’s high volatility, the creation of a stable exchange rate is near impossible. Another problem is the inequality of distribution: Many cryptocurrencires are held by only few people. As an example: about 1.000 people hold half of the total amount of bitcoins in the world. This means that if any of these persons starts using their cryptocurrency, this has an effect on the exchange rate. It also means that these people have a great influence on the value of the currency, and are able to change its value easily. The cryptocurrency itself is only documentation of ownership. Anything like exchange rate is determined outside of the cryptocurrency. Exchange rates are issued by brokers and traders; their indication is no guarantee that the currency is traded at the value proposed. In itself, the unit of cryptocurrency has no value.
In contrast to cyptocurrencies, real currencies are issued and controlled by central banks. Certain econnomic phenomena such as inflation or deflation may change the value (and exchange rate) of a currency. The people who own units of the currency have no direct influence on its value.
Formal definition[change | change source]
According to Jan Lansky, a cryptocurrency is a system that meets six conditions:
- The system does not require a central authority. [sic].
- The system keeps an overview of ownership and amount of cryptocurrency units.
- The system defines if new cryptocurrency units can be created. If new cryptocurrency units can be created, the system defines the method to create new units, and the method to determine the ownership of these new units.
- Ownership of cryptocurrency units can be proved exclusively cryptographically.
- The owner of a unit of cryptocurrency can transfer this unit. For this transfer to be successful, the current owner must prove the ownership.
- If two different instructions for changing the ownership of the same cryptographic units are entered at the same time, the system performs at most one of them.
Blockchain[change | change source]
Main article: Blockchain
The validity of each cryptocurrency's coins is provided by a blockchain. A blockchain uses cryptograpy in order to create a list of blocks that are able to point to one another.Each block typically contains a hash pointer as a link to a previous block, a timestamp and transaction data. Blockchains do not allow data to be manipulated after it has been set. A blockchain is managed by a peer-to-peer network and follows the protocol in validating new blocks. Once the data has been recorded, nothing can change it unless the entire sequence changes.
Blockchains are secure by design. This security allows for a decentralized consensus.
References[change | change source]
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