What are cryptocurrencies?
Cryptocurrencies are the digital media of exchange which use cryptography and shared transaction ledgers to create a secure, anonymous, traceable and potentially stable monetary system.
Cryptocurrencies take their name from their use of cryptography. Cryptography is the study of the methods of encrypting information, primarily with the intention of sending a message securely and privately but also for tasks such as data security and authentication. Crypto, the prefix in both words, comes from the Greek word kruptos, which means “secret.” Cryptocurrencies incorporate many of the technologies and theories developed by cryptographers in order to create a digital money exchange system that is resistant to both censorship and fraud.
In the two decades prior to 2008, there had been several attempts at creating a decentralized currency that would rely on cryptographic protocols and distributed networks. It is only with the launching of Bitcoin, however, that the idea has really taken root and started to attract multiple followers all over the globe.
Bitcoin remains the most popular cryptocurrency, but there are now virtually thousands of cryptocurrencies with various levels of popularity, value and originality. Cryptocurrencies other than Bitcoin are often referred to as “altcoins.” While there are many altcoins that are simple clones on the Bitcoin system, the most successful ones tend to have a unique hook or advantage that Bitcoin either can’t or chooses not to provide. The best-known examples of popular altcoins include Ripple, Litecoin and Dogecoin.
How cryptocurrencies work
Cryptocurrencies are backed by math rather than the word of a government or financial institution. While they, like all currencies, still depend on their perceived value, their scarcity is based on math and cannot be adjusted by any one group or person. They are neither tied to the availability of physical goods, such as gold, nor can they be artificially created by governments or financial institutions like dollars can.
Cryptocurrencies use a distributed network to allow for a p2p (peer-to-peer) transaction system without the need for third parties. In order to keep this secure, cryptocurrencies utilize mathematical algorithms and a public ledger.
In order to ensure every transaction is legitimate, complex mathematical equations are used to link each account with the amount of virtual currency the account holder would like to spend. Users, commonly referred to as miners, dedicate their computing resources to solving these equations and are generally rewarded with a small amount of cryptocurrency.
Future of cryptocurrencies
Digital currencies have been notoriously unstable because their market size is still relatively small. As the market cap for cryptocurrencies grows, so will their stability. Once that happens, they have the potential to be more stable than fiat currencies.
Cryptocurrencies are designed to be inherently rare, and their inflation grows at a slow, controlled rate. This potentially gives them more stability than currencies where governments, central banks and financial institutions can simply “add a few zeros” to the end of their bank account as needed.
Cryptocurrencies have the potential to change the financial world and in many ways already have. Bitcoin was the first, remains the largest and has the best chance at achieving mainstream adoption, but there are plenty others with innovative ideas that should not be ignored.