Cryptocurrencies: What They Are and How They Work

Written by LeeAnn Reynolds on October 3, 2017
Cryptocurrencies

Cryptocurrencies

Even if you're not involved in the finance world, chances are you've heard of cryptocurrencies. There are several types of cryptocurrencies, but the most common ones are Ethereum, Litecoin, Dash, and, of course, Bitcoin.

But what, exactly, is Bitcoin? Is it a coin that you bite to test its authenticity, like you see cashiers do in cartoons? (Of course not, but if you're interested in why biting a coin is a thing, you can check out this CNN article.) Continue reading on RateZip if you'd like to learn more about what cryptocurrencies are and how they work.

Understanding Cryptocurrencies

For many people, cryptocurrencies exist and operate in the same, slightly magical way that the internet does. How does it work? Where is it "located?" If you're not sure, it's difficult to even begin to imagine.

currency versus cryptocurrency

To begin to understand a cryptocurrency, first take a look at how traditional currencies work. For the United States, the U.S. Treasury decides when to print money. The value of the U.S. dollar comes from people's faith in it. By itself, a dollar bill is just a bit of paper. But because society believes it has value, a dollar can be traded for a cup of coffee or a fast food meal. So the United States government controls the creation of dollar bills and backs their value, which people have faith in.

Cryptocurrencies, by contrast, are not influenced or controlled by any specific institution or government. Their value still comes from people's faith in it, but instead of an institution creating the cryptocurrency, it's created when a transaction is verified.

The Process

You may be wondering, how exactly is cryptocurrency different than, say, online banking? Through online banking, you could transfer money from one account to another account, all without ever actually seeing the cash money. However, the numbers on your computer screen still represent cash money, which you could withdraw from a bank.

coins

Cryptocurrency, by comparison, only exists in its own network.  Everyone who is a part of that network has a balance, and as long as the cryptocurrency is perceived as having value, it can be transferred to someone else in exchange for goods, services, or other currencies. When someone requests a transaction, other computers in the network verify it. The verified transaction is then processed, which causes one person's cryptocurrency balance to go down (the payer) and another person's balance to go up (the receiver). Once the transaction has been verified, it is added to a public ledger.

Cryptocurrency Mining

If you've researched cryptocurrency at all, you may have heard of mining. Mining is how cryptocurrency is created, and it goes back to the verified transactions mentioned in the last section.

Since there's no one bank or institution that controls cryptocurrency, the records of transactions are public. This means that everyone can have a ledger that contains all the cryptocurrency transactions ever processed. However, in order to prevent someone from making fraudulent transactions or from completely controlling the ledger, "miners" confirm the transactions being made. This is done by computers that solve complex mathematical puzzles. Once a computer verifies a transaction, the transaction is added to the ledger, and cryptocurrency is added to the balance of the person that owns the computer.

spending cryptocurrency

Spending Cryptocurrency

Since cryptocurrency only exists in its own network, you may be wondering how you can spend it. More and more retailers are accepting cryptocurrency as a form of payment. You can manually enter a bitcoin address in order to perform a transaction, or you may be able to scan a code to automatically input the address. Then you just need to approve the transaction. Cryptocurrency can be used to order food, buy products, even for donations! And you can expect the market for cryptocurrency to continue to expand.

Features

Cryptocurrency differs from traditional currency in more ways than how its created. For one thing, despite the ledgers being available to everyone, neither your name nor your address are connected to your cryptocurrency account. There are no "gatekeepers" associated with cryptocurrency; anyone with access to the proper tools can have a balance. Cryptocurrency is a world-wide currency, but transactions take only seconds to complete. Cryptocurrency is also exceptionally secure. In fact, the term "cryptocurrency" comes from the word "cryptography," which means "the science or study of the techniques of secret writing, especially code and cipher systems." However, transactions are also irreversible, so if you make a mistake or get scammed, there's no way to get your money back.

Types of Cryptocurrencies

Obviously, Bitcoin is the most famous type of cryptocurrency. However, it's not the only one! Here's a quick summary of some of the various types of cryptocurrency.

Bitcoin

Bitcoin

About: Bitcoin was the first successful cryptocurrency. It was developed as a peer-to-peer electronic cash system, and aimed to eliminate the need for a trusted third party to verify transactions.  Read the original white paper here. Because of a code that puts a limit on the supply of Bitcoins, people can calculate approximately how many will be available at a given time. However, based on the code, by the year 2140, no more Bitcoins will be produced.

Ethereum

About: While Bitcoin only validates transactions, Ethereum can be used to validate transactions, contracts, and programs. So if Bitcoin is like digital gold, Ethereum is like digital gas.

Litecoin

About: Litecoin was the 2nd successful cryptocurrency invented. It is larger than Bitcoin and approximately four times as fast. It is a more efficient form of cryptocurrency for small transactions.

Dash

About: Dash has changed names several times since its creation, and was formally known as XCoin, and later as Darkcoin. Dash is also faster than Bitcoin, and was designed to be more private.

There are hundreds of more types of cryptocurrencies out there, and no doubt more will continue to be invented.

Buying Cryptocurrency

Buying Cryptocurrency

Mining cryptocurrency isn't the only way to obtain it. You can also purchase and sell it using various platforms. For example, Coinbase allows you to buy and sell Bitcoin, Ethereum, and Litecoin. You can also use cryptocurrency to get other types of cryptocurrency. Changelly currently allows exchanges between approximately 73 different types of cryptocurrency. If you want to invest in cryptocurrency but don't want to start mining it, this is one way how.

Cryptocurrency is sometimes hard to fully understand, just like the internet was when it was first created. As a new technology, cryptocurrencies will change the way we experience money, just like the internet transformed how we experience information.


Oct3

Cryptocurrencies

Even if you're not involved in the finance world, chances are you've heard of cryptocurrencies. There are several types of cryptocurrencies, but the most common ones are Ethereum, Litecoin, Dash, and, of course, Bitcoin.

But what, exactly, is Bitcoin? Is it a coin that you bite to test its authenticity, like you see cashiers do in cartoons? (Of course not, but if you're interested in why biting a coin is a thing, you can check out this CNN article.) Continue reading on RateZip if you'd like to learn more about what cryptocurrencies are and how they work.

Understanding Cryptocurrencies

For many people, cryptocurrencies exist and operate in the same, slightly magical way that the internet does. How does it work? Where is it "located?" If you're not sure, it's difficult to even begin to imagine.

currency versus cryptocurrency

To begin to understand a cryptocurrency, first take a look at how traditional currencies work. For the United States, the U.S. Treasury decides when to print money. The value of the U.S. dollar comes from people's faith in it. By itself, a dollar bill is just a bit of paper. But because society believes it has value, a dollar can be traded for a cup of coffee or a fast food meal. So the United States government controls the creation of dollar bills and backs their value, which people have faith in.

Cryptocurrencies, by contrast, are not influenced or controlled by any specific institution or government. Their value still comes from people's faith in it, but instead of an institution creating the cryptocurrency, it's created when a transaction is verified.

The Process

You may be wondering, how exactly is cryptocurrency different than, say, online banking? Through online banking, you could transfer money from one account to another account, all without ever actually seeing the cash money. However, the numbers on your computer screen still represent cash money, which you could withdraw from a bank.

coins

Cryptocurrency, by comparison, only exists in its own network.  Everyone who is a part of that network has a balance, and as long as the cryptocurrency is perceived as having value, it can be transferred to someone else in exchange for goods, services, or other currencies. When someone requests a transaction, other computers in the network verify it. The verified transaction is then processed, which causes one person's cryptocurrency balance to go down (the payer) and another person's balance to go up (the receiver). Once the transaction has been verified, it is added to a public ledger.

Cryptocurrency Mining

If you've researched cryptocurrency at all, you may have heard of mining. Mining is how cryptocurrency is created, and it goes back to the verified transactions mentioned in the last section.

Since there's no one bank or institution that controls cryptocurrency, the records of transactions are public. This means that everyone can have a ledger that contains all the cryptocurrency transactions ever processed. However, in order to prevent someone from making fraudulent transactions or from completely controlling the ledger, "miners" confirm the transactions being made. This is done by computers that solve complex mathematical puzzles. Once a computer verifies a transaction, the transaction is added to the ledger, and cryptocurrency is added to the balance of the person that owns the computer.

spending cryptocurrency

Spending Cryptocurrency

Since cryptocurrency only exists in its own network, you may be wondering how you can spend it. More and more retailers are accepting cryptocurrency as a form of payment. You can manually enter a bitcoin address in order to perform a transaction, or you may be able to scan a code to automatically input the address. Then you just need to approve the transaction. Cryptocurrency can be used to order food, buy products, even for donations! And you can expect the market for cryptocurrency to continue to expand.

Features

Cryptocurrency differs from traditional currency in more ways than how its created. For one thing, despite the ledgers being available to everyone, neither your name nor your address are connected to your cryptocurrency account. There are no "gatekeepers" associated with cryptocurrency; anyone with access to the proper tools can have a balance. Cryptocurrency is a world-wide currency, but transactions take only seconds to complete. Cryptocurrency is also exceptionally secure. In fact, the term "cryptocurrency" comes from the word "cryptography," which means "the science or study of the techniques of secret writing, especially code and cipher systems." However, transactions are also irreversible, so if you make a mistake or get scammed, there's no way to get your money back.

Types of Cryptocurrencies

Obviously, Bitcoin is the most famous type of cryptocurrency. However, it's not the only one! Here's a quick summary of some of the various types of cryptocurrency.

Bitcoin

Bitcoin

About: Bitcoin was the first successful cryptocurrency. It was developed as a peer-to-peer electronic cash system, and aimed to eliminate the need for a trusted third party to verify transactions.  Read the original white paper here. Because of a code that puts a limit on the supply of Bitcoins, people can calculate approximately how many will be available at a given time. However, based on the code, by the year 2140, no more Bitcoins will be produced.

Ethereum

About: While Bitcoin only validates transactions, Ethereum can be used to validate transactions, contracts, and programs. So if Bitcoin is like digital gold, Ethereum is like digital gas.

Litecoin

About: Litecoin was the 2nd successful cryptocurrency invented. It is larger than Bitcoin and approximately four times as fast. It is a more efficient form of cryptocurrency for small transactions.

Dash

About: Dash has changed names several times since its creation, and was formally known as XCoin, and later as Darkcoin. Dash is also faster than Bitcoin, and was designed to be more private.

There are hundreds of more types of cryptocurrencies out there, and no doubt more will continue to be invented.

Buying Cryptocurrency

Buying Cryptocurrency

Mining cryptocurrency isn't the only way to obtain it. You can also purchase and sell it using various platforms. For example, Coinbase allows you to buy and sell Bitcoin, Ethereum, and Litecoin. You can also use cryptocurrency to get other types of cryptocurrency. Changelly currently allows exchanges between approximately 73 different types of cryptocurrency. If you want to invest in cryptocurrency but don't want to start mining it, this is one way how.

Cryptocurrency is sometimes hard to fully understand, just like the internet was when it was first created. As a new technology, cryptocurrencies will change the way we experience money, just like the internet transformed how we experience information.

About LeeAnn Reynolds
LeeAnn Reynolds is a regular contributor to RateZip.com.