Although there can be exceptions to the rule, there are some factors (beyond the basics above) that make cryptocurrency so different from the financial systems of the past:
Adaptive Scaling: Adaptive scaling means that cryptocurrencies are built with measures to ensure that they will work well in both large and small scales.
Other measures are included in digital coins to allow for adaptive scaling including limiting the supply over time (to create scarcity) and reducing the reward for mining as more total coins are mined.
Cryptographic: Cryptocurrency uses a system of cryptography (AKA encryption) to control the creation of coins and to verify transactions.
Decentralized: Most currencies in circulation are controlled by a centralized government so their creation can be regulated by a third party. Cryptocurrency’s creation and transactions are open source, controlled by code, and rely on “peer-to-peer” networks. There is no single entity that can affect the currency.
Digital: Traditional forms of currency are defined by a physical object (USD existing as paper money and in its early years being backed by gold for example), but cryptocurrency is all digital. Digital coins are stored in digital wallets and transferred digitally to other peoples’ digital wallets. No physical object ever exists.
Open Source: Cryptocurrencies are typically open source. That means that developers can create APIs without paying a fee and anyone can use or join the network.
Proof-of-work: Most cryptocurrencies use a proof-of-work system. A proof-of-work scheme uses a hard-to-compute but easy-to-verify computational puzzle to limit exploitation of cryptocurrency mining. Essentially, it’s similar to a difficult to solve “captcha” that requires lots of computing power. NOTE: Other systems like proof-of-work (such as proof-of-stake) are also used.
Pseudonymity: Owners of cryptocurrency keep their digital coins in an encrypted digital wallet. A coin-holder’s identification is stored in an encrypted address that they have control over – it is not attached to a person’s identity. The connection between you and your coins is pseudonymous rather than anonymous as ledgers are open to the public (and thus, the ledgers could be used to glean information about groups of individuals in the network).
Value: For something to be an effective currency, it has to have value. The US dollar used to represent actual gold. The gold was scarce and required work to mine and refine, so the scarcity and work gave the gold value. This, in turn, gave the US dollar value.
Cryptocurrency works similarly regarding value. In cryptocurrency, “coins” (which are nothing more than publicly agreed on records of ownership) are generated or produced by “miners.” These miners are people who run programs on specialized hardware made specifically to solve proof-of-work puzzles. The work behind mining coins gives them value, while the scarcity of coins and demand for them causes their value to fluctuate. The idea of work giving value to currency is called a “proof-of-work” system. The other method for validating coins is called proof-of-stake. Value is also created when transactions are added to public ledgers as creating a verified “transaction block” takes work as well. Further, value comes from factors such as utility and supply and demand.
Learning More about How Cryptocurrency Works
If at this point, you feel a little bit confused, don’t worry and don’t give up. Understanding the concepts that are fundamental to cryptocurrency is a challenge. One explanation works for some people, and a different explanation works of others. We all learn in different ways.
The trick with cryptocurrency is not getting worried if you don’t understand it at first – each new video, explanation, or article that you learn from will make your understanding of cryptocurrency clearer until, eventually, it clicks.
To learn more, check some of the other, more blogs on our site to dive deeper into the inner-workings of cryptocurrency. You can also watch informational videos about the how cryptocurrency works .