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Cryptocurrency Explained

Written by Science

Cryptocurrency is, as the name suggests, a form of currency. But what exactly makes it tick? Well, unlike ‘ordinary’ currency, it has no central bank controlling it or issuing it. Anyone – anywhere – can buy and sell the currency for goods, services or money itself. As the name may also suggest, it isbased on encryption: specifically, the algorithms surrounding it.

In the ‘olden days’, most currencies were backed by gold reserves or other reserves of a known
value. Nowadays, currencies like the Sterling have become currencies of promises. Their value
comes from the fact they have value to people. Cryptocurrencies have never had backing from a
reserve. A central bank in a conventional currency scenario can choose to increase or decrease the amount of money in circulation. So-called ‘quantitative easing’ has been used recently in the UK during the 2008 economic crisis, but almost always results in inflationary pressure. Simply put, the more money there is the less valuable it is.

The transaction fee for Bitcoin peaked at around $55.

An algorithm regulates cryptocurrencies. There is a hard upper limit on the volume that can be
produced. Bitcoin, the current largest cryptocurrency, has a maximum volume of 21 million units.
This limit is enforced as a by-product of the means of the currency’s production. With normal currencies, an actual note must be printed or coin stuck to represent a unit of that currency. With cryptocurrency, a process called ‘mining’ must take place. As part of this process, a computer must solve a mathematical puzzle that gets exponentially harder the more currency is in circulation, and stops when the set limit is reached. The exponential nature slows down production as more coins are produced, ensuring scarcity is maintained. This is how cryptocurrencies get their value; the scarcity is the value.

So, back to hashing in depth. An underlying technology deployed in all cryptocurrency applications is called blockchain. Again, to put it in simple terms, it is an incorruptible ‘ledger’ of transactions that have taken place which is distributed across umpteen different nodes to guarantee neutrality. To add a block to this chain (and hence verify a given transaction’s authenticity) the mining machine must complete a cryptographic calculation which produces a value called a hash. The chain cannot be corrupted, as if a block is altered the hash created when it was added won’t match its current hash value and the chain will collapse.

Each block can store many transactions, so your transaction is queued until a block is mined which can take it. This means during slow days your transaction could take a long time to clear (people have waited multiple days). Also, these miners need paying. The transaction fee for Bitcoin peaked at around $55 but is now down to about $5 per transaction. Still, this is a pretty penny to pay for your morning croissant.This makes cryptocurrencies currently very difficult to use for everyday payments.

Image: Wikimedia

So why the fuss? Well, they make an excellent item to trade with. Their volatility makes it possible to make big gains if you’re careful about how you invest, but it comes with many risks. Bitcoin ‘futures’ have been traded for a few months now. Futures are simply contracts you purchase which promise you a value at a given point in time. They can be bought and sold, but you don’t need to worry about moving actual cash around or trying to put it in a big cryptocurrency wallet (the computer program used to store units that are not being used) as it’s held somewhere else. After recent volatility, however, wariness of the prospect of trading in cryptocurrencies is picking up.

One of the most notable benefits of cryptocurrencies is not in fact cryptocurrencies, but rather
blockchain. Savvy technology firms are repurposing blockchain to be used in a number of diverse applications, such as creating an unchangeable record of where your fruit and veg has been and actually using it to monitor the movement of normal currency. Blockchain can be deployed  wherever a reliable record needs to be maintained. We could even see it deployed in the future to
authenticate your degree as being valid. No matter the current climate, it’s clear that  cryptocurrency and blockchain will have a significant impact on finance and many other industries in years to come.

Last modified: 26th February 2018

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