With the recent spike in cryptocurrency prices, you may be asking, “What is cryptocurrency?” Cryptocurrency can be defined simply as “digital currency,” but this simple definition does not address why it has value or why some find it preferable to fiat currencies such as the American dollar.
To truly understand what cryptocurrency is, you first need to learn more about it.
Examples of Cryptocurrency
Cryptocurrencies may alternatively be referred to as “coins”. The most popular and well known is Bitcoin, the coin that pioneered the space in 2014. Many other digital coins, such as Ethereum, Dash, Ripple, Litecoin, zCash, and Dogecoin also exist. These are called altcoins, or alternate coins, to differentiate them from the Bitcoin most people naturally think of when considering cryptocurrency.
Why Cryptocurrency Has Value
All currencies, digital or not, act as stores of value because people believe them to be valuable. They all solve the problem of double coincidence of wants by offering the flexibility to be exchanged for whatever you might need.
The more people who share this belief, the more valuable the currency becomes. A wider base also promotes stability in the value of the currency.
Furthermore, cryptocurrency is infinitely divisible where fiat currencies are not. For instance, it is impossible to receive less than 0.01 of an American dollar, but you can get 0.0000000000001 of a Bitcoin. This facilitates micro-exchanges that simply cannot exist without cryptocurrency.
Cryptocurrency also has the advantage of the blockchain, a new technological concept that makes currencies such as Bitcoin more secure and verifiable than a traditional bank account.
Cryptocurrency vs. Fiat Money
The best way to grasp why cryptocurrency is better than traditional paper money is to review why paper money was better than the barter system it replaced. Under the barter system, individuals seeking a particular product had to locate another individual willing to trade what they wanted for what they had.
For example, a tailor looking to trade clothing for wheat had to find a farmer looking to trade wheat for clothing in order to complete the transaction. Economists refer to this situation as the double coincidence of wants.
Fiat money improved this situation by establishing a universal store of value. With it, it is no longer necessary to locate somebody with a specific interest in what you have to offer.
Instead, you can make the trade using money, which anyone will accept because it can be turned into whatever they’re interested in buying. In retrospect, modern man often wonders why fiat money took so long to come about.
However, it was not always obvious that paper money would be the future. Imagine that you are the tailor mentioned above at the onset of paper money. The clothing you typically offer has an intrinsic value, so you are confident that you will always be able to trade it for what you need.
This newfangled fiat money is just little slips of paper with no built-in value. Is relying on it truly a better idea than sticking with an economic system that had worked for thousands of years?
The answer is obviously yes, but you can appreciate why the tailor would be skeptical about such a dramatic change. When it comes to cryptocurrency, modern man has become the tailor.
Digital money facilitates exchanges between individuals who usually accept different fiat currencies by being liquid to all of them. For instance, if you want American dollars but your customer has euros or Mexican pesos, cryptocurrency offers a universal exchange system that can give everyone what they want.
How The Blockchain Supports Cryptocurrency
The blockchain network operates with the help of voluntary miners, or computer systems that verify, encrypt, and secure every cryptocurrency transaction.
This system prevents the theft or creation of counterfeit coins by checking every transaction against the public ledger. If something doesn’t jive with the millions of copies of the ledger on file, the transaction will be denied.
Miners are rewarded for their efforts with a small amount of coins from that cryptocurrency exchange. For example, Ethereum miners receive 0.000444 ETH as a standard fee split among every miner who contributed.
Wallets are a smaller version of the miners idea in that they record and verify cryptocurrency transactions. They come in both hardware (thumb drive) and software (apps) flavors and store your cryptocurrency until you decide to use it.
When you deposit cryptocurrency into your account, your wallet tells the network that you have more money to spend. Every wallet has an address that looks like an account number, ensuring that cryptocurrency always arrives at the correct final destination.