It is well understood that cryptocurrency is a decentralized digital medium of exchange that is not issued by a government or bank. Most people have heard of Bitcoin by now, and you may have heard of Ethereum as well.
However, those are only two of the over 5,000 cryptocurrencies trying to be the next big thing.
With so many, you might be wondering where they all come from.
Without a bank and a government, there is no printing or minting — therefore neither is required. Although it can be spent like conventional money, cryptocurrency is the result of an entirely another process.
Cryptocurrency Is All Software
Whatever the mechanism of creation, all cryptocurrency is software that is built by code. That code governs every aspect of the cryptocurrency, from the way data is kept and transactions are recorded to the allocation of mining rewards and the maximum amount of tokens that can be issued.
In virtually all situations, the code is public, and the software used to generate a certain cryptocurrency, like the coin itself, is decentralized. Instead of a central server, that public, decentralized software is hosted on individual computers all over the world.
At the Heart of It All Are Algorithms, Cryptography, and Blockchain
When cryptocurrencies are designed to be used as money, transactions are maintained on a blockchain, which is a type of secure database that serves as a ledger of all coded transactions. Consider it a cryptocurrency checkbook.
No one can ever change an entry in the database once it has been added to the blockchain unless certain requirements are met. Everyone who is involved has access to the public record of all transitions.
As a result, blockchain technology enables cryptocurrency to achieve its three most significant distinguishing characteristics:
Transparency, Decentralization, Immutability
The portion of the code that encodes what end users refer to as “tokens” or “coins” is simply a string of integers kept on a blockchain. Algorithms generate cryptocurrency, and those algorithms rely on cryptography – hence the name cryptocurrency.
The majority of cryptocurrency is mined.
In most cases, the algorithms that power the cryptocurrency factory are designed to reward computers that contribute transactions to the blockchain with tokens. Mining is the term for this process. Miners contribute transactions to blockchains by using special hardware and the cryptocurrency’s public, decentralized software.
Miners are compensated in new cryptocurrency tokens in exchange for providing vital blockchain upkeep. The majority of cryptocurrency coins or tokens are created in this manner.
Technically, anyone can be a miner, but for the most part, it is a useless undertaking. It’s complicated, competitive, costly if you fail — which is quite likely — and it consumes a massive amount of power.
However, some are not.
Some cryptocurrencies were never intended to replace fiat currency such as the dollar. In other words, it was never intended to be used as currency. This type of non-mineable, unspendable cryptocurrency is typically created to reward early investors in a new cryptocurrency launch, also known as an ICO (initial coin offering).
In other situations, a new cryptocurrency can be generated as a result of a blockchain departure known as a hard fork. Hard forks occur when blockchain protocols change so drastically that a new, distinct branch of the chain is generated that is incompatible with the previous chain. Bitcoin Cash, for example, was created as a result of a hard fork on the original Bitcoin blockchain.
Proof of Work and Proof of Investment
Verification is at the heart of cryptography. The value of bitcoin, unlike fiat cash, is not predicated on trust. It is based on one of two methods of verification: proof of work or proof of stake.
The majority of transactions are validated via proof of work. Algorithms generate complicated mathematical puzzles that miners race to solve using specialized technology. A miner verifies a set of transactions known as a block by solving the puzzle, which is subsequently added to the broader blockchain ledger. The miner who completes the task first receives cryptocurrency.
Proof of stake was created in order to reduce the amount of power required to validate transactions. In order to check transactions and compete for rewards using this approach, someone must demonstrate that they have skin in the game. To be able to validate transactions, users must “stake” their existing money by storing it in a shared vault.
The more you stake, the more transactions you’ll be able to verify and the more bitcoin you’ll be able to earn.