What are Cryptocurrencies?

cryptocurrencies

The magical world of cryptocurrencies began in 2009 with the launch of Bitcoin by Satoshi Nakamoto. Although bitcoin is still by far the largest cryptocurrency based on market share and number of users, today there are thousands of other cryptocurrencies you can invest in. At their core, they are all similar to bitcoin and are digital currencies over which no single entity has complete control. No one can just change the rules or the amount of coins in circulation.

Unlike the euro, bitcoin is guaranteed never to exceed 21 million in circulation. These rules are guarded by modern cryptography, very powerful big numbers that no computer in the world can match. More on cryptography later. Want to invest in Bitcoin now? Make sure you know what to look for when buying bitcoin!

Bitcoin was certainly not the first attempt by computer scientists to create digital money, but it was the first successful one. Because Satoshi Nakamoto has managed to build a system where no one has absolute power, bitcoin cannot be sued. Earlier projects did have a central entity which could be sued and this gave governments the ability to stop the development of these digital coins.

Cryptocurrencies and cryptography

cryptocurrencies explained

As discussed earlier, cryptocurrencies owe their name to cryptography, the building block and foundation of each cryptocurrency. Cryptography is best thought of as gigantic digital walls of numbers that protect bitcoin because it is impossible to guess those big numbers.

Even if you could build the most powerful computer that could theoretically exist and use all the sun’s energy to power it, after 100 billion years you would still only have a 25% chance of breaking part of the wall. To quote Satoshi Nakamoto:

SHA-256 (the cryptography that protects bitcoin) is very strong. It is not like the incremental step from MD5 to SHA1. It can last several decades unless there is some massive breakthrough attack.

To better understand how powerful the numbers are that protect bitcoin and other cryptocurrencies, it is interesting to read some quotes from computer scientist Bruce Schneier.

These numbers have nothing to do with technology; they go beyond the limits of thermodynamics. This means that until computers are made of something other than matter and they no longer take up space, it will be impossible to break through these walls of defence with brute force computing.

What he is basically saying here is that there is no physical force, even in theory, that makes it possible to breach the defensive walls of bitcoin and other cryptocurrencies. The next time someone says to you that bitcoin can be hacked you can answer with this.

Cryptocurrencies and the concept of decentralization

cryptocurrencies trading

An important feature of cryptocurrencies is that they are kept online by a decentralised network of computers. For example, anyone can download bitcoin’s software, verify all transactions, and check that everything is correct themselves. You don’t have to trust anyone to use bitcoin.

The situation is different with our own Euro. Within the euro network the European Central Bank is the big boss and can in principle print new euros without limit. In the bitcoin system this is not possible because there are over ten thousand computers around the world which keep the network running. Every computer has the same rules and an important part of those rules is that no more than 21 million bitcoin will ever circulate.

If one computer decides to change that rule, the rest of the network simply stops listening to that computer. For example, you could download bitcoin’s software and make modifications to it so that 42 million bitcoin suddenly circulate, but then no one is listening to you anymore and you have effectively created your own version of bitcoin. You are disconnected from the decentralised network. This is known in jargon as a hard fork, your computer disconnects by using different rules to the rest of the network.

This decentralised nature is what makes bitcoin so powerful. There is no central entity within the network which can just change the rules. If the rest of the network disagrees with a rule change then nothing happens. So you can download bitcoin’s software, run it on your computer and in effect become your own central bank. In fact bitcoin is a very transparent, insightful and fair system. All transactions ever made are publicly stored and available for all to see.

How do cryptocurrencies arise?

cryptocurrencies altcoins

That is a good question! We have mentioned several times now that there are only 21 million bitcoin in circulation, but how does that actually work? Most cryptocurrencies are mined. In the past, bitcoin mining was something for computer nerds who used their gaming computers or laptops to mine cryptocurrencies as a hobby. Now this is a billion dollar industry with serious (listed) companies behind it.

All those computers which act as miners in the bitcoin network are constantly looking for a very special number. The only way to find that number is to guess continuously and very quickly. The more powerful the computer, the more often it can guess and the greater the chance that it will find that special number. If the so-called miners manage to find that particular number they will be rewarded with a little bit of new bitcoin.

At the time of writing, miners receive 6.25 bitcoin for finding a special number. This reward halves every four years until it reaches zero. At that point the maximum of 21 million bitcoin has been reached. The miner who found the special number may publish it and at the same time add a block of transactions to the network. On average miners will find a special number every 10 minutes after which they may add a new block of transactions.

Once they publish that block and the special number, all computers in the network download that new block and start looking for the next special number. This is why the underlying technology of bitcoin is called blockchain technology. In fact bitcoin is a chain of blocks connected by the previously discussed cryptography. Now you immediately understand how bitcoin and other cryptocurrencies are created and how the new units are brought into circulation. In most cases, this is done through mining.

A short summary

We have now come to the end of your first introduction to the subject of cryptocurrencies. The most important ingredients for a successful cryptocurrency are cryptography, a large network of miners and decentralisation. All three play an important role in protecting the network. The more powerful the cryptography, the more unlikely it is that a cryptocurrency can ever be hacked. The more decentralised a cryptocurrency network is, the harder it is to change the rules at the expense of the users. It is very unlikely that bitcoin users will ever decide to spend 50 million bitcoin instead of the maximum of 21 million bitcoin.

This is because it is not to their advantage to put more bitcoin into circulation. The fewer bitcoin there are, the scarcer bitcoin is and the more valuable the asset will eventually become. Cryptocurrencies are therefore powerful because they only make changes that are beneficial to the entire network of users.

Currently, there are thousands of different cryptocurrencies that you can buy. We fully understand that it is difficult for beginners to determine where to start. To help you get started we have written a comprehensive guide to various coins which you can find here.

Want to buy bitcoin now? Make sure you not only keep an eye on the bitcoin price, but also compare bitcoin providers!