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Cryptocurrency - what is it and how do they work?

A Cryptocurrency is a digital or virtual currency. The term is made up of cryptography and currency. The former is also the specialty and characterizes the digital currency. Because thanks to the cryptographic encryption, the units of the currency, which are often referred to as coins or tokens, are forgery-proof.

Another characteristic of cryptocurrencies is theirsdecentralized naturebecause they are not issued or controlled by any government or central body. Many proponents see this as an advantage over fiat currencies such as the euro or the dollar, which can often be subject to the risk of inflation or almost complete currency devaluation, as has been observed several times in Argentina, for example.

The world's first public cryptocurrency was Bitcoin. She was given the pseudonym in 2009Satoshi Nakamoto presented and published for the first time. Bitcoin's first intention, however, was not to create a cryptocurrency, but to enable digital and secure money transfer on the basis of a peer-to-peer network. Since the release of Bitcoin, many other competing products followed such as Ethereum, Litecoin, IOTA, Ripple, Peercoin and many more.

What is a cryptocurrency?

A cryptocurrency is digital moneythat can be bought, sold, and transferred using cryptography. The data is therefore encrypted and protected. In contrast to regular currencies (fiat currencies), which exist in material form, a crypto currency is purely digital money and only exists on the Internet. In addition, it is not endorsed or managed by an authorized third party such as a bank or government.

How do cryptocurrencies work

Distributed Ledger Technology (DLT) is the heart and basis of every cryptocurrency. Most cryptocurrencies are based on blockchain technology. The use of this technology makes it possible to carry out transactions in a decentralized manner and to prevent double expenses. The transactions are stored in blocks in a chain. A copy of this chain, the blockchain, is available on many different nodes that synchronize each other. Once entered in the blockchain, it can no longer be deleted. These points make the theft of cryptocurrencies or manipulation of the transaction history particularly difficult.

Since there is no central authority behind the crypto currencies, they cannot be generated easily, such as by a central bank. New coins are therefore created, for example, during the mining process. The mining is primarily intended to maintain the consensus within the network, i.e. it is used to validate transactions. The basis is an algorithm, often a proof-of-work mechanism or, in some cases, proof of stake.

Other methods are, for example, Proof of Capacity or Proof of Importance. Cryptocurrencies offer many possibilities for use, but they also have to struggle with problems. In addition to security issues such as the risk of a 51% attack or hacker attacks in general, scalability is a decisive hurdle that prevents Bitcoin and other currencies of this type from being used on a large scale and integrated into people's everyday lives.

Wallets or digital purses

Cryptocurrencies are kept in a digital wallet and can be used to pay for goods and services. However, you are no legal tender and so far often cannot be accepted. Digital currency payments are made online, but merchants can also accept payments in your mobile device store. Usually this is done with very low transaction fees.

Popular with criminals

The relatively anonymous nature of digital currencies has made them very attractive to criminals who can use them for money laundering and other illegal activities. Cryptocurrencies are a popular payment method for transactions carried out on the dark web. However, one should also bear in mind that fiat money is still the most frequently used for illegal transactions.

Examples and possibilities of cryptocurrencies

Each cryptocurrency has different capabilities depending on the purpose for which it was developed.

The Bitcoin cryptocurrency

Bitcoin is primarily a digital currency. Users on the bitcoin network known as bitcoin miners use computer intensive software to validate transactions that go through the network and receive new bitcoins in the process. Bitcoin was developed as a decentralized global payment system, but it has also been bought and sold in bulk as a speculative investment. However, the digital currency has problems with scaling. Thus, the future of Bitcoin could also just "digital gold" be.

The Ethereum cryptocurrency

Ethereum uses blockchain technology to operate an open software platform. It can process transactions, contracts (smart contracts) and other programs (dApps) that enable developers to create and run any program, in any programming language, on a single decentralized platform. Instructions on how to buy can be found at this link.

The Litecoin cryptocurrency

Like Bitcoin, Litecoin was created as an electronic payment system. However, transactions in the Litecoin network are processed faster and there are more Litecoins in circulation than Bitcoins. Some users see Litecoin as a "lighter" version or as a bitcoin replacement.

The Ripple cryptocurrency

Ripple is a transaction protocol designed to complement Bitcoin by allowing real-time transfers between users in any currency. It is a database that allows users to store and transfer values ​​in any currency, including other cryptocurrencies, on a protected network. For more information, see our Ripple Buying Guide.

Ripple uses tokens created by the developers and not mined like other digital currencies. Some users don't see Ripple as a real cryptocurrency, but the technology is popular with financial institutions.

The goals of cryptocurrencies

The main goals of cryptocurrencies are to facilitate the transfer of funds, especially in the international area and in countries with weak financial systems. This should make transactions faster, cheaper and safer. They also prevent double-spending, which is a major problem with traditional digital money transactions such as online banking and card payments.

The use of cryptocurrencies also offers onePseudo anonymitythat are not possible with traditional banking systems. Cryptocurrencies can not only be used as a pure means of payment. Projects like Ethereum, for example, use the internal currency ether to offer a platform for decentralized software programs (dApps). In this case, the cryptocurrency is an instrument and is intended to be used as an internal currency for trading on the platform. There are also other possible uses as part of a bonus points program, in which companies offer their customers coins for purchases or special offers.