What is a Cryptocurrency? A Beginner’s Explanation

The term “cryptocurrency” is a contraction of “cryptographic currency.” In March 2018, Merriam-Webster announced that they would include this term in their dictionary. Their definition is as follows:

cryptocurrency noun cryp·to·cur·ren·cy  \ ˌkrip-tō-ˈkər-ən(t)-sē , -ˈkə-rən(t)-sē \ : any form of currency that only exists digitally, that usually has no central issuing or regulating authority but instead uses a decentralized system to record transactions and manage the issuance of new units, and that relies on cryptography to prevent counterfeiting and fraudulent transactions. First Known Use: 1990

This definition isn’t bad, apart from:

  • The placement of the word “usually”
  • The muddying of the fact that recording transactions and managing issuances also rely on cryptography

To clarify, the stated “decentralized system” behind transaction-recording and issuance management is the blockchain.

As the name implies, cryptography is first and foremost in any cryptocurrency. Transactions are only recorded if they meet the network rules, which are defined in the code run by both relaying and mining nodes. Blocks are only included in the blockchain through some form of proof of work, which depends on a cryptographic process.

Similarly, new coins are only issued when miners or stakers (if using a proof-of-stake system) receive their block reward for generating a new, valid block. Therefore, the decentralized system is ultimately ruled by cryptography.

An Improved Definition of  Cryptocurrency

These objections may appear pedantic, but they’re important. As Merriam-Webster’s definition currently stands, mechanisms like SWIFT or PayPal might be considered cryptocurrencies. While “unusually” centralized and regulated, such payment mechanisms are also purely digital systems that depend on cryptography to prevent fraud and counterfeiting.

A more correct definition would read as follows:

cryptocurrency noun cryp·to·cur·ren·cy  \ ˌkrip-tō-ˈkər-ən(t)-sē , -ˈkə-rən(t)-sē \: any form of currency that usually exists digitally, and that has no central issuing or regulating authority, but instead uses a decentralized, cryptographically secured system to record transactions, manage the issuance of new units, and prevent counterfeiting and fraudulent transactions. First Known Use: 1990

The word “usually” has been shifted to account for the existence of items like physical cryptocoins and key backups.

More importantly, this definition makes it clear that the security of cryptocurrencies relies entirely on cryptography, but never on centralization or regulation. In other words, the issuance and transaction record of true cryptocurrencies are unaffected by human decision-making.

Synonyms for Cryptocurrency

For convenience, this term is often shortened to “crypto.” An example is the cryptocurrency-only exchange, Cryptopia.

And “cryptocoin” has the same meaning as the well-known cryptocurrency news site, CryptoCoinsNews.com.

If it’s clear from the context that the intended meaning is cryptocurrency, the shortened term “coin” can be used. This term is derived from the numerous clones of Bitcoin, which often display a unique prefix (such as Litecoin or Dogecoin). But the best example of this usage is the well-known listing site for market capitalization: CoinMarketCap.com.

Features of a Cryptocurrency

Decentralized Blockchain

Cryptocurrencies use blockchains to order transactions. Blockchains are the best (and perhaps only) way to maintain a consensus about the state of a record among a decentralized, trustless network. If a currency relies on a trust in the form of a centrally maintained and managed record, it’s simply not a cryptocurrency (which is why PayPal and SWIFT aren’t cryptocurrencies.)

Note: In order to have a trustless, permission-less, decentralized blockchain, you need three main ingredients:

  • Cryptography
  • A distributed network of architecture
  • Some sort of consensus about mechanism (such as proof of work or proof of stake)

Usable as Money

So far, this article has focused on the “crypto” part of cryptocurrency, but the “currency” part is equally important. While blockchains are a natural fit for monetary systems, efforts are being made to apply them to other functions (such as timestamping and record-keeping). While such systems can be useful, they can’t be considered cryptocurrencies if they serve no monetary function.

Software Running on Digital Technology

In addition to cryptography, computing and networking are essential to the function of cryptocurrencies. These currencies are software, but they’re dependent on computing and networking hardware. Further physical aspects may be involved in certain cryptocurrencies (such as RFID tags or the backing of precious metals).

Non-Cryptocurrencies

Under our improved definition, numerous electronic-payment systems in existence fail to qualify as cryptocurrencies. One major example is Ripple (XRP), which is issued by a company that controls all transactions. While Ripple contains cryptographic elements, credit cards do as well.

According to our definition, ICO tokens also aren’t cryptocurrencies. A single smart contract is responsible for the issuance of ICO tokens, so this system can’t be considered to be “decentralized,” even if it’s “cryptographically secured.”

Lightning Networks aren’t cryptocurrencies either. They lack their own blockchain, and rely on the chain of an underlying coin for initiation and settlement. If Bitcoin’s Lightning Network succeeds, it will emphasize the critical properties of cryptocurrencies: security, decentralization, and immutability. And it’ll shift their secondary characteristics (such as speed and scalability) to Lightning Networks and other layered solutions.

Permissioned blockchains are often proposed by corporations or (central) banks, since access to reading and writing about them are restricted to approved parties. Due to the restricted nature of their blockchains, they can’t be considered true cryptocurrencies.

The term “cryptocurrency” was coined (pun intended) to describe Bitcoin, so it’s best to only apply it to systems that are fundamentally similar to Bitcoin. By stretching the definition to fit every entry on CoinMarketCap (or even the forthcoming state-controlled or bank-controlled coins), the term becomes far too generalized to be meaningful.

Our suggested terms for these not-quite-cryptocurrencies are “token” or “digital asset.”

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Mike Holton
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Mike Holton

What would you recommend for a crypto beginner? I’m a total rookie, but I’d love to start getting involved. I’m thinking this platform is looking quite good: crown.tech

Nadine
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Nadine

We need to be open-minded about how blockchain technology can be used. The technology can be implemented for a variety of purposes, including banking purposes. So ripple may not be a true cryptocurrency, it is true to blockchain technology

yo yasse
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yo yasse

I don´t understand what “physical cryptocoins and key backups” could be…

I thought that the cryptocurrency itself is ALWAYS and ONLY in the blockchain. What I´ve got in my software-, hardware– paper- whatever wallet are only the KEYS, the permission/possibility/code to ACCESS these online “currencies”, but not the assets themselves.

So, wouldn´t be the correct definition:”…any form of currency that exists digitally, and…”, without mentioning the word “usually” at all?

Just a question.

Keith Idaho
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Keith Idaho

Ripple is a bankster coin, to be avoided by those of us within the crypto space that value decentralization. Boycott Craple at all cost. This is our movement. Don’t cave in to Big Brother’s shitcoin. Stay strong and research your investments. There’s some shitcoins out there. Buy the wrong coin and you are supporting the enemy. Research my friends.

Mike
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Mike

Ripple XRP is definitely a security token and not cryptocurrency. Its used for nothing but to crowdfund the ripple labs centrally contolled network.

Lyle
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Lyle

I don’t see how Bitcoin can properly be considered a crypto currency when it seems like my Bitcoin is controlled by coin base. How do I break free of big brother and what will it cost me?

Nigel Bruce
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Nigel Bruce

How does Paypal depend on cryptography to prevent fraud and counterfeiting?
An employee of Paypal with appropriate access to their master database could in principle manipulate the records of past transactions and change the balances. With a true cryptocurrency, the cryptographic problem that needs to be solved* to win the right the add the next block to the chain and the fact that you can’t win this race again and again, prevents this happening.

*Or the tokens you’ve staked would become worthless in the case of PoS currencies.