The term cryptocurrency refers to digital assets that also function as a medium of exchange. Individual asset attributions are recorded in a distributed database, usually a so-called blockchain. This public financial transaction database uses strong encryption technology to confirm and secure the transactions, possessions and, if necessary, the creation of further coins or even the destruction of coins.
As of January 2023, there were over 10,000 different cryptos, a few of which were designed as currencies. What they have in common is that the coins of these projects, some of which themselves offer a purpose, are tradable. Different crypto exchanges, but also decentralized exchanges offer trading or direct purchase for different coins and tokens. These can be transferred to private wallet addresses, where they are protected from access by third parties and can only be accessed by a key.
As a typical object of speculation, cryptocurrencies have not yet been recognized by states as an official type of money, except in El Salvador, but they were used by over 220 million people worldwide. Especially in developing and emerging countries with underdeveloped financial systems and high inflation, rapid adaptation is observed, while many countries are simultaneously working on the digitization of their currencies.
Cryptos are not currencies in the strict sense and do not exist in physical form (such as paper money and coins). Except for El Salvador, they are not legal tender in any country and are not usually issued by a central authority or supervisory body. Instead, behind many cryptos is capitalist private-sector interest, as well as the desire for speculation and decentralized control: anyone can become the owner of the means of production to produce and issue the coins and participate in the management of these and also participate in the value creation. Nevertheless, there are also crypto projects where a single issuer issues all coins. By distributing the coins or tokens accordingly, however, it is also possible, if desired, to convert them into decentralized projects.
Cryptocurrencies enable digital payment transactions without central authorities such as banks. This is done using decentralized data storage and cryptographically encrypted transmission protocols. Ownership of funds is represented by the possession of a cryptological key. The credit, which is also cryptological signed, is mapped in a joint accounting system in the form of distributed ledger technology, usually a blockchain. Cryptocurrencies do not exist in physical form (like fiat money) and, unlike fiat money or central bank digital currencies in their originally conceived form, are not issued by a central authority. But even if many cryptocurrencies, in contrast to everyday money, a single party alone is not able to accelerate, impair or in any way significantly abuse the production of currency units, many other cryptocurrencies are produced centrally by owner-managed, private, profit-oriented companies. For example, Ripple Labs held up to 80 per cent of the new issues of the cryptocurrency Ripple and distributed them at its discretion.
The combined market capitalization of all cryptocurrencies has been determined since 2013. In 2017, a combined market capitalization of 100 billion US dollars was reached for the first time, which reached its peak in January 2018 with 800 billion US dollars. Subsequently, this fell within a few weeks to below 500 billion. This limit was only exceeded again in November 2020. Since then, prices have exploded. The prices of cryptocurrencies, except the so-called stablecoins, are therefore extremely volatile. The trading prices of all cryptocurrencies are also directly related to the valuation of Bitcoin and generally fall when the price of Bitcoin falls, and vice versa. All coins and tokens that are not Bitcoin are summarized under the term Altcoins.
How Cryptocurrencies Work
A currency without intrinsic value can only function if there is a sufficient degree of confidence on the part of those involved. In the case of conventional fiat money, the central bank must be trusted, or the central bank or the respective state enforce the use of the currency regardless of the trust or mistrust of the population through coercion, the monopoly on the use of force and state authority. In the case of cryptographic currencies, new issues and transactions are confirmed by a majority of participants who are fundamentally suspicious and mutually controlling.
Since binary information is almost arbitrarily reproducible, it must be ensured – as with any other cashless payment system – that the amount in circulation does not increase unregulated. Thus, a transaction is only valid if the sum of the inputs (accounts from which an amount is deducted) is equal to the sum of the outputs (accounts to which an amount is added). The only exceptions are new issues, which in turn must follow predetermined rules that are comprehensible to all to achieve the necessary trust.
In ordinary cashless payment transactions, the participant must trust an operating authority (bank, credit card company, etc.) to monitor and enforce compliance with the rules. In the case of cryptocurrencies, this task is entrusted to the community of all stakeholders. Corrections to the system are only possible if the majority of the parties involved agree to them by application.
Except for the above-mentioned privately operated cryptocurrencies, in which a company gives itself a special role, the jointly operated grassroots democratic. However, this leads to the next fundamental problem. Democracies in the traditional sense are based on the equal distribution of voting rights over a defined group of persons. On the Internet, people are not identifiable. For reasons of discretion, identification is also not desired. Cryptocurrencies must therefore distribute voting rights differently. Two principles are mainly applied: the proof of work and the proof of shares/stake.
With proof through work, the participant gains more influence on the overall system by solving arithmetic tasks and thus proving computing power expended. By solving as many tasks as possible, the participant not only gains more influence on the system but also increases his chances of profiting from new issues and transaction fees. At the same time, this incentive to provide computing power ensures that a sufficient number of participants always use sufficient computing power to keep the system running. The tasks are therefore designed in such a way that they also take care of the system’s accounting in their entirety.
When proving shares, the person who already holds large shares of the assets receives more influence and benefits. Not only is the credit, but also its age is evaluated. An example of this is Peercoin. Jointly operated cryptocurrencies are therefore based on a special understanding of democracy that differs greatly from everyday ideas.
The expenditure of the highest possible computing power to have greater chances of profiting from new issues is also referred to as mining. Since real goods are traded with cryptocurrencies and they are also exchanged for conventional currencies, there is a real economic incentive to solve the computing tasks set for mining as efficiently as possible. This led to the use of increasingly specialized hardware. Initially, normal processors, as they work in PCs, were used, soon after there were implementations that used graphics processors. Meanwhile, devices based on FPGAs and ASICs are traded, which were developed specifically for this purpose. This resulted in a massive increase in computing power.
For the individual user of an ordinary PC, it has thus become almost impossible to participate in new issues or transaction fees with attractive cryptocurrencies, where there is competition for computing power.
To do justice to this effect, the increasing number of participants and Moore’s Law, cryptocurrencies have adaptable difficulty levels in the computing tasks set. Thus, only those solved tasks are accepted by the participants that correspond to a predetermined and regularly adapted level of difficulty. This allows emission rates to be kept constant and the effort for possible manipulation to be increased. The principles of proof-of-work and holding shares can also be combined. For example, holders of large, as old as possible balances may submit solutions with a reduced degree of difficulty to Peercoin. The resulting higher chance of allocation of new issues or transaction fees is regarded by the creators of this cryptocurrency as a kind of interest on these balances.