What exactly is cryptocurrency and why do they call it that? The term is a compound word formed by two other words, but the meaning cannot be discerned from its component parts. Taken at face value, one would assume that it is “hidden money”, which it is not.
What it actually is can be described as a form of money that is created, exchanged, and accounted for by way of digital cryptographic technology.
In centuries past, cryptography was most commonly used to encode messages, particularly during wars. Communications were needed to reach allies without being understood by enemies if they were intercepted either physically or via radio transmission.
A simple example of encryption is letter substitution. If numbers are assigned to the alphabet, such as 1 for A, 2 for B, etc., then the word “dad” becomes the encrypted word “414”. In spy movies we’ve seen another example where coded messages are often sent as groups of numbers wherein the first number represents the page number of a book, then a line on that page, then a word in that line. The message could not be decoded without the key, or cipher, which in this case would be the name of the relevant book.
Modern forms of encryption are vastly more complex with the tremendous power of computers that can do billions of calculations per second.
Today, we use encryption daily, whether or not we’re aware of it. When you send an email message, it may be encrypted by the software on your computer, then decrypted by the receiving computer so that if it’s intercepted by someone in between, they won’t be able to read it. The same goes for your login credentials on websites, and all of your online banking.
Now, take this concept of encrypting information to keep it hidden from anyone but the intended recipient and add in the concept of digital money, which only exists in computers. Paper money can be “hidden” in safes or banks, or stored under a mattress, or whatever, and once you spend it, it’s obviously spent because you no longer have it in your possession to try to spend a second time. But once you’re dealing with money that doesn’t exist physically, a method is needed to verify many things about that money, such as, is it yours, have you spent some, to whom are you giving it, and, are you trying to spend money that you’ve already spent?
All of these questions, and more, are handled by new forms of encryption and accounting. A fairly long series of seemingly random numbers is generated to represent your possession of digital currency in a digital wallet. When you send currency in the form of a digital coin to someone else, that transaction is also identified by a long series of numbers.
When such a transaction occurs, its authenticity must be confirmed, and an entry is made into a LEDGER after it has been confirmed, and after a “proof of work” is completed. A hidden number is embedded in the transaction that can only be discovered by multiple educated guesses by many computers working simultaneously to figure out what this number is. In simple terms, think of it as an algebra equation wherein the computer must solve Y in the problem 2 x Y = 6. Once a single computer, referred to as a miner, solves the math puzzle, it then sends the solved equation to other computers for verification that the answer is correct. (The puzzles are literally millions of times more complex than this ultra-simplified example.) When the answer is confirmed, the transaction is added to the public ledger.
The transaction, which consists of your wallet I.D., the recipient’s wallet I.D., the amount of currency you’re sending, how much money is in your wallet, what you’re purchasing, information about you or your location, etc., are all encrypted. All of the information except the wallets and the currency type are hidden. Thus we have cryptographic-currency, shortened to cryptocurrency.
The ledger that tracks all of these transactions and is publically available is called the blockchain, which is another term you’ve most likely heard. A certain number of transactions can be stored in what is called a block, which is just a container of a limited amount of information. The blockchain is essentially a different type of database that stores data in sequential blocks, rather than in rows and columns which you would find in a classic database. When one block is filled up, a new block begins. Each block is linked to the one before it, continuously, and thus forms a chain.
The first widely used blockchain was the one associated with the digital currency known as Bitcoin. Later, a new digital currency became well known which is called Ethereum, which has its own blockchain. A new blockchain has come along that may well end up being the third prominent blockchain in the near future, created by the Cardano Foundation.
You should have a rudimentary understanding now of what cryptocurrency is, and why it is called that, and some minor familiarity with a few other associated terms.
For a more advanced understanding of mining, transaction verification, and blockchain technology, and how it all relies on encryption, I recommend this three-part article by Chris Pacia:
Bitcoin Mining Explained Like You’re Five [years old]
https://chrispacia.wordpress.com/2013/09/02/bitcoin-mining-explained-like-youre-five-part-1-incentives/
