What is a cryptocurrency?

Explainer: Cryptocurrency

Fuelled by a boom, Bitcoin “mining” is thought to be producing enough COto rival the city of London, and consuming almost as much energy as all the data centres in the world combined. Cryptocurrency exists in a notoriously confusing world, where definitions slip and slide and metaphors abound. It’s hard to understand what exactly a Bitcoin is, or what mining actually means in the crypto context.

What is cryptocurrency?

Cryptocurrency is a purely digital type of currency. It enables transactions between online users, and cryptocurrency “coins”, or units, can be exchanged for actual currency, or for goods and services. 

Cryptocurrency is designed to allow the storage and transferal of value without anyone administrating the flow of currency – it is decentralised, as opposed to traditional currencies which are controlled or overseen by banks or governments. 

“The main difference, the one that crypto-nerds get excited about, is that cryptocurrencies are not controlled by anyone,” says Mark Ferraretto, a lecturer in technology and law at Flinders University, South Australia.

“Let’s compare that with regular (or ‘fiat’) currencies. A fiat currency is controlled, usually by a central bank established by the government. Australia is an excellent example. 

“It’s the Reserve Bank that controls the Australian dollar. The Reserve Bank can determine interest rates and can also set the amount of dollars in circulation.

“Cryptocurrencies on the other hand do not have this central control. Instead, the currency is controlled algorithmically.”

Cryptocurrencies are often exchanged via online trading platforms and apps, but they are also used to make illegal transactions – for example, Bitcoin is heavily used on the dark web.

Examples of current popular cryptocurrencies include BitcoinEthereumRipple and Cardano. Some cryptocurrencies are extremely valuable, though their value can fluctuate wildly.

For example, in March 2020 Bitcoin lost half its value in two days, dropping to a low of $10,000 per coin, but it hit a new peak in February 2021 at $58,000 per coin.

Where did cryptocurrency come from? 

In 2008, an anonymous person(s) calling themselves Satoshi Nakamato invented Bitcoin, the first cryptocurrency. This coincided with the 2008 global financial crash. The first block in the blockchain (more on this later) contained a message, “Chancellor on brink of second bailout for banks”, seen by many to suggest that Bitcoin was formulated in response to the reckless banking that caused the crash.

Since then, numerous other cryptocurrencies have been invented, many of which fill specific niches, such faster transactions or the exchange of digital art.

How does cryptocurrency work? 

Blockchain technology

To understand how cryptocurrency works, you have to understand what a “blockchain” is. 

Blockchain technology forms the basis for the exchange of cryptocurrencies. A blockchain is essentially a digital “ledger” – a permanent record of all transactions that have ever been made using the currency.

Each transaction’s information is recorded in a “block”, which is broadcast to every network in the system; the block contains both data about the transaction, and also the ID of the block before it, so that they can be linked in a chain.

Blockchains can’t be altered, and they exist on every single computer in the network. If one user’s copy of the blockchain is different from all the rest, the network can reject that transaction as a fraud.

“If nobody is in charge, then everyone is in charge,” says Ferrarettp. “Blockchain reflects this by allowing anyone to become part of the blockchain.”

Cryptocurrency mining

Not all cryptocurrencies use mining, but Bitcoin does.

“The premise of blockchain is that nobody can be in a position of greater trust than anyone else,” says Ferraretto, “meaning everyone is just as trustworthy as anyone else. This in turn means that anyone can add a new block to the blockchain.

“But there needs to be some measure of control, otherwise blocks would be added willy-nilly and everything would degenerate into a complete mess.

“Mining solves this problem. Mining makes the process of adding a new block artificially difficult. It also becomes more difficult over time. Miners must solve a cryptographic problem. The difficulty of the problem is adjusted automatically so that it always takes, in the case of Bitcoin, about ten minutes to solve.”

The solution is found by extremely powerful computers that crunch the numbers at breakneck speeds until they eventually get the right answer. 

A Bitcoin mining computer may make more than 150 quintillion (that’s 150 plus 18 zeros) attempts every second to solve the equation in the chain. 

As noted in last week’s story, all that computing power consumes a vast amount of electricity, which means digital currency has a very real, physical impact on the planet.

Does cryptocurrency matter?

Cryptocurrency has real-world implications, so it shouldn’t be relegated it to the back-channels of the deep, dark web.

Firstly, it has emancipatory potential. 

“Why does crypto get people excited?” asks Ferraretto. “The attraction of cryptocurrencies and blockchain is the decentralised nature – the fact that nobody needs to be trusted and yet the integrity of the ledger can be trusted.”

Cryptocurrencies are owned by the users, not by a central authority like a bank or a government, so they can’t be manipulated or withheld. Whether this is a good or bad thing depends on how you look at it, but what it does do is remove the monopoly of authorities – for better or worse. 

“There is also a human-rights potential,” says Ferraretto. “A large number of people in the world are ‘unbanked’. All these people would need is a cryptocurrency wallet, which is free to obtain, and they have instant access to an international currency.

“All of a sudden, the issue of ensuring that workers in less-developed countries are paid becomes trivial and also trivial to verify.”

But cryptocurrency is also ideal for illegal and nefarious uses, because it’s uncontrolled and anonymous – the blockchains contain no information about the people using the currency.

Cryptocurrency may also present unique legal challenges in the future. For example, questions around what happens when a person dies who holds assets in cryptocurrency may be difficult to resolve, since there is essentially no legal infrastructure surrounding cryptocurrencies.

The rush to mine and invest in cryptocurrency presents a very real threat to the environment, as illustrated in our story last week drawing on the latest estimates by Dutch researcher Alex de Vries.

Using the example of Iran, De Vries also cautions that cryptocurrency may present very real security threats. Iran has invested so heavily in cryptocurrency mining that it now makes up around 8% of the overall computing power in the Bitcoin network, allowing it to work around international sanctions and continue to make money – money the country could feasibly invest in the nuclear capabilities the sanctions are designed to prevent.

A crypto-future 

What’s clear is that cryptocurrency is a disruptive, powerful thing, and something that’s moving from the fringes into mainstream society. The implications – both good and bad – to some extent remain to be seen.

As Ferraretto puts it: “They are not something that should be ignored.”

The Royal Institution of Australia has an Education resource based on this article. You can access it here.