Cryptocurrency 101: What are cryptocurrency properties?
Cryptocurrency is unlike traditional currency in the very obvious sense that is devoid of any central authority. Unlike, say the United States Dollar or British Pound, cryptocurrency is not backed by a state or central bank. Rather the trustless nature of cryptocurrency means that for the currency to function information must be distributed to all users. This gives cryptocurrency a completely unique set of characteristics. In this article, we will explore the transactional properties of most cryptocurrencies.
Cryptocurrency Transactional Properties
The transactional properties of cryptocurrencies are what enable them to be true disruptors of the financial sector. Traditionally, transactions require a trusted central authority to validate both sides of a transaction. This authority has the power to deny a transaction, reverse one that has already been made, and approve transactions. Typically, these central authorities come in the form of central governments, banks, and other financial institutions. Though this has worked for some time, it has meant controlling the flow of money is left to institutions and this control is removed from the individual. This leaves individuals vulnerable to the numbers in their account being altered by complicated rules set by central authorities. We will see that cryptocurrencies have a vastly different set of transactional properties that remove these vulnerabilities whilst performing some of the security functions that traditional currency offers.
Traditional currency requires trust from both parties making a transaction that the other person has what they say they have and will transfer when requested. Trust in traditional currency is offered by protection of a central authority. This central authority becomes the biggest point of weakness for the currency. With cryptocurrency’s nobody has to trust anybody for the network to function.
You may be asking ‘Well, why on Earth would I want to transact with somebody on a trustless network?’ - A valid concern. The answer lies in the decentralized ledger, the blockchain, that every node on the network has a copy of. This decentralized ledger has a record of every transaction on the network and is therefore able to verify transactions. When a transaction is broadcasted into the network to verify signatures, all nodes receive it, if the signatures are valid then the transaction is authorized and if not, the transaction is discarded.
Therefore, cryptocurrencies are trustless because they do not require a central authority/third-party to verify transactions because the ledger held by everyone on the network means that everyone can verify transactions themselves.
To be immutable means to be unchangeable. In the realm of cryptocurrency, this immutability means that transactions cannot be reversed (or altered once committed) and it also means that only the holder of the private key can make transactions. As you may well have guessed, this is achieved by recording all transactions on the blockchain.
In a traditional bank, you trust that they won’t manipulate your accounts and will reverse any errors made on the account. As we now know, there is no central authority, like a bank, on a cryptocurrency network so ensuring publicly writing all transactions to the decentralized ledger ensures that everyone trusts the network. This also means that transactions should not be reversed (otherwise the trustless network begins to fail). There are a few exceptional circumstances when transactions can be reversed within a crypto network but this requires the entire network to be compromised and is rarely done.
You can’t have a discussion about cryptocurrency without the word decentralized coming up. So what exactly does it mean? Vitalik Buterin put it best by stating:
“Blockchains are politically decentralized (no one controls them) and architecturally decentralized (no infrastructural central point of failure) but they are logically centralized (there is one commonly agreed state and the system behaves like a single computer).”
We can break this down further. Firstly, because of the political decentralization there is less chance of corruption and collusion on the network to manipulate things unethically for personal gain. Next, the architectural decentralization means there is reduced chance of system errors because many nodes have to confirm transactions. There is another benefit here that attacking a crypto network is difficult and expensive - how do you attack thousands of nodes at once?
Ah the namesake of cryptocurrency - cryptography. Cryptocurrencies gained their general name due to the mathematical security methods that are employed to keep them secure. Crypto funds are locked in a cryptographic public key system, or digital signature system. In this system, everyone has access to public keys but funds can only be transferred if you hold the corresponding private key as well. This means that only the owner of the private key can send money from their wallet to yours. The cryptographic security strength is such that the chances of an asteroid hitting your house are higher than your crypto wallet being hacked. With that said, if somebody got hold of your private key then you would be completely at the attackers mercy. The lesson here - keep your private key in a nuclear tight vault.
The other cryptography that is used in cryptocurrencies is hashing. Hashing is used to verify data integrity, and as the system for encrypting users addresses/transactions on the blockchain.
The decentralized nature of cryptocurrency means that you can transact with anyone across the world just as easily as transacting with your roommate. The process for both of these types of transaction is the same. All transactions are broadcasted across the entire network for verification and this is usually completed within minutes. The fast, secure, and global nature of cryptocurrency make for a groundbreaking alternative to doing international transactions in the traditional manner. This traditional approach often costs a high transaction fee and can take many days.
In a cryptocurrency network, nobody knows who you are. Accounts and addresses are not held against real-world identities. Further, these networks are typically permissionless meaning that anyone can hold a cryptocurrency account and hold multiple of them. You receive cryptocoins via an address that has a related flow of transactions attached to it but unless publicly stated you can’t find out who those previous transactions were done by.
Cryptocurrencies have a distinct set of transactional properties which enable it to function the way it does. It gains trust among users through its trustless nature which means that everyone on the network must have access to all the transactions (enabled by the blockchain). The blockchain cannot be altered (it is immutable) and therefore all transactions are final. Decentralization means that there is no single authority in charge of the network, rather all users are responsible for ensuring that transactions are legitimate before being authorized. Cryptography is used to ensure the network is secure and that users information is reliably encrypted so that they remain anonymous. Finally, the distributed nature of cryptocurrency authorization means that transactions are the same for everyone across the globe and authorized at an incredible speed.