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What is a Cryptocurrency? A Beginner’s Explanation

Last updated on April 15th, 2018 at 01:23 pm

The term “cryptocurrency” is a contraction of “cryptographic currency”. It was included as a new word in the Merriam-Webster Dictionary in March 2018, according to an announcement by the company. 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 isn’t a bad definition – apart from the word “usually” and the obscuration of the fact that recording of transactions and management of issuance also relies on cryptography. The stated “decentralized system” behind transaction recording and issuance management is, of course, the blockchain.

As the name implies, cryptography is first and foremost in a 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 upon 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. The decentralized system is therefore ultimately ruled by cryptography.

An Improved Definition for “What is a Cryptocurrency?”

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

A more correct definition would read as follows:

any form of currency that usually only exists digitally, that has no central issuing or regulating authority but instead uses a decentralized, cryptographically-secured 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

The “usually” word has been shifted to account for the existence of things like physical crypto-coins 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. The issuance and transactional record of true cryptocurrencies are unaffected by human decisions.

Synonyms for Cryptocurrency

The term is often shortened to “crypto” for convenience. An example would be the cryptocurrency-only exchange, Cryptopia.

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

Another term having the same meaning is “coin” – at least where it’s clear from context that the intended meaning is cryptocurrency rather than specie. This term is derived from the numerous clones of Bitcoin, which often used a unique prefix along with the “coin” suffix, for example Litecoin or Dogecoin. The best example of this usage is the famous market capitalization listing site, CoinMarketCap.com.

Features of a Cryptocurrency

Decentralized Blockchain

Cryptocurrencies use blockchains to order transactions. Blockchains are the best and perhaps only way to maintain consensus on 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 (e.g. Paypal, SWIFT).

Note: In order to have a trustless, permissionless, decentralized blockchain you need three main ingredients – cryptography, a distributed network architecture and some sort of consensus mechanism (i.e. proof of work, proof of stake).

Useable as Money

While this article has focused thus far on the “crypto” part, 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, if they serve no monetary function they can’t be considered cryptocurrencies.

Software Running on Digital Technology

In addition to cryptography, computing and networking are essential to the function of cryptocurrencies. Cryptocurrencies are software, dependent on computing and networking hardware. There may be further physical aspects involved to certain cryptocurrencies, such as RFID tags or backing by precious metals.

Non-Cryptocurrencies

Numerous existing electronic payment systems fail to qualify as cryptocurrencies under our improved definition. One major example would be Ripple (XRP), which is issued by a company that controls all transactions. Although Ripple does contain cryptographic elements, so too do credit cards…

ICO tokens also fail to meet our definition of cryptocurrency. As a single smart contract is responsible for the issuance of ICO tokens, this system can’t be considered as “decentralized” even if it is “cryptographically-secured.”

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

Permissioned blockchains, where read/write access is restricted to approved parties, are often proposed by corporations or (central) banks. Due to the restricted nature of their blockchains, they can’t be considered true cryptocurrencies.

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

The suggested term of use for these not-quite-cryptocurrencies is “token” or “digital asset.”


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