The rise of cryptocurrency has been one of the most fascinating technological developments of the digital age, helping to usher in a new era of decentralized finance, with an emphasis on concepts like security, privacy and transparency. In order to fully get to grips with cryptocurrency and understand its appeal, it is important to go beyond headlines about price fluctuations and hone in on the underlying logic that drives crypto ecosystems.
After all, cryptocurrencies have already shifted the way we think about digital assets and ownership. In some cases, cryptocurrencies have even redefined how we think about money and financial transactions.
Today, cryptocurrencies have an important role to play in everything from maintaining online privacy and financial transparency, through to cybersecurity and safe betting online. In this article, we will take a deep dive into major cryptocurrencies like Bitcoin and Ethereum, explore the logic behind them and consider not just how cryptocurrencies work, but why they exist at all and what problems they can help us to solve.
What is Cryptocurrency and How Does It Work?
Cryptocurrency is a form of digital currency, which works over the internet and operates on decentralized networks, rather than relying on a central authority, like a bank. This means no single individual or entity has control over the currency and transactions can take place directly, without the need for intermediaries. In general, this decentralization can remove unnecessary barriers and reduce transaction fees.
All cryptocurrency transactions are secured using codes and mathematical techniques; a process known as cryptography. On top of this, all records of transactions and cryptocurrency ownership are stored on a digital ledger called a blockchain. Combined, these features prevent tampering, increase trust and enhance security and authenticity. Transactions are also validated using the shared processing power of the network.
Another big feature of cryptocurrencies is relative anonymity. Owners of cryptocurrency are not immediately identifiable, because the cryptocurrency in a wallet is not tied to an individual, but to specific private keys.
Bitcoin was the first cryptocurrency and remains the most widely-known and used example. However, alternatives include Ethereum, Solana, Tether, Litecoin and Dogecoin. These alternatives to Bitcoin are collectively known as altcoins.
Decentralization as the Central Logic of Crypto
Diving deeper into the underlying logic of cryptocurrencies, one of the single most important elements is decentralization. In simple terms, this means cryptocurrencies operate over a shared digital ledger, called a blockchain. The blockchain is tamper-proof, shared across multiple computers and records are permanent. As a result, cryptocurrencies do not rely on a central bank, government or any other single entity for oversight.
This use of decentralization as the central logic of cryptocurrencies helps to solve many of the problems associated with traditional currencies. While conventional systems use a combination of banks, payment processors and regulators to approve transactions and prevent fraud, this introduces fees and delays, which are mostly avoided with crypto.
Essentially, with cryptocurrencies, the trust comes from mathematical verification, instead of institutions. So, rather than relying on a bank to confirm that a transaction is real, users rely on the shared rules of the network.
Decentralization provides cryptocurrencies with a number of significant advantages. First, the ledger is public, which increases overall transparency. Second, as transactions do not rely on intermediaries, like payment processors, transaction fees are generally lower. There is also no single point of failure, adding to network resilience.
Finally, cryptocurrencies, unlike more conventional fiat currencies, are not tied to a specific country or bloc of nations. This gives the likes of Bitcoin and Ethereum a borderless quality, which reduces geographical barriers.
The Role of Cryptocurrencies in Cybersecurity
Cybersecurity is also at the very heart of cryptocurrency logic. As mentioned, financial transactions are secured through cryptography, which has the benefits of preventing tampering and reducing the risk of fraud. Crypto transactions are also usually permanent and irreversible, offering protection against techniques like chargeback abuse.
The funds owned by users are secured using private keys, which are entirely the responsibility of that user, rather than a company. Cryptocurrencies help to remove the threat of data theft, because users are not required to provide bank details, link their personally identifying information to their funds or share card numbers.
Some blockchains, like Ethereum, provide great options for smart contracts. Meanwhile, most cryptocurrency blockchains are also public, meaning transactions can be independently verified. This also ensures suspicious activity can be detected, further increasing the credibility and integrity of the cryptocurrency over time.
However, it must also be understood that the security of cryptocurrencies comes with some trade-offs. One of these is increased personal accountability, but decreased safety nets. For example, while the integrity of a private key system is extremely robust, if a private key is lost or stolen, there will not be simple solution like a password reset to recover it. This means multi-factor authentication and other good security practices are paramount.
Digital Assets and Value Derived From Scarcity
Cryptocurrency has helped to transform the way people think about digital assets. In the past, digital assets did not appear to hold much value, as they could be copied easily and continuously. However, one of the ways cryptocurrencies have been able to transform this reality is by controlling supply in relation to demand to create scarcity. Yet, the way this scarcity is managed and built into the platform can differ significantly from one cryptocurrency to the next.
Bitcoin maintains scarcity and creates value by having a controlled and finite supply. From its inception, Bitcoin was programmed to have an absolute limit of 21 million coins. There are currently around 19 million Bitcoins in circulation and the remaining number will be created gradually over time, until the maximum is reached in the year 2140.
Once a Bitcoin is created, it remains part of the total supply forever, even if some Bitcoins become inaccessible over time, due to owners losing access or dying before passing private keys on.
Ethereum takes a totally different approach to scarcity, because it does not have a maximum supply. However, Ethereum still has mechanisms written into its protocol that limit the effective growth of supply. As an example, since 2021, a percentage of transaction fees are burned, meaning they are permanently removed from circulation.
Regardless of how it is achieved, this scarcity provides cryptocurrencies with value beyond what has historically been possible for digital assets. Unlike other digital assets, coins also cannot be copied or reproduced.
How Cryptocurrencies Can Protect Online Privacy
Another key component to the logic of cryptocurrency is its ability to protect privacy by providing a degree of anonymity. In a world where people are increasingly concerned about cyber attacks, personal information being retained by private companies and their online activity being tracked, cryptocurrencies like Bitcoin offer some clear advantages over using government-issued currencies to pay for certain goods and services online.
Most blockchains break away from the convention of names or account numbers that are directly tied to a person’s identity. Instead, they use strings of letters and numbers called cryptographic addresses to represent a user’s wallet. This means Bitcoin transactions, for example, do not require the provision of personally identifying data. However, cryptocurrencies can be best thought of as pseudonymous, because transactions are visible on the blockchain.
One of the other key ways cryptocurrencies can protect online privacy is by preventing certain transactions from showing up on regular bank statements. Take online gambling. There may be many reasons why a user may not want deposits to show up on their monthly bank statements, from personal to cultural.
An online casino that accepts crypto, like Stake.com, can allow users to participate and enjoy gaming, while keeping their deposits and winnings away from their everyday banking records. This approach also means users do not need to share bank or card details, and they benefit from the enhanced security of cryptocurrency transactions too.
Key Differences Between Major Cryptocurrencies
It is also important to understand that cryptocurrency is a catch-all term for a wide range of cryptocurrency platforms and while they share certain elements of underlying logic, there are some differences too.
For example, the underlying logic of Bitcoin prioritizes ideas like security and predictability. It places an emphasis on reliability and changes to this underlying logic are extremely rare, which helps to establish consistency and build trust. However, all of this does potentially come at the cost of a certain amount of speed and flexibility. It is also primarily seen by users as an alternative to fiat currencies, like Dollars or Pounds.
Ethereum, on the other hand, was developed to be more flexible than Bitcoin and its primary appeal lies in its ability to facilitate smart contracts and allow users to run decentralized applications on its blockchain. It does also have a native cryptocurrency, Ether, but this is sometimes viewed more as a fuel to power apps and smart contracts, rather than as a direct alternative to fiat currencies, even though it can serve this function too.
Exploring the Logic Behind Crypto’s Volatility
The volatility of cryptocurrencies is sometimes used as a stick to beat them with and this forms the basis of many criticisms of the technology’s underlying logic. Essentially, cryptocurrencies often experience significant swings. However, this is not necessarily any sort of flaw in the way cryptocurrencies work.
Instead, it is the reality of a new digital asset, with limited liquidity. Any asset of this kind is naturally going to encourage experimentation and lead users to explore both its potential and its limits. This has led to a strong association between cryptocurrencies and speculation, with many people hoping for big returns.
Fluctuations in the value of cryptocurrencies like Bitcoin are also understandable, as it is an asset that is still finding its feet in a world of established government-issued currencies. The use cases are still evolving and people are still exploring when it makes sense to use Bitcoin, when it makes sense to hold onto it and the specific situations when it is preferable to use crypto rather than a more conventional currency, like Dollars, Euros or Pounds.
In fact, we are seeing clear evidence of maturity in Bitcoin, with its daily volatility decreasing significantly from the early 2010s until now. Although sharp price moves still happen, they are less severe and less frequent than in the early years. This indicates that the currency is maturing, even if its volatility is still higher than most fiat currencies. Logically, other cryptocurrencies may experience a similar maturation over time, as speculation decreases.
The Main Real-World Use Cases for Cryptocurrency
Cryptocurrency has a wide range of uses and the real-world use cases are actually growing all the time, especially as people become increasingly tied to the digital world. Nevertheless, to fully understand the logic of cryptocurrency, it can be useful to explore some of the most common everyday uses:
- Direct Digital Payments – Cryptocurrencies can be used to send money directly to other people, using the internet. The transactions also do not depend on intermediaries, reducing transaction fees. Many of these benefits are especially notable when sending money from one country to another.
- Online Subscriptions – A growing number of online service providers accept cryptocurrencies as a payment method, with examples including virtual private networks (VPNs), web hosting services and subscription software.
- Privacy-Focused Transactions – Users may opt to benefit from the relative anonymity associated with cryptocurrencies for a range of transactions, including online gambling and entertainment purchases. This anonymity is also sometimes useful when purchasing VPN services, as it creates a further layer of identity protection.
- Investment or Trading – Some people invest in cryptocurrencies, ranging from Bitcoin to the latest meme coins, with the express intention of selling it for a profit when the value hits the right level.
Conclusion
The underlying logic behind cryptocurrency is based around complex ideas like digital privacy, decentralization and cybersecurity. Yet, all of these elements are increasingly important in an age where more of our lives take place in online spaces and where people are increasingly concerned about personal data, safety and anonymity. This ability to address real concerns gives currencies like Bitcoin and Ethereum a strong base to build on for an exciting future.
