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Blog 28, Oct

What are cryptocurrencies?

What are cryptocurrencies?

In general, a cryptocurrency is a type of money – like other currencies we live with on a daily basis – with the difference that it is completely digital. In addition, it is not issued by any government (as is the case with the real or the dollar, for example).

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But is this possible? To explain that it is, Fernando Ulrich, author of the book Bitcoin: A currency in the digital age, makes a very simple analogy: “What e-mail did with information, Bitcoin will do with money”. Before the internet, people depended on the post office to send a message to anyone who was elsewhere. An intermediary was needed to deliver it physically – unimaginable for someone who has access to email and other messaging services.

Something similar will happen with virtual currencies in the future. “With Bitcoin you can transfer funds from A to B anywhere in the world without ever having to trust a third party for this simple task,” explains Ulrich in the book.

Although Bitcoin is the most well-known digital currency, the concept of cryptocurrency predates it. According to the Bitcoin.org website, maintained by the Bitcoin community, cryptocurrencies were first described in 1998 by Wei Dai, who suggested using cryptography to control the issuance and transactions carried out with a new type of money. This would dispense with the need for a central authority, as with conventional currencies.

What are worth for

Cryptocurrencies can be used for the same purposes as physical money itself. The three main functions are to serve as a medium of exchange, facilitating commercial transactions; store of value, for the preservation of purchasing power in the future; and also as a unit of account, when the products are priced and the economic calculation is carried out according to it.

In Ulrich's view, currencies such as Bitcoin have not yet acquired unit of account status, due to the high volatility their prices are subject to for the time being.

What is mining?

To understand what mining is, you need to know that digital currencies – such as Bitcoin – represent a complex code that cannot be changed. Transactions carried out with them are protected by encryption.

As there is no central authority that tracks these transactions, they need to be registered and validated one by one by a group of people, who use their computers to record them on the so-called blockchain.

Blockchain is a huge transaction ledger. According to Ulrich, it is a public database containing the history of all operations carried out with each unit of Bitcoin (other digital currencies are based on this same technology). Every new transaction – a transfer between two people, for example – is checked against the blockchain to ensure that the same Bitcoins have not previously been used by someone else.

Those who record transactions on the blockchain are the so-called miners. They offer the processing capacity of their computers to carry out these records and check transactions made with the currencies – in exchange for this, they are remunerated with new units of them. Bitcoins are created as the thousands of computers that make up this network manage to solve complex mathematical problems that verify the validity of transactions included in the blockchain.

In other words, mining represents the creation of new units of some types of digital currencies. If more computers are used to increase processing power for mining, the mathematical problems that need to be solved become more difficult. This happens exactly to limit the mining process.

“Bitcoin is designed to replicate the extraction of gold or other precious metals from Earth: only a limited and previously known number of bitcoins can be mined,” explains Ulrich in his book. (More details in the “Bitcoin” section of this guide).