What is a cryptocurrency?

First, man exchanged goods. Then came the age of metal currencies such as gold and silver. Today we pay with banknotes, the credit card, or use virtual currencies on the Internet. There are a lot of them these days. These three crypto currencies in particular are much discussed: Bitcoin, Ethereum and Ripple.

But what is a currency? What makes the 20 € in your hand to 20 €, or why are 20 € actually worth 20 €? Philosopher John Searle says, “Just because we all believe that the paper in our hand or the numbers in our account have real value, they have that value.” This has worked fantastically so far. You go to a supermarket with your 20 € and also get goods worth 20 €. Just because the dealer also believes that the 20 € in your hand, are actually worth 20 €.

Advocates believe cryptocurrencies are the next big revolution in global payments. Even if the new currency is not yet used much in everyday life, a large religious community has already emerged. The value of Bitcoin is rising and falling and had reached its highest value to date of just over USD 33,000 per coin at the beginning of January 2021 (as of February 3, 2021). That’s a pretty strong belief. That’s why we explain the most important aspects of cryptocurrencies here. Cryptocurrency: What is it?

Cryptocurrencies such as Bitcoin, Ethereum or Ripple exist ONLY virtually. Like the money in your bank account, virtual currencies are not physically present. The difference with your money in the bank is that you can always convert your numbers in the account into cash. This is not possible with crypto currencies, as they only exist digitally and are not deposited with a bank. Virtual currencies do not require a bank at all. A transaction takes place solely within the so-called blockchain. The blockchain is the only system for cryptocurrencies that allows trading and all transactions for virtual currencies. As a means of payment, crypto currencies have the decisive difference that they function without banks. The money in your pocket or in your account, on the other hand, is always a securitized debt that the bank must redeem to you.

In the past, for example, owning a dollar assured the owner that he could exchange it for gold at any time at a bank. However, the “gold standard” that set this value was abolished in the twenties of the last century. Today, central banks and states guarantee the preservation of value. So money is always faced with a certain material value. In the case of crypto currencies, this hedging is completely omitted. This is also where critics see the greatest risk.

For a purely digital currency, the equivalent results solely from trust in a shared network: the blockchain. The blockchain is the central instrument and foundation for any digital currency. Each transaction is encrypted and combined into so-called data blocks by means of complicated computing operations. These are stored decentrally and can be viewed by every user. When it comes to security, the blockchain has a decisive advantage. The generated data blocks are stored on different computers in crypto currencies. Each user becomes a backup for the entire network (the chain). If someone wants to intervene in this system, they have to hack virtually all computers participating in the blockchain. This is especially impossible with large blockchain associations with millions of participants such as the Bitcoin blockchain. How does a cryptocurrency work?

Since virtual currencies, such as Bitcoin and Ethereum, are stored purely digitally in the blockchain, no one can manipulate them just like that. The blockchain is a kind of open book that generates virtual currencies, assigns them to owners and documents every transaction. Digital means of payment can only exist as a digital currency within the blockchain and change hands. This is where proponents see the biggest advantage: the movements of cryptocurrencies can be tracked at any time and everyone can see how many virtual currencies (for example, in Bitcoin) are in circulation. In addition, the maximum quantity that can be produced for the Bitcoin is determined from the outset. The digital currency is limited in its code to 21 million Bitcoin (abbreviated BTC). No one such as the European Central Bank (ECB), the US Federal Reserve Bank (FED) or other state institutions can intervene in this system and multiply money unhindered. In crisis areas, trade and transactions can be carried out even if the banking system collapses there. In general, the transactions are possible across any national borders. In most cases, there are only small or no fees. But how does the transaction actually work?

Trading cryptocurrencies has become a very popular hobby. The speculation on Bitcoin or Ethereum is enormous. Over $170 billion in market capitalization is now in Bitcoin. With Ethereum, it is at least 34 billion. Anyone who invests in cryptocurrencies flushes money into the system for virtual currencies. So you exchange real Euros for BTC and Co. This is done on a coin exchange, also called a coin exchange. Providers such as Coinbase or Kraken are the first gateway to the digital currency. Here you will also receive your so-called wallet. A Bitcoin wallet is comparable to the account at your bank. It is a code that is assigned only to you and represents your address or account number for crypto currencies. To this address you deposit money virtually in the form of crypto currencies by means of a coin exchange. Now you are part of the blockchain and can send virtual currencies back and forth. All you need for the transaction is the recipient’s wallet address. Everything you buy in Bitcoin, you can only transfer digitally. When choosing the coin exchange, you must make sure that the means of payment, i.e. the cryptocurrency that the recipient requests, is also in your wallet. Since each currency uses its own system, no conversion takes place. If someone requests Ripple and you send Ethereum, the money is just gone! Bitcoin miningFor mining you need appropriate hardware – so-called ASIC miners. Highly specialized devices for mining cryptocurrencies.

Trading, storing and sending digital currencies requires hardware and energy. This is where the Bitcoin miners come into play. They provide computing power to ensure the smooth running of transactions and to create new bitcoins. They are members of the decentralized network of the blockchain and validate – i.e. confirm – the transactions that run from one wallet to another.

In addition, all transactions are documented in a – also virtual – “ledger” (payment book). This ledger lists all movements with the amount of the transaction, the wallet numbers of the sender and receiver. Here, too, computing power is provided by the miners. They are rewarded for this with Bitcoin. Mining itself is stopped when the predetermined upper limit of 21 million virtually generated Bitcoin has been reached. With the maintenance of the ledger, money can still be earned in the form of BTC afterwards. What many do not know: ANYONE can become a Bitcoin miner. All you need is a mining client and you have to join a mining pool and you can earn on the new currency without risk.

However, there is a catch: the more participants a blockchain system has, the more difficult it becomes for the individual to actually earn money with it. This money-making works by a user verifying and thus legitimizing transactions. This works faster the more computing power is available. The motto is “Whoever can deliver the fastest will be awarded the contract”. However, since very powerful systems also have a very high power consumption, the bottom line – especially for “lone fighters” – is that there is little profit left – if they do not even pay more. Are cryptocurrencies legal?