Now that you’ve read our Blockchain 101 lesson about how blockchain works, let’s look at how cryptocurrency can be used in everyday life. Blockchain and cryptocurrency are two different things but they are closely integrated.
This lesson will give you a basic understanding of what cryptocurrency is, how to store it, how to use it, and everything in between.
What is Cryptocurrency?
Cryptocurrency is a digital currency that is used to exchange value, just like other currencies. The “crypto” part refers to the cryptography, or encryption, technology used to verify transactions as well as to regulate the generation of new coins or tokens. Cryptocurrency has no central bank and no one entity controls it, which is why it’s known as decentralized currency. It uses the blockchain platform to securely verify and permanently record all verified transactions. This also ensures anonymity or pseudo-anonymity for all its users because all transactions are done through public and private keys (more on that below).
In addition to transactional value, cryptocurrency is used to reward for miners for the computing power they lend to secure the blockchain network. As we mentioned in Blockchain 101, mining is the process of verifying and recording transactions. Think of mining as accounting — and accountants don’t work for free!
Miners earn the native cryptocurrency of a given blockchain. For example, Bitcoin miners are paid in Bitcoin; Ethereum miners are paid in Ether. Small amounts of new cryptocurrency are minted with each block of a blockchain. One important note is that the coins or tokens never exist in a tangible way — there are never physical or fungible digital tokens, just account balances that move up, down, or stay the same.
Let’s look at standard bank accounts to illustrate this. When you log into your online banking dashboard, you see your current account balance. That number is a “marker,” or illustration of how much money you have. You don’t physically have the money in your hand, but you know it’s an accurate portrayal of your funds and your ability to spend.
How Do I Store Cryptocurrency?
First, you need a wallet. A cryptocurrency wallet is a software program that stores your private and public key, plus lets you interact with a blockchain to send/receive cryptocurrency and monitor your balance. We’ll run through the different wallet types a little later in this article.
What are private and public keys?
Cryptocurrency holdings are identified by an alphanumeric string called a public key or public address. When you give someone your public key, they can then send cryptocurrency to your account, as well as see your account balance and previous transactions. They cannot alter your account balance or financially harm you in any way.
Your private key should be kept, well…private. It is a different alphanumeric string that’s mathematically connected to your public key. While the public and private keys look different (they are different sets of numbers and letters), the two “match” each other much like a physical lock and key. However, unlike a physical lock that can be “picked,” it is impossible for someone to access your account without your private key.
The private key is what you use to “sign” your transactions — it’s what lets the miners know that you have authorized a transaction. If someone gets your private key, they effectively get complete control over your wallet. From the miners’ perspective, they can’t tell whether you authorized a transaction or whether it was someone with access to your account. So, just like your PIN or online banking password, never give your private key to anyone unless you completely trust them.
What Kind of Wallet Should I Use?
Now that you understand what wallets store and how they work, let’s take a quick look at the different types that are currently available:
- Software (desktop or mobile): This is an app that you can download to your phone or personal computer. Most software wallets store your private key in an encrypted “vault” within the app that only you can access. They can only be accessed via the device you downloaded the app on. They are generally a convenient option as you can use your favorite device to interact with the blockchain and send/receive money. But, if your PC or phone gets stolen or hacked, your private key is now in someone else’s control. This is the drawback on software wallets.
- Online: You can create a wallet online and access it using any device via a username, password, or some other login. This is convenient because you can access your accounts regardless of the device you’re using. However, with this added convenience comes more risk. Online wallets store your private keys online and are controlled by a third party, which makes them more vulnerable to hacking attacks and theft.
- Hardware: These are actual devices designed specifically to hold cryptocurrencies. In general, hardware wallets are the most secure as they store your private key on the unit itself — not on a computer that could be hacked, or in a third party’s database. Making transactions with a hardware wallet is fairly straightforward. You just plug it into an internet-connected device, enter a PIN, send the currency, and confirm. Hardware wallets make it possible to easily transact while also keeping your money offline and away from danger. The drawback is if you lose the device, you lose your funds.
Regardless of which option you use, if you lose your private key, you lose access to your funds — there is no “forgot password” button to click, or customer service line to call. So, always make a backup of your private key.
The key itself is extremely hard to remember due to its length and complexity. The safest option is to write your private key on a piece of paper and put it in a safe, safety deposit box, or anywhere else that you store valuables. For added security, we recommend laser engraving your key on metal (instead of writing on paper) to protect in the case of a fire or flood.
How Do I Use Cryptocurrency?
When someone sends you cryptocurrency, they’re essentially signing off ownership of the coins to you through your wallet address. To receive those funds, the private key stored in your wallet must match your public address the currency is being sent to. If public and private keys match mathematically, the transaction will be processed. Again, there is no actual exchange of real coins. Transactions are signified merely by a record on the blockchain and a change in the balance of your cryptocurrency wallet.
Once you start a transaction to send or receive cryptocurrency, the information is sent to the blockchain and miners to validate. They check that the sender’s account has the required funds and that they haven’t tried to send those funds to someone else already. Once a miner verifies that both are true, they will “confirm” the transaction. The number of confirmations needed to process a transaction varies from blockchain to blockchain.
Now that you’ve learned about cryptocurrency, try it out! While you get the hang of it, we have a few suggestions:
- Do a few “test transactions” to a friend or a separate wallet that you control.
- If you’re sending a large amount of money, send a small portion of the payment to confirm the recipient’s address is correct. There are no refunds in the world of cryptocurrency!
That’s all for Blockchain 102. If you’re interested in learning more about the different types of blockchains and benefits of each kind, keep an eye out for our Blockchain 201 lesson coming soon!