The idea of non-physical money isn't too crazy. After all, the balance of your bank account is, in a sense, exactly that. However, many people find the idea of money that maps to no physical entity or that has no physical beginning to be strange (although, to be sure, not every dollar in every bank account "maps" to a dollar in a physical bank vault - though we are most certainly not be going into that here).
First, if you haven't already, go and read the first post in this series on blockchains. It's short, and we'll be building on the ideas there in this post.
The Crypto in Cryptocurrency
Cryptocurrency is defined in the dictionary as a digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a central bank.
Now, there's a lot to break down here. Well start by breaking down the definition, then use an analogy to gain a firmer footing.
Cryptocurrency is a digital currency. In other words, it has no traditional physical analog or form, and exists only in the blockchain (in a database). How can this be? We'll get into it in a bit.
Cryptocurrency uses encryption techniques that regulate the generation of units of currency. This is the "crypto" in cryptocurrency. In fact, the prefix "crypto" is short for "cryptography" or "the art of writing or solving codes." This is literally at the heart of every form of cryptocurrency.
Verifiable Solutions
This system depends on every coin being accounted for. To ensure this, the "coin" has certain mathematical properties associated with it, and each account in a transaction has a special numerical key associated with it. In fact, you can think of the currency itself as a number that produces a verifiable solution to an incredibly complex math problem when combined with a special numerical key associated with an account. This key cannot be easily faked because while it is verifiable, not all parts of it are public.
Woah there, Wilbur.
Whatchu talkin' 'bout, Willis?
Think of it this way. Take a look at the following basic algebra equation:
x + y = 10
What if I told you that a good solution for x to this problem would represent one coin? Well, the only way to find a good, verifiable solution is to know what y is. In this case y would be the key. If the key (y) were 6, then I would know someone was trying to cheat the system if they gave me any answer other than 4 for x, because although y isn't shared publicly I know the solution must equal 10 for the "coin" transaction to be a valid one. Now, this is not that hard to beat, so obviously the actual equations are more complex to an almost incomprehensible degree and this is an incredible oversimplification.
For now, just keep in mind that cryptocurrencies are basically just accounting systems that keep track of and verify transactions of a finite amount of coin (though usually steadily growing) using complex mathematical equations. We'll break the idea down further and touch a bit on how these digital coins are generated in future lessons.
Other Posts in This Series:
Cryptocurrency for Absolute Beginners: What is a Blockchain?
Cryptocurrency For Absolute Beginners: So What Is Cryptocurrency Anyway (Part 2)