Cryptocurrency: noun
a digital currency in which transactions are verified and records maintained by a decentralized system using cryptography, rather than by a centralized authority.
Erm... okay. But... how does that actually work?
Let's try to answer that.
You can think of cryptocurrency as simply a number in a spreadsheet:
What the number represents (often called "tokens" or "coins") almost doesn't matter. What matters is that, unlike this Google spreadsheet example, the "decentralized system" cryptocurrency uses is globally distributed, running on thousands of servers, computers, and specialized equipment all over the world, all synchronized and coordinated so that if a valid change is made anywhere on the spreadsheet, it updates for everyone everywhere at the same time.
This is called a blockchain. And no, it's not actually a spreadsheet, but a secure data store of connected "blocks" chained together so you can't go tampering with something that already happened. What's done is done, and can't be modified in the future.
In the example, the crazy looking thing in column A is called your public key (or public address). Every public key has a private key associated with it. Only someone who controls the private key for a given public key can transfer value from that cell to someone else.
Meaning if 1NsjbyuNdiRhxsawR4QDW3JVGMWCsSZ58K wanted to take some of that 1 they have and give half of it to 1Pqb5ujvKiEMdq3XweHtgka4w7vPAanYQu, only someone with the private key for 1NsjbyuNdiRhxsawR4QDW3JVGMWCsSZ58K can do that.
The rules of the decentralized system which define a "valid change" can not easily be broken. The rules require you to have the private key for a given public key if you want to transfer some number out from that account to some other account. You can also never transfer more than you have. Depending on the specific rules of the blockchain (and there are many blockchains like Bitcoin, Ethereum, EOS, HIVE, FIO Protocol, and more), if you can trust 51% (on some systems) or 2/3rds+1 (on other systems), you can have 100% guarantee the rules are being followed. If anyone on the network tries to break the rules, it will be obvious to the whole network. The economic incentives to play by the rules are strong which keeps everyone in line and, ultimately, creates the financial value people believe in.
But what is it backed by? How can these numbers be value?
All value is belief.
The pieces of paper in your wallet with pictures of dead white people on them only work as "money" because others believe as you do. By that I mean they believe by receiving this money in exchange for goods and services, they will be able to use them again in the future in exchange for goods and services they want. It's all story telling and shared belief.
The story behind the money in your wallet is failing.
Unlike cryptocurrency, governments and central banks can basically go into the global spreadsheet for your money and just add more out of thin air. They are creating more constantly which means you get to buy less stuff with more money.
They are doing this so often of late that the trust story that backs the value of your money is falling.
Cryptocurrency has a better trust story.
The technology behind this global system is so advanced (and yet simple to understand), that it can not be censored, hacked, or cheated. It just works. Keeping track of your private key is important, because individuals can (and do) get hacked, but that's another story for another day.
Also, not every cryptocurrency has the same belief story. Some, like Bitcoin and Ethereum, have been around a long time and have a lot of people running software to secure the network meaning the trust story behind the cryptocurrency is very high. Many others (literally thousands of others) don't have as many people involved and in some cases, their value proposition is questionable. Before you decide to own a cryptocurrency, you should understand the value story behind it.
Simple to understand, you say?
Yes. Watch this 26 minute video and you will understand exactly how blockchains and cryptocurrency actually work. 26 minutes is a worthwhile investment in your financial education to simply understand a very amazing and complex system.
But it's still complicated, right?
This is true and something I'm currently working to fix with my role as the Managing Director for the Foundation for Interwallet Operability which built a way to make this easier called the FIO Protocol. With the FIO Protocol, instead of the complicated string of characters like 1NsjbyuNdiRhxsawR4QDW3JVGMWCsSZ58K you can instead use a simple human readable name like luke@stokes. You can also request value from others and include notes about transactions (similar to how you see a memo next to transactions on your credit card statement).
You can get yourself a human readable name using a cryptocurrency wallet (that's software which keeps your private keys safe) which has integrated with the FIO Protocol: https://fioprotocol.io/free-fio-addresses/
If you're not sure which wallet to choose, try the Edge Wallet.
Let me know what your human readable FIO Address (in the username@domain format) is in the comments. I hope this post was useful to you. Please share it with your friends who are wondering what cryptocurrency actually is.