What are cryptocurrencies? Hmm. Good question. But let's start with something just a tiny bit easier. What aren't cryptocurrencies? In fact, cryptocurrencies are not like anything we're used to having in our wallets or keeping track of in our bank accounts. 

They're not this.  

Or this.  

Or this.  

These items all represent currency that the Bank of Canada stands behind.  

And the Bank of Canada does not stand behind cryptocurrencies. Neither does any other central bank or government or in fact any institution. Which is what we mean when we say that cryptocurrencies are decentralized. 


Even though cryptocurrencies are decentralized, it doesn’t mean that they don’t follow any rules. They do. It’s just that those rules exist outside the traditional financial system… and within a computer network. 

In 2009, Bitcoin, the first decentralized digital currency, introduced a technology known as the blockchain.  

Imagine the blockchain as an enormous ledger in which every transaction on the network is recorded, making sure no user can cheat the system by spending the same money twice.  

Thousands of specially equipped users around the world—known as “miners”— verify these transactions. Recording them on the blockchain earns those miners new Bitcoin. It’s a permissionless system -- that means nobody needs permission to become a user or a miner and no institution is in charge of the system. 


But why go to the trouble of using cryptocurrencies? What’s wrong with cash, debit, and credit?  

Some people are in favour of money that is not managed by governments and that functions outside of existing bank systems—a political statement. 

Others regard cryptocurrencies as investment opportunities. If you're able to catch cryptocurrencies on the way up and sell before they head down in value, you can make a tidy sum. 


Just like cash transactions, there is no exchange of personal information when you buy something with cryptocurrencies. With them, users can now make transactions online anonymously. This can be attractive for many reasons. 

But, nothing’s perfect. It may be possible to use information outside the blockchain to reveal the identity of a user. The FBI used that kind of information to help shut down Silk Road, an illegal goods trading platform that used Bitcoin. 

Concern over cryptocurrencies is growing. A number of countries, including Canada, plan to develop coordinated policies to regulate this new form of currency. 

Cryptocurrencies are on the rise—it’s a story still unfolding. 


Most people use a digital wallet to send and receive cryptocurrencies. A digital wallet can be an online application or an app installed on your computer or smartphone. 

A wallet generates and stores all the public addresses and private keys assigned to every transaction you will ever record on the blockchain. Think of it as an old-fashioned bank book that shows all the balances you hold at each address. 
 
So where do you buy a cryptocurrency? Enter the digital exchange.


It’s here that most people buy and sell cryptocurrencies using debit or credit—as you normally would for any online purchase. 

And just like shares on a stock exchange, the value that they’re bought and sold at can fluctuate greatly. 

You can buy some cryptocurrencies at some ATMs or even directly from another person. 


Which is all good – but let’s face it, smartphones and hard drives can fail and wallet websites can go bust, so backing up your keys to other devices is highly recommended.  

As a safeguard, some users print out versions of their public addresses and private “keys” as QR codes that can be quickly scanned back into the system when needed. Some even write out their keys by hand. 

Your digital wallet is only as safe as the media it is stored on. Just like losing cash, if you lose access to your private keys, you’re out of luck. But unlike losing cash, lost cryptocurrency can never be found—by anybody. 

Cryptocurrencies aren't just used online, but also in some “real world” stores.  


To make a transaction, both buyer and merchant must be able to access their own digital wallets.   

For a Bitcoin transaction, the merchant will enter the price into their digital wallet. If the price is in dollars, the wallet will automatically convert the price into Bitcoin. A QR code will appear on the merchant’s monitor. 

When scanned with the buyer’s smartphone, this code tells the buyer’s wallet where the funds should be sent to. 


The buyer enters the amount of the purchase and then taps send, broadcasting the transaction on the network for verification. 

Wallet applications add a small transaction fee to the purchase; normally around five cents for Bitcoin, which is paid to the miner. This encourages miners to collect and process transactions quickly.  

Bitcoin payments usually take around ten minutes to appear in the merchant’s address.  


In most cases, merchants who say they accept Bitcoin won’t actually handle the cryptocurrency at all. For a fee, the transaction can be routed through a third‑party payment processor, who accepts the buyer’s Bitcoin, converts it into dollars, and then sends it to the merchant.  


New cryptocurrency is generated through a process called mining. Bitcoin miners are users who compete to validate and record transactions by solving cryptographic problems. This process is called proofofwork. 

The first miner to solve this problem is paid what’s called a block reward: newly created Bitcoin, which happens about every 10 minutes. 

Mining is a highly competitive business. 


The early miners’ desktop PCs have long since been replaced by mining rigs with lightning quick, specialized processors. These are now chained together by the hundreds in warehouse spaces called mining farms. 
 
Smaller miners cooperate in networked pools to compete with these big farms. Some miners don’t own rigs at all, but simply rent a portion of a farm’s computational power. 

But as miners add more computing power to compete to solve a proof-of-work problem, the network automatically increases the difficulty of it to maintain the 10-minute interval, making it even harder for miners to make money. Every four years, the block reward is cut in half.  


It's unclear what will happen as Bitcoin block rewards become too small for profitable mining. A hike in Bitcoin value or higher transaction fees may become necessary to compensate miners.  

Smaller miners may abandon some cryptocurrencies altogether. 


Networks would then become almost centralized, composed of a smaller and smaller number of powerful mining operators…operators who are accountable to nobody.  

But without mining, there are no transactions, so cryptocurrency developers may have to discover new solutions to these unique problems.