The Complete Handbook of Virtual Currency

Chapter 1: Understanding Virtual Currency

Virtual currency is not a physical object, nor is it a number stored in a bank's database. To understand what it actually is, you must first discard the mental model of a coin or a bill. Virtual currency is an entry on a shared, distributed record of ownership, a ledger that is maintained by a network of independent computers rather than a single trusted institution. The term "currency" is something of a misnomer, as these assets are often used as stores of value, units of account for programmatic contracts, or collateral for loans, rather than solely as a medium of exchange. The defining characteristic is that ownership is verified cryptographically, and transactions are settled by consensus across the network, not by a central authority.

Consider the most well-known implementation, the Bitcoin network. When you own bitcoin, you do not own a file. You own a private key, which is a 256-bit number. This private key allows you to generate a digital signature for a transaction that transfers ownership of a specific portion of the ledger to someone else's public address. This transaction is broadcast to the network. Specialized nodes, called miners, collect pending transactions into a candidate block. The miners then compete to find a value that, when hashed with the block's data, produces a specific output that meets a difficulty target. This process is called proof-of-work. The first miner to find this value broadcasts the block to the rest of the network. Other nodes