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How Do Digital Currencies Work?

Digital currencies are electronic money that aren’t denominated by any national currency, nor are produced by any government-endorsed central banks.  These currencies are known as “alternative currencies,” and thus are sometimes called “altcoins.”  

Many digital currencies are cryptocurrencies, a type of digital currency that relies on cryptography, as well as a proof-of-work scheme.  Essentially, it involves a mathematical process to create the currency at a reasonable rate so that the currency doesn’t become too numerous, and thus, lose its value.  Bitcoin was the first cryptocurrency, while many others have followed.

The second-most valuable “altcoin” is known as “litecoin.”  It shares many similar features to bitcoin, but it has a shorter block rate (litecoin’s block rate is 2.5 minutes versus bitcoin’s 10 minutes).  This means that the litecoin can be processed and put into people’s digital wallets faster than the bitcoin can.  Even though litecoin is cheaper than bitcoin, it is not as popular as Bitcoin, and thus, litecoin is used in fewer places than bitcoin.

The third-most valuable “altcoin” is known as “peercoin.”  It too is modeled after Bitcoin, but unlike Bitcoin, peercoin has no hard limit on how many peercoins will be mined.  The only certainty is that peercoin is designed to eventually hit a target of one percent inflation.  That could help the peercoin to last long term as a digital currency.

“Namecoin” is the fourth-most valuable “altcoin.”  It is very interesting because it is the first prominent iteration of the Bitcoin model to serve a function beyond payments.  It is designed to manage information access, as it utilizes all of the same Bitcoin principles to serve as a distributed Domain Name System (DNS).  With this unique feature, it may survive on its own even if Bitcoin fails.  There may be further variations of this type of model as well in the future.

“Primecoin” is interesting in its own right because the mining of this digital currency actually contributes to society by implementing scientific proof-of-work.  As a result, new blocks of this digital currency are generated every minute, which results in smoother difficulty adjustments and faster transaction times.

One other interesting “altcoin” that is not like Bitcoin and the other digital currencies is “ripple.”  Ripple has gained much venture capital from Google Ventures, Andreessen Horowitz, Lightspeed Venture, and other venture capitalists.  It acts as a decentralized payment system and exchange to complement other currencies, both virtual and physical.

Digital currencies work by mining those currencies on one’s computer via a “mining” software that brings about the currency.  This is recorded in the respective network to show such new units of the currency exist.  These coins can go into a person’s digital wallet, then be used to complete transactions. The types of transactions include physical items such as books and video games to digital items such as domain name registration and digital salaries for work performed.

As you can see, there are more digital currencies out there than just Bitcoin, and it seems to be that there will probably be more in the future, both based on current digital currencies and even brand new ones.  

As the world continues to become more “digitized” in terms of the Internet and e-commerce, digital currencies will continue to gain more prominence and use.  While replacing physical currencies is probably unlikely, especially in the near future, having more sites accepting digital currencies and conducting transactions using digital currencies is probably likely.


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