How is Cryptocurrency Generated? Is it Like Normal Currency?
The Process of Creating Cryptocurrency: Is it the Same as Regular Money?
Is Cryptocurrency Generated Like Normal Currency? Cryptocurrencies are unique digital assets that have exploded in popularity in the last few years, but how are new coins and tokens minted and how are they like the regular currency we use daily?
Before we get into how they’re generated, it should be understood that cryptocurrency coins and tokens run off of blockchains, which are essentially packets of transactional data packed up in blocks and chained together to create a decentralized, immutable, and (usually) public ledger. This underlying technology allows cryptocurrencies to work autonomously without the need for a central middleman in a trustless environment usually facilitated by smart contracts on a blockchain itself.
Now that you have a brief primer of how the technology behind cryptos work, we’ll briefly touch upon the two major consensus mechanisms (protocols used to verify blockchain activity) used in crypto and how they forge new coins/tokens.
Proof of Work (PoW):
For coins that utilize the PoW consensus mechanism (such as Bitcoin and Dogecoin), miners around the world need to compete against one another in order to be the first to validate the next transaction on the blockchain. They do so by utilizing high-powered computers that essentially attempt to calculate complex mathematical puzzles and guess the correct answer (or target hash) to the problem, thus confirming the next block of data and adding it to the chain.
As a reward for validating the transaction and adding to the blockchain, new bitcoins are minted (currently 6.25 BTC per validation), and given to the miner(s) as an incentive, along with any transaction fees.
Proof of Stake (PoS):
The PoS consensus mechanism works a little differently in that the way its transactions are validated are not by computational power nor mathematical calculations, but rather by selecting a validator node from a pool of stakeholders (holders of the coin or token) who’ve locked up their coins or tokens within the network. The node that’s used to validate the next transaction is usually selected with some degree of randomness, but this can vary depending on the coin or token. For example, in some networks, those who hold more coins or tokens have a better chance at being selected. The stakeholder who owns the node that’s selected and successfully validates the data forges a new block and receives the transaction fees from that new block as a reward. Most coins and tokens using the PoS consensus mechanism have a fixed supply, therefore not all of them mint new coins or tokens with each validation. Cardano and Solana are two well-known coins that utilize PoS.
How Crypto Compares to Fiat:
“Normal” currency (also known as fiat), is government-issued money that’s backed by a central bank or government, as opposed to being backed by a commodity such as gold. Though it lacks intrinsic value, fiat money is recognized and agreed upon to be legal tender and have value by the government who mints and prints it and their citizens.
In the United States, the Federal Reserve (or the Fed) acts as our central bank and is the entity that can create new money through open market operations such as buying and selling U.S. Treasury securities, or by creating bank reserves that are issued to commercial banks. While the Fed controls the supply of money, the Bureau of Engraving and Printing and the U.S. Mint (both agencies within the Treasury) are the institutions that print new paper bills and mint new coins respectively.
As mentioned earlier, cryptocurrency is entirely decentralized. Unlike fiat, there’s no central entity in control of how it operates. Instead, it utilizes smart contracts and blockchain technology to function and create new coins or tokens all on its own. Additionally, most blockchains that record crypto activity are public and all transactions can be found with some light research, another way it differs from traditional currency which can be a lot more difficult to track.
Closing Thoughts:
While somewhat similar in their uses and underlying purpose, cryptocurrency and fiat are vastly different in how they are created, not to mention how they’re used worldwide. The old saying “cash is king” still holds true for most, though crypto adoption is slowly but surely spreading throughout the world. Many ardent crypto believers see a world in which digital currencies replace fiat money completely, though for the time being the two will continue to co-exist together in relative harmony.
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