Digital Currency

Cryptocurrency

Cryptocurrency is a type of digital currency that uses cryptography to secure transactions and that runs on a decentralised network rather than under any single authority.

Common examples: Bitcoin, Ethereum, Litecoin.

Cryptocurrency features:

• Cryptographic security: each transaction is signed with the sender's private key, so only the legitimate owner of the funds can spend them.
• Public ledger: every transaction is recorded openly on the blockchain (covered in section 3), so anyone can verify the history of every coin.
• Decentralised: many computers ("nodes") around the world hold copies of the ledger; no single bank, government or company controls it.
• Pseudonymous: identities are represented by wallet addresses (long random-looking strings), not real names; the addresses are public, but real-world identities behind them often are not.

Exam note: the papers only ever say "digital currency" and never use the word "cryptocurrency". In real life cryptocurrency is just one kind of digital currency (centralised bank-issued digital currencies also exist), but this distinction is not tested.

Volatility

Cryptocurrencies are famously volatile: their value in dollars or pounds can rise or fall sharply over short periods. A coin worth £100 one week may be worth £150 or £60 the next. This makes them risky to hold as an investment and tricky to use for everyday pricing.

2. Cryptocurrency vs traditional currency

A side-by-side comparison covers the main differences.

Trade-offs in a single line

• Traditional currency is stable, regulated and reversible, but centralised and slow internationally.
• Cryptocurrency is decentralised, fast and (often) cheap to send globally, but volatile, irreversible, and less protected if something goes wrong.

3. Blockchain: the technology behind cryptocurrency

A blockchain is a digital ledger of every transaction in a currency, organised as a chain of blocks linked by cryptographic hashes, with copies stored across many computers in a decentralised network.

Three big ideas in that definition:

1. A ledger: a record of who owns what and who sent what to whom.
2. A chain of blocks: transactions are grouped into "blocks" and each block links to the previous one through a hash, so the whole history is connected in order.
3. Distributed across many computers: no single computer holds "the" blockchain; many computers (nodes) keep copies and agree on the same version.

What is inside a block?

Each block typically contains five things:

What a hash is

A hash is the fixed-length cryptographic fingerprint of some data, produced by a one-way function. Even a tiny change in the data produces a completely different hash.

Two important properties of a hash:

• Deterministic: the same input always produces the same hash.
• Sensitive to change: changing even one character in the input produces an utterly different output. This is what makes hashes useful for spotting tampering.

How blocks form a chain

Each block stores the hash of the previous block in its own header. This is the "link" in the chain:

Block 0          Block 1          Block 2          Block 3
[ hash: H0 ]     [ hash: H1 ]     [ hash: H2 ]     [ hash: H3 ]
                 [ prev: H0 ]     [ prev: H1 ]     [ prev: H2 ]
[ data ]         [ data ]         [ data ]         [ data ]

The first block (block 0) is special and is called the genesis block; it has no previous block, so its prev field is zero or empty.

When a new block is added, the network calculates the hash of the latest block and stores it as the new block's prev. The chain grows one block at a time.

4. How blockchain resists tampering

The clever property of a blockchain is that an attacker cannot simply change an old transaction and get away with it. Several mechanisms work together to make tampering nearly impossible.

Mechanism 1: Hash linking propagates changes

If an attacker modifies a transaction inside an old block:

1. That block's contents change.
2. So the block's hash changes.
3. But the next block still stores the old hash as its prev value.
4. So the chain is broken: the next block's prev no longer matches the previous block's actual hash.
5. The attacker would also need to re-calculate the next block's hash to fix the link, and then the one after that, all the way to the current end of the chain.

This means a tampered block forces the attacker to rewrite every block after it, not just one. The longer ago the block was, the more work this is.

Mechanism 2: Proof-of-work makes rewriting blocks expensive

Adding a new block (mining) is computationally expensive on purpose. The network requires the new block's hash to meet a specific mathematical condition (e.g. starting with a certain number of zeros). To find a hash that meets the condition, a miner must try many random small adjustments (called the nonce) until one works.

For the Bitcoin network in particular, finding a valid block hash takes the entire global mining network roughly 10 minutes. To rewrite the last 6 blocks, an attacker would need to redo 60 minutes of the world's combined mining work, while also keeping up with honest miners who keep extending the legitimate chain. This is practically impossible for anyone short of a state-level adversary.

Mechanism 3: Distributed copies make local tampering useless

Many computers hold a copy of the blockchain. Even if one attacker quietly rewrites their own local copy, they still have to convince the rest of the network to accept it. The rule of consensus is that nodes accept the longest valid chain. An attacker's tampered chain will be shorter than the honest one (because the honest network is mining ahead), so the network simply ignores it.

To beat the honest network, an attacker would need to control more than half of the entire network's mining power (the "51% attack"). For large blockchains like Bitcoin, this would cost billions of pounds in hardware and electricity.

Mechanism 4: Every transaction is signed

Each transaction is digitally signed by the sender using their private key. Anyone in the network can use the sender's public key to verify that the signature is valid (asymmetric encryption, topic 6). Without the private key, no one can forge a transaction from someone else's wallet.

Why these four mechanisms together make tampering impractical

A blockchain is tamper-resistant because:

• A change to an old block breaks the hash chain, which everyone can detect.
• Re-doing the work to repair the chain requires more computing power than the rest of the world combined.
• Many copies of the ledger across the network mean local tampering is ignored.
• Digital signatures stop anyone from forging a transaction from someone else's wallet.

Putting the whole payment flow together: a buyer creates a transaction, the transaction is distributed and validated across the network using cryptographic hashing, the block holding it is then committed to the blockchain held by many distributed copies, and the seller receives the payment.

5. Advantages and disadvantages of cryptocurrency

These are the main pros and cons of moving from traditional money to cryptocurrency.

Advantages

• Decentralised: no single bank or government can freeze accounts, devalue the currency by printing more, or block specific transactions.
• Fast international transfers: cross-border payments settle in minutes, not days.
• Low fees (in periods of low congestion) compared to international wire transfers.
• Open ledger: anyone can audit the chain to confirm that the supply rules are being followed.
• Pseudonymous: users do not have to reveal their real identity to send or receive funds.
• Programmable: smart-contract blockchains (Ethereum and others) let people build automated financial agreements, marketplaces and games on top of the same chain.

Disadvantages

• Highly volatile prices make cryptocurrency awkward for everyday spending and risky as a savings instrument.
• Irreversible transactions: if you send money to the wrong address (or to a scammer), there is no central authority that can refund you.
• No consumer protection: no equivalent of a chargeback when goods are not delivered or services not provided.
• Environmental cost: proof-of-work mining (especially Bitcoin) consumes huge amounts of electricity, often from non-renewable sources.
• Used for illegal activity: anonymity has made cryptocurrencies popular with ransomware, fraud, dark-web marketplaces and money laundering.
• Technical literacy required: managing wallets, private keys and addresses is unforgiving. A lost private key means lost money, permanently.
• Regulation varies and is changing: some countries ban or restrict crypto; tax treatment is complicated and inconsistent.
• Scaling limits: most blockchains can only process a small number of transactions per second compared to traditional payment networks (Visa handles thousands per second; Bitcoin handles a handful).

When cryptocurrency makes sense and when it does not