What is virtual currency? Understand virtual currency in one article: principles, characteristics, and development trends.

1. Definition and Classification of Virtual Currency#

1. What is Virtual Currency?#

Virtual currency (also known as cryptocurrency) is a type of digital currency issued based on cryptographic principles and relying on blockchain technology. It does not depend on central banks or government credit but is issued, traded, and managed through a decentralized network.

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Unlike traditional currencies (such as the Renminbi or US Dollar), virtual currencies do not have a physical form; their value is determined by market supply and demand and relies on consensus mechanisms (such as Proof of Work (PoW), Proof of Stake (PoS), etc.) to maintain their security.

3. Main Classifications of Virtual Currency#

There are many types of virtual currencies, which can be mainly classified into the following categories:

Bitcoin (BTC): The first decentralized cryptocurrency, proposed by Satoshi Nakamoto in 2009, primarily used for value storage and peer-to-peer payments.
Ethereum (ETH): A blockchain platform that supports smart contracts, with its token ETH used to pay transaction fees and run decentralized applications (DApps).
Stablecoins: Pegged to fiat currencies (such as the US Dollar) or gold to reduce price volatility, such as USDT and USDC.
Altcoins: Cryptocurrencies other than Bitcoin, such as Litecoin (LTC), BCH, DOGE, etc.

2. Core Principles of Virtual Currency#

1. Blockchain Technology#

The core of virtual currency is blockchain, which is a distributed ledger technology with the following characteristics:

Decentralization: Data is stored across multiple nodes on the chain rather than a single entity.
Immutability: Once transaction records are on the chain, they are nearly impossible to modify.
Transparency and Traceability: All transaction records can be found through a "blockchain explorer," ensuring transparency in the flow of funds.

2. Consensus Mechanism#

To ensure the validity of transactions, blockchain employs consensus mechanisms, commonly including:

Proof of Work (PoW): The method used by Bitcoin, where miners compete for the right to record transactions through computation, which is energy-intensive.
Proof of Stake (PoS): The method used by Ethereum 2.0, where holders participate in validation by staking tokens, which is more energy-efficient.
Delegated Proof of Stake (DPoS): Such as EOS, where holders vote to elect supernodes for transaction recording.

3. Cryptographic Algorithms#

Virtual currencies use asymmetric encryption (public key + private key) to ensure transaction security:

Public Key Address: Equivalent to a personal account, can be publicly shared for receiving payments.
Private Key: Equivalent to a private password, must be kept strictly confidential for signing transactions.

3. Characteristics and Applications of Virtual Currency#

Characteristics:#

Decentralization: Virtual currencies are not controlled by institutions; transactions are maintained collectively by global nodes, reducing the risk of single points of failure.
Anonymity and Transparency: Although transaction records are public, user identities are usually presented as addresses (a string of code), providing a degree of anonymity (unless linked to real identities).
Global Circulation: Virtual currencies are not restricted by regions and can facilitate cross-border instant transfers.
High Price Volatility: Due to market speculation, regulatory policies, and other factors, the prices of virtual currencies can fluctuate dramatically; for example, Bitcoin surpassed $60,000 in 2021 and then plummeted to $16,000 in 2022.
Irreversibility: Once a transaction is confirmed, it cannot be revoked, so caution is needed to avoid sending to the wrong address or falling victim to scams.

Application Scenarios:#

Investment and Trading: Many people purchase virtual currencies (such as Bitcoin and Ethereum) as long-term investments or for short-term trading, expecting to profit from price increases or decreases.
Smart Contracts and DeFi: Platforms like Ethereum support smart contracts that can automatically execute agreements and have given rise to decentralized finance (DeFi), such as lending, exchanges, insurance, etc.
NFTs and the Metaverse: Non-fungible tokens (NFTs) based on blockchain are used for digital artworks, game assets, etc.; the economic system in the Metaverse also relies on virtual currencies.
Privacy Payments: Privacy coins like Monero (XMR) and Zcash (ZEC) offer stronger anonymity, suitable for specific needs.

4. Development Trends of Virtual Currency#

1. Institutional Entry#

Companies like Tesla and MicroStrategy have purchased Bitcoin as reserve assets, and asset management giants like BlackRock have launched virtual currency trust products, promoting the "institutionalization" of the market. The trading volume of Bitcoin futures on the Chicago Mercantile Exchange (CME) has surged, blurring the lines between traditional finance and virtual currencies.

2. Development of Layer 2 and Cross-Chain Technologies#

Bitcoin (1.0): Strengthening its value storage attributes as "digital gold."
Ethereum (2.0): Ethereum's Layer 2 solutions (such as Optimism and Arbitrum) and cross-chain protocols (such as Polkadot and Cosmos) will enhance blockchain scalability. Emerging public chains (such as Solana and Polygon) challenge Ethereum's position with high performance and low costs, forming a multi-chain coexistence pattern.

3. Sustainable Development as a Core Issue#

Popularization of PoS Mechanism: After Ethereum's merge, energy consumption was reduced by 99.95%, promoting a green transformation in the industry.
Carbon Offset Programs: Some projects neutralize carbon emissions by purchasing carbon credits, responding to ESG investment trends.

4. Diversification of Application Scenarios#

DeFi: Decentralized lending and trading platforms have locked in over $100 billion, challenging traditional banking intermediary services.
NFTs: Tokenization of digital artworks, virtual real estate, and other assets opens up a new paradigm of digital ownership.
Metaverse Economy: Virtual currencies serve as transaction mediums within the Metaverse, connecting the real and virtual worlds.

The essence of virtual currency is a blend of code and economic incentives, a collision of technological idealism and capital profit-seeking. It may disrupt traditional finance or become a fleeting bubble. However, this experiment is irreversible—just as the internet changed information dissemination, virtual currencies are reshaping humanity's understanding and transmission of "value." For ordinary users, understanding its principles and assessing risks may be the optimal answer for participating in virtual currencies.