Digital currency
Digital currency is a type of currency that exists only in electronic or virtual form. It has no physical equivalent, such as banknotes or coins.
In the context of Cambridge Computer Science exams, when you see the term 'digital currency', it almost exclusively refers to cryptocurrencies (like Bitcoin) that use decentralised systems and blockchain technology. Do not confuse this with standard electronic bank transfers (e.g., using a debit card), which are centralised and managed by traditional banks.
Key characteristics include:
- It is decentralised: No single authority (like a government or bank) controls it.
- It uses encryption to secure transactions and control the creation of new units.
- Transactions are recorded on a distributed ledger.
Building on the concept of a ledger, a blockchain is a chain of blocks. Each block contains:
- A list of recent transactions.
- A timestamp (recording when the block was created).
- A unique code called a hash (a digital fingerprint of the block's data).
- The hash of the previous block in the chain.
This linking of hashes is crucial: if anyone tries to alter a transaction in an old block, its hash changes, which breaks the link to the next block, making the tampering obvious.
How are transactions verified and added to the blockchain? This process is called mining.
- Transaction Broadcast: When a user sends digital currency, the transaction is broadcast to the network of nodes.
- Verification (Mining): Specialised computers (miners) compete to solve a complex mathematical puzzle (Proof of Work). This verifies that the transactions are valid and prevents double-spending.
- Block Creation: The first miner to solve the puzzle creates a new block containing the verified transactions.
- Reward: The successful miner is rewarded with newly created digital currency units. This is how new currency enters circulation.
- Chain Update: The new block is added to the blockchain, and the process repeats.
Imagine Alice sends 1 Bitcoin to Bob.
- Initiation: Alice signs the transaction with her private key. The transaction is broadcast to the network.
- Verification: Miners check Alice's digital signature and ensure she has enough balance. They group this transaction with others into a candidate block.
- Mining: Miners solve the cryptographic puzzle. One miner succeeds.
- Recording: The new block (containing Alice → Bob) is added to the blockchain. It includes a timestamp and links to the previous block.
- Completion: The network updates its ledger. Bob now has 1 Bitcoin. The transaction is irreversible and traced permanently on the public ledger.
Correction: While bank balances are digital, they are centralised. The bank controls the ledger. In Cambridge exams, 'digital currency' refers to cryptocurrencies which are decentralised and use blockchain. Always mention 'decentralised' or 'no central authority' to distinguish it from standard e-money.
Correction: A blockchain is a distributed ledger. It is copied across many computers (nodes). If one computer fails, the network continues. Also, remember that blocks are linked by hashes, not just by order.
Why examiners accept this: Examiners look for specific technical terms that demonstrate understanding of the system's security and structure. Vague answers like 'it is safe' are not enough.
Correct phrasing: Use phrases such as:
- 'It uses a distributed public ledger.'
- 'Transactions are encrypted and time-stamped.'
- It is decentralised (no single point of failure/control).
- Blocks are linked by hashes.
Example Answer: 'Blockchain is a decentralised, distributed public ledger where transactions are encrypted, time-stamped, and linked via hashes to ensure integrity.'
Why examiners accept this: You must explain that verification is not automatic; it requires computational work (mining) to secure the network and prevent fraud.
Correct phrasing: Use phrases such as:
- 'Miners solve complex mathematical puzzles.'
- 'This process is called mining or proof of work.'
- Successful miners are rewarded with new currency units.'
Example Answer: 'Transactions are verified by miners who solve complex mathematical puzzles. The first miner to solve the puzzle adds the block to the blockchain and is rewarded with new digital currency.'
- It exists only electronically/virtually (no physical form).
2. It operates on a decentralised system (or uses blockchain/encryption).
- Transactions are recorded on a distributed public ledger shared across many computers.
2. Blocks are linked by hashes, making it difficult to alter past records without detection.