[5.2.1–2] Digital currency & blockchain
Digital Currency and Blockchain: Core Ideas
What is a digital currency?
Digital currency is money that exists in electronic form. You cannot hold it like coins or notes; instead it is stored and moved as entries in computer systems. Some digital currencies are issued and controlled by a central authority (e.g. a bank's internal system), while others are decentralised and operate without a single controlling organisation. The most well-known decentralised digital currencies are often called cryptocurrencies because they rely on cryptography to secure transactions and to control the creation of new units.
At IGCSE level you should be able to explain how a decentralised digital currency records transactions, why people can trust the record without a central controller, and what role blockchain plays in making it tamper-evident. You do not need to write code, but you should understand the sequence of steps that a typical transaction follows and the main advantages and limitations.
Why Blockchains?
From ledgers to distributed ledgers
A ledger is a list of transactions showing who paid whom and how much. In everyday banking, the bank holds the ledger and you trust the bank to maintain it correctly. A distributed ledger shares the ledger across many computers (called nodes) on a peer-to-peer network. Everyone stores and updates a copy. The goal is that no single party can secretly alter past records.
A blockchain is one approach to building a distributed ledger. Transactions are grouped into blocks. Each block contains a summary of the previous block (a cryptographic link) so that blocks form an ordered chain. If someone changes a transaction in an old block, the summary would no longer match, alerting everyone that the data was altered. This property makes the chain tamper-evident.
How a Blockchain Records Transactions
From the user's wallet to a confirmed block
Users typically hold a pair of keys in a wallet: a public key (like an account address that others can see and send funds to) and a private key (kept secret and used to authorise spending). When the user wants to transfer digital currency, the wallet creates a transaction and broadcasts it to the network. Nodes verify it and include it in a new block that, once agreed by the network, becomes part of the permanent record.
The wallet constructs a transaction stating that address A transfers a specific amount to address B. The wallet signs this with A's private key to prove authority. Nodes check that A has enough unspent balance and that the signature is valid. The transaction is placed into a block and, after the block is accepted, B's address shows the new funds. Later blocks add further confirmations, increasing confidence that the payment is final.
If a user tries to spend the same funds twice, nodes detect that one of the transactions uses already-spent outputs. Only the transaction that appears first in the accepted chain remains valid. The later, conflicting transaction is rejected as it attempts to reuse funds that no longer exist in the unspent pool.
Occasionally two valid blocks are created around the same time, causing a fork (two competing tips). Nodes follow a rule such as the longest or most-work chain. As more blocks are added, one branch becomes clearly longer and the network converges on that branch. Transactions in the abandoned branch are returned to the pending pool unless they also exist in the winning chain.
Security Building Blocks
Keys, hashes and consensus (at a conceptual level)
- Public/private keys: The public key (or derived address) is shared so others can send funds. The private key stays secret and is used to create digital signatures that prove the owner authorised a transaction. Without the correct private key, a transaction cannot be forged.
- Hashing: A hash function turns any input (like a block of transactions) into a fixed-length output that looks random. If the input changes, the output changes unpredictably. Each block stores the hash of the previous block, linking the chain.
- Consensus: The network needs a fair way to agree which block becomes the next in the chain. Different blockchains use different consensus methods. For example, proof of work requires significant computation to propose a block, while proof of stake selects validators based on stake or reputation. At IGCSE level, it is enough to know that consensus makes it difficult for a single dishonest participant to control the ledger.
Comparing Digital Money Models
Centralised vs decentralised approaches
| Feature | Centralised digital money (e.g. bank records) | Decentralised blockchain currency |
|---|---|---|
| Who keeps the ledger? | A single organisation (bank or payment provider) | Many independent nodes across a network |
| Trust model | Trust the institution's security and policies | Trust the open protocol, cryptography and consensus |
| Reversing payments | Possible via customer support or chargeback | Generally irreversible once confirmed in the chain |
| Availability | Dependent on provider's systems | Network continues as long as enough nodes run |
| Privacy | Institution sees user identities and balances | Addresses are pseudonymous; activity is public on the chain |
| Performance | High-speed within a private system | Varies; public networks may be slower to ensure consensus |
From Idea to Everyday Use
Practical scenarios
A retailer displays a blockchain address or QR code at checkout. The buyer's wallet signs and broadcasts a payment. The shop's system waits for a set number of confirmations before shipping. The benefit is global reach; the drawback can be waiting time and price volatility.
Two people in different countries use a digital currency to send funds without the delays of traditional banking. Fees and times vary by network, but transfers can settle outside banking hours. The sender must still take care with addresses because transactions are hard to reverse.
Blockchains can store proofs of events, such as certificates or supply chain steps. The chain makes later tampering visible. However, large files are not stored directly on-chain; instead, a small reference or hash is recorded.
Strengths and Limitations
Balanced evaluation for exams
- Strength: Integrity - Linking blocks with hashes makes alterations easy to detect, helping preserve a trustworthy history.
- Strength: Resilience - Many nodes share data, so there is no single point of failure.
- Strength: Open verification - Anyone can independently check the chain of transactions.
- Limitation: Throughput - Public chains may handle fewer transactions per second compared with centralised payment systems.
- Limitation: Finality time - Users often wait for several confirmations before a payment is considered final.
- Limitation: Key management - If a private key is lost, access to funds can be permanently lost.
- Limitation: Energy or resource costs - Some consensus methods require significant resources; others reduce this at the cost of different trade-offs.
Key Terms and Definitions
| Term | Definition |
|---|---|
| Digital currency | Money represented as digital records rather than physical notes or coins. |
| Cryptocurrency | A decentralised digital currency that uses cryptography to secure transactions and control supply. |
| Wallet | Software or hardware that stores public and private keys and manages transactions. |
| Public key / address | The identifier others use to send funds to you; safe to share. |
| Private key | Secret information used to sign transactions; must be kept secure. |
| Block | A batch of verified transactions plus metadata, linked to the previous block by a hash. |
| Blockchain | An ordered chain of blocks that together form a tamper-evident ledger. |
| Consensus | The method nodes use to agree which block becomes the next in the chain. |
| Double spend | An attempt to spend the same funds twice; honest nodes reject the second transaction. |
| Fork | When two valid blocks temporarily compete; the network later converges on one branch. |
| Confirmation | Each block added after a transaction's block counts as an extra confirmation of finality. |
Key Takeaways
- Digital currency is electronic money; decentralised versions rely on cryptography and networks rather than a single institution.
- A blockchain groups transactions into linked blocks so that changes to history become obvious to everyone.
- Public and private keys enable users to receive funds and authorise spending securely.
- Consensus allows many nodes to agree on one shared ledger, resisting double-spends and tampering.
- Blockchain systems offer integrity and resilience, but may have limitations such as slower throughput and irreversible transactions.