Virtual Currency Fundamentals and Blockchain Technology
This domain tests whether you understand how virtual currency actually moves and who controls it, because every later rule - travel rule, sanctions screening, custody, tax reporting - depends on those mechanics. Expect questions on ledger models, consensus, wallet custody, transaction finality, and the compliance consequences of hosted versus unhosted addresses.
Ledger and transaction mechanics
- Bitcoin uses an unspent-transaction-output (UTXO) model: coins are consumed and recreated as outputs. Ethereum-style chains use account balances plus a nonce to order transactions.
- A transfer is valid only when signed by the private key controlling the address. Key control is the operational reality; legal ownership is a contract layer on top.
- Confirmations reduce settlement risk but do not eliminate it. Chain reorganizations can reverse recent blocks, which is why exchanges set confirmation thresholds before crediting deposits.
- Permissionless chains are pseudonymous, not anonymous: every transfer is permanently recorded and linkable through clustering and off-chain data.
Custody models
- Hosted (custodial) wallets hold keys for customers. The provider can freeze balances, reverse internal ledger entries, and is clearly an AML-obliged financial institution.
- Unhosted (self-custody) wallets leave keys with the user. The provider sees addresses only and must lean on blockchain analytics, IP data, and customer statements.
Worked example
A customer sends 2 BTC on-chain to an exchange, which credits an internal database balance after three confirmations. A reorganization at depth two would have reversed the deposit before credit - the confirmation policy protected the exchange. After crediting, the customer's trades never touch the chain; only withdrawals do. So an internal transfer is not an on-chain transfer for travel-rule or reporting analysis.
Traps
- Calling the blockchain anonymous. It is pseudonymous and traceable.
- Treating an exchange ledger movement as an on-chain transaction.
- Assuming immutability means funds cannot be frozen.