Key Takeaways:
- Cryptocurrencies operate on a decentralized network called the blockchain, allowing for secure transactions without a central authority
- Cryptocurrencies offer advantages over traditional currencies, including decentralization, limited supply, tamper-proof transactions, divisibility, and anonymity
- Cryptocurrencies utilize cryptography for security and validation of transactions, employing public-key cryptography and hashing algorithms to protect information
What is Cryptocurrency?
Cryptocurrency is a digital currency using cryptography.
It is not issued by any central authority, like a traditional currency.
It operates on a decentralized network known as the blockchain. This technology provides a distributed ledger which records transactions across many computers, also known as nodes.
They have no physical form like we know it from traditional money, also called fiat money. It just exists in virtual form, which makes it harder to understand for most people.
Bitcoin was the first cryptocurrency created by a person or group called Satoshi Nakamoto. The invention of Bitcoin also opened the path for many other cryptocurrencies which are now available.
They all share a similar technology to facilitate secure payments and store value without a central institution.
This allows people to stay in full control over their funds. The more people realize this new technology, the more it will continue to grow in popularity.
This way, it could be an attractive alternative to traditional money.
What Are the Advantages Over Traditional Currencies?
Cryptocurrencies were developed to eliminate the disadvantages of fiat money.
The major factor is the decentralization aspect.
This means no financial institution or government regulates it. This allows us to exchange it freely, without limits.
The main purpose is to provide an alternative financial system without needing third parties or intermediaries to operate.
The major differences between traditional money and cryptocurrencies are:
Decentralization
Decentralization is the key advantage over traditional money.
It means that no institution controls it.
Instead, it is managed by a network of nodes. These nodes verify the transactions instead of a single central source. This offers not only full transparency but also security.
Because of decentralization, it is nearly impossible to manipulate the system or control the transactions within it. These risks are higher by using banks.
Transactions are also faster because a third party doesn’t need to validate it with its slow system.
This even allows for extremely small fees because no intermediary has to be paid for its service. This advantage is even more prominent if you transfer money between countries.
Limited Supply
Cryptocurrencies can have limited supply, but not every crypto offers it.
Bitcoin has a limitation of 21 million units.
This means that there won’t be more coins, which cannot be just printed as traditional money. This makes Bitcoin scarce and gives it another key advantage. The blockchain allowed for the first time to limit a virtual asset.
Because we cannot multiply the supply inflation cannot happen with this asset. This is a key advantage over traditional currencies, which are multiplied as often as the government needs it.
Other digital money like Ethereum doesn’t have a limit. But they limit the amount of ether that can be created per day depending on the amount staked. A limited supply similar to gold can give the potential for an increase in value.
Tamper Proof
Transactions are recorded on the blockchain and cannot be changed.
This makes them tamper proof.
There is no possibility of copying crypto and using this fake version. The recorded transaction in the ledger would immediately detect that these coins don’t match with the records. Every transaction tried with fake crypto would be rejected.
Therefore, there is no possibility to use copied crypto. Traditional money can be printed and criminals can print it, too. They can print in a quality which is not distinguishable by inexperienced people.
To alter the blockchain, a participant needs more computing power than the rest of the network.
Because all computers in the network have a significant amount of computational power when summed, no one could provide even more of it.
Divisibility
Compared to traditional money with a divisibility up to two decimal places, crypto can be divided much more.
Bitcoin, for example, can be divided up to a hundred million subunits.
This allows for a much more efficient usage. This can open a new market allowing for micro-payments. These types of payments could have a value worth a fraction of a cent. This enables small fees or the smallest purchases.
With traditional money, transfers with small amounts of funds are expensive and cheap things are sold in packages containing dozens of the same product.
The divisibility could allow for more flexible payment solutions in the future.
Anonymity
You need to provide personal details to use bank accounts.
For crypto, you can use it without this information.
You only need your wallet address and your private keys to transfer it. This way you can stay anonymous and it is harder to trace you. The blockchain ledger is public and the transactions on it, too. Everyone can trace the transaction from a wallet address.
These addresses don’t contain any personal information, so no one knows to whom it belongs to. A problem here could be that if someone achieves to connect a wallet address to you, then he could trace all your transactions.
Therefore, you should always apply maximum caution to everything you do on the internet.
Smart Contracts
The Ethereum blockchain provides further use cases besides only to work as a currency.
Its technology allows for creating further applications such as decentralized apps, smart contracts or Non-Fungible Tokens known as NFTs.
The technology the blockchain provides allows not only to solve the double-spending problem by giving an actual proof of ownership.
The proof of ownership can also apply to other data like applications, files, images or documents.
It opens many possibilities to provide the same proof for all kinds of applications.
This market is relatively new, but in the future it could provide useful applications.
How Does Cryptocurrency Work?
Cryptocurrency uses cryptography to secure its transactions.
They are created by two methods, depending which one was chosen by the developers.
We can create them by using “staking” or “mining”. With staking, a user provides a specific amount of coins which need to be lent. You lend the coins and lock it into the system. They are now used to validate transactions for which you get rewarded.
With mining you operate a computer which solves mathematical problems. If you solve the problem, you get rewarded. The mining process also validates the transactions in the ledger. New coins are created in this mining process.
The person who got the newly created coins can now hold or sell cryptocurrency to the market. Another possibility to get crypto is to buy it. For this you need a digital wallet which provides you an address similar to a bank giving you a bank account number.
With these addresses, you can store cryptocurrency and buy or sell it.
How Do Cryptocurrencies Use Blockchain Technology?
The blockchain is the essential part of any cryptocurrency.
It enables us to solve the double-spending problem each electronic payment system encounters.
Imagine you have a file on your computer and want to send it to someone else. If he gets this file, then you don’t have it anymore. But what if you make a copy before you send it?
The other person also gets the file, but what they don’t know is that you have a copy. Now you can take this copy and send it to another person. Now you sent the file two times without both people knowing that they aren’t the only one now possessing this file.
This is the double-spending problem. We cannot prove clearly that there aren’t any copies of this file. We would need a system which would allow us to prove that the file is available only one time with no copies possible.
The blockchain finally solved this problem. It tracks all transactions related to every coin. This is the same principle as how a bank works. They also have a ledger and keep track of it. This way banks solve this problem.
The difference here is that fiat currencies need intermediaries (banks) which record the transaction, so no money is double spent.
Cryptocurrencies use the blockchain instead of intermediaries for the same purpose.
The network of all nodes taking part in it maintains the blockchain. Therefore, this system is not centralized, but decentralized. This prevents one entity from having the power over the currency.
What is Proof-of-Work and Proof-of-Stake in Cryptocurrency?
Both are two methods to create new crypto and to validate transactions on a blockchain.
It depends on the developers which model they choose to create a new cryptocurrency.
With staking, a participant can hold a specific amount of crypto in a wallet and lock it there. This allows the user to become a validator. With this status, he can now validate with his node the transactions on the blockchain. This is Proof-of-Stake (POS).
For this work, he gets paid in transaction fees. The Proof-of-Work (POW) process also allows a participant to validate a transaction, but instead of staking your own crypto, you just need a computer to mine a new crypto.
Your computer gets a node and receives complex problems to solve. This requires a significant amount of computational power.
Within this process, you validate transactions on the blockchain and also get transaction fees as a reward for it.
With mining, you also get newly mined crypto as an additional reward. This process is extremely hard, so only mining farms with enormous amounts of resources can mine new coins in an acceptable time frame.
How to Mine Cryptocurrency and How Does It Work?
Crypto mining is verifying transactions and creating new crypto.
Miners who need powerful computers to solve mathematical equations do this process.
This allows them to prove the authenticity of the transactions. A batch of these validated transactions is added into a new block. After the validation process, the block is added to the blockchain.
The miner who solves the problem gets the privilege to add the block to the blockchain and gets newly created coins as a reward for it. Bitcoin is the most popular example which uses this mechanism.
Bitcoins are also the reward a miner gets for his effort. This is an essential part of the blockchain, allowing it to provide a decentralized character. Because all miners are in competition, there is no central instance controlling this process.
The first miner, which can solve the problem, gets rewarded. Therefore, the miners are incentivized by upgrading their systems to compete. This further increases the security of the blockchain.
The more powerful the miners are, the harder it is to manipulate the data.
This is the case because it is always a majority of the computational power needed to validate the transactions.
If a crypto uses the Proof-of-Stake mechanism, the mining process is not used. Ethereum is the most common cryptocurrency which uses this mechanism. In the past, it also used the POW mechanism but changed to POS in late 2022.
Within this system, the blockchain creates new coins by itself and not by its users. The users can only validate transactions.
How is Cryptography Used for Security and to Validate Cryptocurrency Transactions?
Cryptography is the pillar of any cryptocurrency, giving these currencies their name.
It is a technique used to protect information through code.
Cryptocurrencies use it in the form of hashing algorithms. This part of the blockchain gives it top security. Without it, every data would be readable and the entire technology would be useless. It gives the mathematical problems their difficulty.
The concept of Public-Key Cryptography is used by cryptocurrencies. It means that there are two separate keys needed in order to decrypt and encrypt data. These keys are called public and private keys. The public key encrypts data.
The public key works as an address. These addresses can receive cryptocurrency. The address is public and can be seen and read by anyone. This makes sense because you want people to send crypto to your address.
Therefore, it should be publicly available. The public key always comes with a corresponding private key. The private key allows access to the data which the public key has received.
This way, only the person with the private key can access the data. Here, addresses receive cryptocurrency.
Everyone can send cryptocurrency to this address and look in blockchains public ledger to see what the amount of funds is stored in there. The private keys then allow access to this data. This principle allows this system to work securely.
Types of Cryptocurrency (Bitcoin, Ethereum, etc.)
Since the inception of Bitcoin, many other cryptocurrencies have been invented.
The most known alternative is Ethereum.
But this is the name for its blockchain. This blockchain creates a cryptocurrency called ether. This is often misinterpreted. If people talk about this crypto, they often mean ether instead.
Besides it, there are cryptocurrencies like Tether (USDT), Binance Coin (BNB), USD Coin (USDC), or Ripple (XRP). We commonly describe all alternatives to Bitcoin as “altcoins”. Therefore, we can divide all cryptocurrencies into Bitcoin or altcoins.
With altcoins, we can divide them further into regular altcoins or “stablecoins”.
Stablecoins are cryptocurrencies which are tied to a real asset.
The reason is to maintain a stable value instead of the extreme volatility other cryptocurrencies can have. Tether is the most known stablecoin and tied to the value of the United States dollar.
Another way to group cryptocurrencies is to group them in regular cryptocurrencies like Bitcoin or crypto which allows the use of smart contracts, decentralized apps or Non-Fungible Tokens like Ethereum.
Cryptocurrencies have seen tremendous growth in interest in recent years because they provide many opportunities.
How to Use Cryptocurrency?
Using cryptocurrencies is relatively simple.
In the first step, you will always set up some kind of wallet.
With your wallet, you will get an address. This address is needed to receive and send cryptocurrency. You will further need an account at some service where you will buy or sell crypto. The most popular and easiest way to buy crypto are crypto exchanges.
Once you have set up an account, you can buy crypto. After you have bought your crypto, transfer it to the wallet you have also created.
If your crypto is finally on your wallet, you have full control over it and can now use it to buy things or store it as an investment. Today, we don’t have many possibilities to buy goods and services with crypto.
But more and more merchants are accepting it and this will probably expand in the future. Keep in mind that most of the time, only Bitcoin is accepted as payment.
This is because, as the oldest and first cryptocurrency, it is more accepted compared to other cryptocurrencies.
How Can You Buy Cryptocurrency?
Buying cryptocurrency is also relatively simple.
You will need a wallet so you can store your crypto on it.
Once you have set up a cryptocurrency wallet, you can go to a crypto exchange and buy whatever crypto you choose. The process is the same as you would buy stocks on a regular exchange. Always go for a good exchange with reputation and competitive fees.
This will enhance your buying process and will minimize the risk of potential loss. Sometimes bad exchanges can just lock you out of your account without getting your access back. This would be a horrible experience.
Before you invest in any kind of cryptocurrency, make sure that you research this topic thoroughly to make an informed decision, knowing about all the risks and potential it can bring to you.
Should You Invest in Cryptocurrency? Is It an Excellent Investment?
Investing in crypto is something everyone should decide for itself.
It is a special digital asset that can bring you several advantages.
These advantages always come with some drawbacks. Therefore, you should always decide if such an investment is a proper match for you and your needs. Because of the major advantage crypto brings to us, it increases in popularity more and more.
The key factor is the concept of decentralization.
This brings not only an independent solution without a central institution having control over it but also security, as this institution could easily get hacked.
To hack and manipulate the blockchain, you would need to have more power than more than half of the entire network. This will practically be impossible even for a group of hackers to achieve.
People could even invest because of the interest in new technologies it can bring to us now and in the near future. If you believe new markets could emerge from this technology, then you could invest in it to support it and be part of it.
The market capitalization has increased significantly over the years.
This happened because of the growing level of trust people and companies have put into this new market. Also, because this market is new, it is extremely volatile.
This brings a lot of risks for your funds. This is the biggest disadvantage you should keep in mind. Before you invest, try to do your due diligence as well as you can and be always cautious before you invest your own money into a new asset you don’t know.
FAQ
What is the Market Capitalization of Cryptocurrencies?
As of January 2023, the market cap has broken through 1 trillion USD.
It is already one of the most valuable assets, even if the market goes down from the peak in 2021.
The market capitalization reflects the total value of all cryptocurrencies in circulation and shows how much money is being invested in this market.
Bitcoin has nearly half of the entire capitalization with currently about 445 billion USD.
It shows that Bitcoin is the most important and accepted cryptocurrency in the market.
Ethereum, as the second largest cryptocurrency, currently has a capitalization of about 193 billion USD.
Here you can see that both these cryptos control the biggest part of the entire market.
How Many Cryptocurrencies Do We Have?
As of January 2023, and based on the information of CoinMarketCap, there are currently slightly below 9,000 cryptocurrencies in circulation.
What we should note is that most of these cryptocurrencies are new and not widely accepted.
Therefore, they can be extremely volatile or lose all their value. Most of them are extremely risky, so especially for beginners, focus on the most known and secure cryptocurrencies.
The most popular cryptos are Bitcoin, Ethereum, Tether, Binance Coin, USD Coin or Ripple.
Each cryptocurrency may offer you distinct features or functions.
Some are intended as a storage of value and others allow you to use them for further applications based on their technology.
Is Crypto Real Money or a Real Currency?
This will depend on how you see it.
Crypto has the same characteristics as money, so it can also be valued as real money.
If you think that a government can only introduce a real currency, then you wouldn’t count crypto as real money but more as an alternative asset to invest in.
You can use crypto to buy goods and make any type of payments in the same way as you can do this with fiat money. You can further use crypto to store your wealth in it in the same way as with regular money.
As crypto will become more and more accepted, it may change from an alternative to even a newly accepted currency by governments.
A popular example is the country El Salvador, which already accepted Bitcoin as a legal tender.
Can Cryptocurrency Be Converted to Cash?
Yes, cryptocurrency can be converted to cash.
Crypto can be bought and sold easily through cryptocurrency exchange in the same way as you would buy or sell stocks on a regular exchange.
The process is the same and therefore relatively simple to convert it to cash. You would do the same process as you would buy crypto. Keep in mind that you can sell your crypto easily, but the money you get for it will stay on the exchange.
If you want to cash it out, you will need to transfer it to your personal bank account to be in full control of the money. This process is relatively straightforward and can be done quickly and safely.
Conclusion: What is Cryptocurrency?
Cryptocurrency is a digital currency that operates on a decentralized network known as the blockchain. It offers advantages over traditional currencies, such as decentralization, limited supply, tamper-proof transactions, divisibility, and anonymity.
Cryptocurrencies utilize cryptography for security and employ proof-of-work or proof-of-stake mechanisms to validate transactions. Bitcoin is the most popular cryptocurrency, while Ethereum and various altcoins offer different features and functionalities. As the understanding and adoption of cryptocurrency grow, it has the potential to become a viable alternative to traditional money.
