You don’t have to spend a lot of time online to have heard of the global phenomenon that is cryptocurrency – “the money of the future.”
According to Wikipedia, cryptocurrency is a “digital asset designed to work as a medium of exchange that uses strong cryptography to secure financial transactions, control the creation of additional units, and verify the transfer of assets.” However, this is only part of the whole definition.
In order to explain what cryptocurrencies are, how they work, what are their advantages and disadvantages, and what they can be used for, we have to first strip away all the hype and noise surrounding them.
Simply put, cryptocurrencies are virtual or digital currencies that work as a medium of exchange. They are called this way because they employ strong cryptography algorithms to reach consensus. An even simpler definition is that cryptocurrencies are basically limited entries in a database no one can alter without ensuring that a couple of specific conditions are fulfilled.
Cryptocurrencies came into existence somewhere in 2008, when Satoshi Nakamoto created the world’s first cryptocurrency (which is also the most popular one to date) – Bitcoin.
The creator called his invention “a peer-to-peer electronic cash system.” The system was completely decentralized, meaning that there was no designated central authority to control it and there were no servers involved. In a sense, Satoshi’s greatest feat was the fact that he had developed a way to achieve consensus in the system even without a central authority. Unlike fiat currency (typical currencies like the US dollar and the Euro), cryptocurrencies cannot be controlled by governments and financial authorities or institutions.
How does cryptocurrency work?
Before understanding how cryptocurrency works, it’s important to note that cryptocurrency, just like any other successful payment system, managed to solve the issue of double-spending, a technique that implies spending the same amount twice.
However, instead of using a traditionally trusted third party that keeps records of the transactions, in a decentralized crypto network this is done with the help of a “blockchain.” A blockchain is basically a public ledger of all the transactions that took place on the network, meaning that everyone can see every account’s balance.
A cryptocurrency network consists of multiple peers, each one with a record of the complete history of all the transactions and the balance of every account. Every transaction is a file that contains both the sender’s and the recipient’s public keys, or wallet addresses, and the total amount of coins transferred. As mentioned before, the transaction is known instantly by all the network participants. Of course, the transaction needs to be confirmed or signed off by the sender with his private key.
The transaction is broadcasted to the network only after it is confirmed, as confirmation is one of the most important aspects of cryptocurrencies. As long as a transaction stays unconfirmed, it is forgeable. Once it’s confirmed and “buried” a few blocks deep, it can no longer be reversed.
What is mining and what does it have to do with cryptocurrencies?
This is where the miners come into play, as it’s their duty to confirm the transactions. This is done by solving a cryptographic puzzle, also known as a hash. Once this happens, and the transactions are marked as legitimate and spread across the network, every node adds them to the database and, as mentioned before, they become part of the blockchain. Each series of records on the blockchain is defined as a block.
The transaction in question becomes both unforgeable and irreversible. For their services, miners are rewarded with a token of the said cryptocurrency and possibly even with transaction fees. In theory, anyone can become a miner. As a general rule, miners need to invest some work by “lending” their computers’ processing power to the network. Miners compete to be the first to solve various hashes. Those who do are the recipients of a block reward.
What do most cryptocurrencies have in common?
As described above, cryptocurrencies are irreversible. This evidently means that no one can change a transaction which has been already made. They are also pseudonymous which means that no information about transactions or accounts is connected to your real-world identity. Since the funds are stored in a public key cryptography system, cryptocurrencies are also very secure. Only the owner of a private key can send cryptocurrency.
Cryptocurrencies can also be sent anywhere in the world in a very short amount of time. Most cryptocurrencies also boast a limited supply of tokens. The supply is controlled by a schedule written in the code. For example, the Bitcoin supply is expected to reach its final number somewhere around the year 2140.
What can you do with cryptocurrency?
The simple answer would be: a lot. More and more merchants (both online and real-world), financial institutions and even countries are starting to accept cryptocurrencies as valid methods of payment. While most cryptocurrencies are not exactly-widely accepted yet, Bitcoin and Ethereum can be used to pay pretty much everything like hotel rooms and other accommodations, flights, apps, services, etc.
Cryptocurrency has also opened a very interesting gateway to investors. There are a couple of interesting stories depicting people becoming millionaires through their investments. We all know the story of how Bitcoin shifted in value from $7,000 in November 2017 to well over $19,000 in December of the same year. Currently, 1 Bitcoin is trading for $6,213 according to CoinMarketCap.
Of course, the reality is that cryptocurrencies are still considered medium- to high-risk investments and the market could only be described as volatile.
How can I buy and store cryptocurrency?
Since cryptocurrencies are digital, they can be stored in cryptocurrency wallets (i.e., Ledger Nano S, Blockchain.info, Jaxx, Coinomi and the official Bitcoin wallets for BTC). Basically, you’re not storing units of crypto, but your private key. If privacy and security are your top requirements, then you can opt for a hardware or a paper wallet. If you think that your computer’s hard drive is the best possible place for storing cryptos, then you can opt for an offline or desktop wallet. Alternatively, you can use an online wallet and access your cryptocurrency keys from anywhere.
When it comes to buying options, they range from diverse to scarce. Since Bitcoin is the most popular cryptocurrency to date, it’s no wonder that you can buy Bitcoin from a plethora of crypto exchanges such as Binance, Bitfinex, Huobi, Kraken, and Bitstamp, as well as from various Bitcoin ATMs (which are becoming more and more popular with each passing day). In the case of less popular cryptocurrencies, they usually require a bit more work in order to find a valid exchange.
The advantages and the drawbacks
By now, you’re probably wondering “why should I use cryptocurrency?” There’s no denying that cryptocurrencies have quite a few advantages over typical government-issued currencies from all over the world. These advantages come in the form of identity protection, low transaction fees, and 100% ownership and control over your funds. Since they require no bank or line of credit to perform transactions, cryptocurrencies are arguably more accessible than typical currencies as well.
Probably the biggest drawback of cryptocurrencies, in general, is the lack of knowledge people tend to have in regards to them. The general awareness for cryptos is still not that great. Volatility is another issue worth mentioning. With cryptocurrency, everything can change from good to bad very quickly. Evidently, with the increasing adoption rate of cryptos, the market should eventually settle, but it’s impossible to predict when this will be.
Of course, there’s a lot more to be discussed about cryptocurrency, as it can sometime feel less like an innovative technology and more like a religion. In spite of all their drawbacks and all the associated FUD (fear, uncertainty, and doubt), HODL (hold on for dear life), and FOMO (fear of missing out), one thing is quite apparent, cryptocurrencies are here to stay, as they are slowly but surely changing the world as we know it.