The Ultimate Guide to Understanding Cryptocurrency
Introduction to Cryptocurrency
Cryptocurrency is the next evolution of money.
We know that in ancient days, commodities essential to daily living were considered money (e.g. cows and chickens) and traded among micro-economies. Then the modernization of society and urban cities brought the need to track money and value across large territories of land, which resulted in the birth of paper and coin money issued from the ruling governments.
Fast forward to a quarter of a century ago, and an invention called the world wide web made it possible for people to buy and sell virtually anything to anyone around the world. Because you sending paper-cash and coins is a burdensome process, the preferred method for these transactions was bank-issued credit cards.
Present times have gifted us with another advancement, which is a new form of money that is native to the internet – cryptocurrency. Below we explore what this new type of money is, how it works, and how you can get involved.
What is the definition of cryptocurrency?
What are the properties of a Cryptocurrency?
Cryptocurrency Properties Explained
Cryptocurrency share some common properties with the cash-money that you use on a daily basis, but are also fundamentally different in other ways.
It is important to note that not all properties listed below will always apply to all cryptocurrencies. Cryptocurrencies are a highly customizable technology that can be modified to fit specific purposes.
Several of the key properties of a cryptocurrency inlcude:
- Fungible: One unit is identical to another unit.
- Divisible: Can be divided into smaller units of value.
- Acceptable: Widely accepted as medium of exchange.
- Limited Supply: Supply is capped and constant.
- Uniform: All versions of the same denomination have the same value.
- Portable: Can be transported and exchanged.
- Durable: Can be reused without deterioration.
How do you explain Cryptocurrency?
Cryptocurrency Simple Explanation
Cryptocurrency is simply the next evolution of money. As many things in our world have transitioned into becoming digital, money too has made the digital transition. The difference between a cryptocurrency and a “Digital Dollar,” is that cryptocurrencies can be independent of any type of controlling authority. This means that there are no Monetary Reserve bodies, Banking Institutions, or required transactional guidelines to follow. Cryptocurrencies can be used by anybody, anywhere, and have the ability to self-manage the entire system, from currency creation and distribution, to ensuring that each transaction is valid.
Our simple explanation of what is a cryptocurrency can be described as a “paperless money”.
Anyone can develop their own cryptocurrency at any time. They can also send it to anyone, anywhere, at any time. A cryptocurrency’s value is only defined by what the public market determines it to be. If enough people believe and trade Bitcoin upwards to $1M+ per coin, then that will be the new price of 1 Bitcoin, thus, cryptocurrency always has a floating or spot price.
Cryptocurrency Technical Explanation
How can a form of online money that is not controlled by a bank or government, actually work? The answer to this question, lies squarely within its name – crypto and currency. The technology acts like traditional government issued currency, but with self-governing and self-sustaining properties made possible through cryptography.
Cryptocurrencies rely on a complex system, often referred to as blockchain technology, to ensure that this self-sustaining monetary system is properly functioning.
Every movement of cryptocurrency (regardless of size) is permanently recorded on a blockchain. This transactional data is then encrypted and then distributed across the entire network. Before the data can be permanently recorded on a blockchain, it has to go through a process called “Mining” which involves specialized computer hardware and software to confirm that the newly received transaction is valid. “Miners” are incentivized to perform this task because there is a possibility that they may be rewarded for this computational work via a block reward. A block reward is not only a payment for miner’s services, but also the way that new coins are generated. At Bitcoin’s inception 1 Block Reward = 50 Bitcoins; at the time of writing, it is down to 12.5 Bitcoins.
This process continually repeats over and over again, which provides for a robust and incentivized monetary system called cryptocurrency. Most of the methodologies described above are predominantly inherent to the Bitcoin blockchain, and may or may not be found in another cryptocurrency.
How Does a Cryptocurrency Work?
Explain what is in Cryptocurrency and how it works.
In a typical transaction, such as using a U.S. dollar, the transaction is handled through the exchange of cash or electronic transfer. The electronic transfer is managed by large banks that we trust to keep our money safe and our transactions honest. In a cryptocurrency transaction, such as using Bitcoin, the responsibility of keeping track of the transaction is no longer in the hands of banks, but in the users.
Blockchain based cryptocurrencies act as fully self-contained systems that control and track each unit of cryptocurrency. This means that the cryptocurrencies act as a “self-regulating” system, in which there is no third party to improperly influence. By design, some cryptocurrencies are controlled by a single entity (i.e. centralized) and others are controlled by the public (i.e. decentralized).
We attempt to explain this concept by breaking down the concept of a cryptocurrency, into two separate components – crypto and currency:
Core Components of a Cryptocurrency
What are the core components of a Cryptocurrency?
Now that you have a thorough understanding of cryptocurrency definitions, properties, and both technical and non-technical explanations, we will examine the technological components of what actually makes a cryptocurrency work. It is important to note that not all characteristics listed below will apply to all cryptocurrencies. Cryptocurrencies are an adaptable technology that can be modified to fit specific purposes. Below, we explore the basic components required for a cryptocurrency to work:
Blockchain technology is the backbone of any cryptocurrency. As covered in our online guide What is Blockchain Technology?, blockchains hold the ever-growing permanent records of all cryptocurrency activity. Each cryptocurrency’s blockchain has all information about past transactions, addresses, wallet balances, and more; from the beginning (i.e. genesis block) to the most recent.
Blockchain based cryptocurrencies employ a globally distributed network of nodes. A node is an internet-connected computer that runs an application specific to the cryptocurrency ecosystem they wish to participate in. This propagates the network by relating information to other nodes spread out across the world. The collective network of nodes spread across the world, is what creates and maintains the decentralized robustness of an overall cryptocurrency network.
What makes a cryptocurrency secure? Answer: Private-key cryptography. Private-key cryptography requires a set of two-keys: a public key (also called the address), which may be openly disseminated, and a private key (also called the secret key) that is only to be known by the owner. Each public key is linked to a private key. The cryptocurrency owner privately preserves the private-key to maintain ownership. Conversely, they openly share the public key for transactions. This system of secret and public keys is how cryptocurrencies are able to securely prove ownership, while publicly transacting with strangers.
Mining – Consensus
Timestamping (commonly referred to as Mining, or in advanced mechanisms, Consensus), is the method in which a cryptocurrency uses various time stamping schemes to avoid the need for a trusted third party to verify the transactions added to the blockchain ledger.
- Bitcoin, the most popular cryptocurrency, uses a Proof-of-work scheme, which is also known as Mining.
- Other cryptocurrencies achieve the same result with alternative approaches such as Ethereum’s Proof-of-Stake.
- Further advanced methods for verifying transactions are labeled as Consensus Protocols or Consensus Platforms.
A cryptocurrency transaction occurs whenever there is a movement of cryptocurrency. This can be either the buying or selling a good or service, or making an investment or divestment of cryptocurrency. Regardless of the intention, each transaction is created by a wallet client using an encrypted electronic signature. It is then broadcasted to the network via a public ledger to provide mathematical proof that the transaction actually occurred. Nodes on the network relay and rebroadcast the transaction, and if the transaction is valid, nodes will include it in the block they are mining.
Cryptocurrency wallets are what you “hold “ your cryptocurrency in. Since cryptocurrencies are digital, what do you actually hold in a wallet? The cryptographic public and private keys. The private key allows you to write in the blockchain; effectively spending the associated cryptocurrency. The public key makes it possible for others to send cryptocurrency to the wallet. Several different types of cryptocurrency wallets exist. From ultra-secure hardware wallets, to exchange hosted software-wallets, it is best practice to ensure that your cryptocurrency holdings are not in a wallet that can be easily compromised.
Types of Cryptocurrencies
What are the top Cryptocurrencies?
If you have heard about cryptocurrencies, then you have likely heard the word Bitcoin.
Bitcoin is the first cryptocurrency to successfully prove the viability of a cryptographic-backed public money supply that is open to anyone. From a market capitalization point of view and public adoption point of view, bitcoin is currently the most popular cryptocurrency. However, there are close to 1,000 different types of cryptocurrencies currently available on coin market cap, the most popular place to discover and track cryptocurrency prices.
Among the many choices available, different cryptocurrencies provide different benefits over others. Cryptocurrencies such as Litecoin (LTC) provide faster confirmation times than Bitcoin (BTC). Newer cryptocurrencies such as Ethereum (ETH), refers to itself as a crypto-asset, and uses its native token to power a decentralized virtual machine that can execute peer-to-peer smart contracts.
Shopping for a new smartphone is the same as deciding which cryptocurrency is right for you. The best cryptocurrency is the one that fits your specific need that you intend to use it for.
How to Invest in Cryptocurrencies
Beginners Guide on How to Invest in Cryptocurrencies
When bitcoin was first introduced to the world in 2009, each bitcoin was valued at less than $1 USD for quite some time. In late 2017, the price of one Bitcoin peaked at almost $20,000 USD.
Hoping to strike it rich with short timelines and significant returns has caught the attention of speculators worldwide, causing great desire to learn how to invest in cryptocurrencies and yield returns that grossly beat the stock market. The cryptocurrency market is barely a decade old and still remains very small in comparison to other global financial markets of the world. These attributes (nascence and size) should remind investors to revisit a fundamental rule of investing: the higher the return, the greater the risk; the lower the return, the lesser the risk.
Cryptocurrency investing can be both an exciting and lucrative endeavor.
Imagine taking part in the early internet; surfing the web before Google and Facebook. Purchasing cryptocurrencies today parallels surfing the early internet. There are greater risks investing in cryptocurrencies today, as the ecosystem is new, however, there is also immense opportunities for early adoption.
We explore some of the basic principles to cryptocurrency investing below:
Return on Investment (ROI) percentages found in the cryptocurrency market are significantly higher than those found in the comparable markets such as stocks or real estate. For those seeking to achieve the same returns that bitcoin investments experienced during the 2009 to 2017 time period, investors should take note of the associated significant risk.
In such circumstances, basic investing principles should be taken into consideration:
Higher Risk = Higher Return
An example of a high risk and high return cryptocurrency investment opportunity investing in a new cryptocurrency or Initial Coin Offering (ICO), with the anticipation that it achieve the same success as bitcoin.
Lower Risk = Lower Return
For those seeking a lower risk and lower return cryptocurrency investment opportunity, an example may include investing in a more mature cryptocurrency such as bitcoin (BTC) or Ethereum (ETH) that may not provide the same upward spike in value again, but may likely experience more natural and gradual growth over time.
An alternative to investing in cryptocurrencies, is investing in the underlying technology of cryptocurrencies, better known as blockchain technology.
Buying and Trading
Buy, Sell, and Swap Cryptocurrency
It has become a relatively painless process to purchase cryptocurrency online. There are many reputable online dealers that make it easy to purchase and hold cryptocurrency. As with all investments, it is recommended to perform sufficient due-diligence in the cryptocurrency dealer. Things to look for include online reviews, duration in-business, and geographic location. First time buyers often find the process of buying cryptocurrencies to be somewhat difficult, yet rewarding. Buying cryptocurrency through several of the reputable exchanges listed below can be done using a credit card, debit card, or bank account.
Trading cryptocurrency is different from buying cryptocurrency. Although many of the places to that sell cryptocurrency online also provide trading services, the two acts are fundamentally different in nature. The cryptocurrency trading sector has vastly matured with many Wall Street alumnus joining the cryptocurrency movement. Cryptocurrency exchanges now provide powerful tools that closely resemble the same market trading tools commonly found in capital markets trading. Below, we have featured several of the most prominent exchanges to trade cryptocurrencies:
Initial Coin Offerings (ICO)
What is an ICO or Initial Coin Offering?
Initial Coin Offerings (commonly referred to as ICOs), are a type of crowd funding supported by making use of cryptocurrencies.
In the process of an ICO, a cryptocurrency is sold by its founders, in the form of tokens to investors desiring to participate in the crowd funding process. Investors buy into ICOs using other popular cryptocurrencies such as Ethereum or Bitcoin. ICOs function similarly to equity. Founders of a cryptocurrency or blockchain-based project hold an ICO to raise funds (for various reasons) and provide the investors with cryptocurrency as a form of ownership (equity).
Blockchain Technology Guides
Different Blockchain Technologies
Cryptocurrencies are only one pillar of blockchain technology. Further explore the depth of these technologies by continuing with one of our other “Ultimate Guide to Understanding” web resources on Blockchain or Smart Contracts.