What Is Cryptocurrency?
Over the last few years, chances are you’ve heard this word thrown around on the news by reporters and techies, often accompanied by a host of other technical lingo that you couldn’t make heads or tails of.
When it comes to understanding cryptocurrency, there is a high barrier for entry that no major organization or player in the crypto space has any interest in lowering. Followers of the trend claim it’s the future of finance and currency, yet for the average person, it’s all just mumbled nonsense.
It’s only natural, of course, that it is full of technical terms; it is a technical topic, after all. But that’s no excuse as to the lack of publicly pushed documentation on the subject that breaks it down in layman’s terms.
That is what this little guide aims to do. Not only is it going to explain what it is, where to buy and use it, and what types there are, we’re also going to talk a little bit about its history.
Before all of that, though, it’s important to understand a bit of the mindset behind the crypto craze. You see, the banks have lost a lot of trust with people since back in the day. Irresponsible decision after irresponsible decision, crashes, and recessions – all of it adds up over time. With the advancement of technology, people started wondering: “What if there was an alternative to large scale corporate banks?” That’s how we ended up with Fintech (finance technology) and cryptocurrency – both a decentralized currency and independent banking platforms.
So while the technology is relatively new, as time goes on and it becomes more and more accessible, it isn’t unreasonable to expect to see a massive migration of consumers from the traditional finance structure to the new one.
What Is Cryptocurrency?
Cryptocurrency is a type of digital currency that uses complex digital coding systems that make the individual units impossible to hack, duplicate, or replicate. There are a few basic principles of cryptocurrency you should be aware of.
The first is the previously mentioned decentralized control of them. The value of a crypto unit is based on the activity of its users, not by a central bank or other authoritative entity.
You can exchange fiat, or normal money, on online exchange built to house the transactions that involve fiat to crypto transactions. Of all the infrastructure in place for cryptocurrency, this one is the most vulnerable to hacks, so avoid using these exchanges to hold your currency; just use it to exchange it.
Cryptocurrencies are also a finite supply. Most, but not all, have built-in code that specifies how many can ever be produced. Miners (who are responsible for the creation of new coins through complicated means) have an increasingly difficult time generating new coins until, eventually, a coin ceases to be capable of being mined altogether. This makes crypto more akin to gold than traditional money, as banks and government institutions can decide how much of a currency to print.
There a few reasons for one to use crypto over traditional fiat currency. Take the U.S. dollar, for example; that currency is under the full control of the U.S. government. It can seize assets and freeze accounts at will. The same cannot be done to crypto accounts, making them significantly more secure than traditional means. This is one of the most prominent advantages of using crypto – the lack of a state body in the whole financial picture.
On the other hand, cryptocurrency is extremely volatile; you only need to look at the rise and fall and rise again of Bitcoin to understand just how unpredictable the value of a cryptocurrency can be. It is not something you should pour all of your life savings into, and it certainly is not for the faint-hearted.
How Cryptocurrencies Work
As mentioned, cryptos are built on a foundation of highly complex levels of code far beyond most people’s understanding, but there are a few facets of it that can be explained.
A blockchain, for example, is probably a word you’ve heard thrown around a lot. Essentially, a blockchain is a master ledger for a particular cryptocurrency. It contains every transaction of that currency to date, validates the ownership of each unit, and constantly updates with each new transaction.
Identical copies of the blockchain are held by miners of a particular coin, which acts as a currency software network. This allows there to be a lag time of a few minutes between the exchange of crypto, which prevents double spending, as well as the duplication of coin.
Every holder of a cryptocurrency has a private key. This key functions similarly to a bank pin, or a key to your bank vault. It is a string of numbers that is between one and 78 individual digits long.
Keys are sort of a catch-22. While it allows your crypto to be extremely secure, it also presents the threat that you’re going to lose it, in which case there is absolutely no way to recover your coins. There’s no customer support and no password recovery; you’ve got nothing to fall back on.
Wallets are, again, another aspect of crypto that takes its name from traditionalism. Your crypto wallet is, like your physical wallet, the device in which you store your coins. It validates you as the owner of the units and allows you to consolidate them all in one place. There are different kinds of wallets, usually defined by whether or not it is connected to the internet.
We’ve talked a little bit about miners, and it’s a very convoluted topic, but let’s try dive into it a little bit. The miners of a particular coin serve as record keepers for it, as well as indirect arbiters of its value. Normally these are collectives of miners as opposed to one individual person, as it requires an extraordinary amount of computing power on a large, industrial-like scale.
The work of miners routinely creates new copies of the blockchain (the record of all of a coin’s transactions), which effectively is the completion of any transaction not included in the most recent block in the blockchain.
The History of Cryptocurrency
While cryptocurrency is certainly a relatively new phenomenon taking the world by storm, its roots actually date all the way back to the 80s. David Chaum, an American cryptographer, created the blinding algorithm, which allowed for the untraceable exchange of information between parties. Needless to say, this opened up the door to all kinds of financial possibilities.
Chaum enlisted the help of other cryptographers and cryptocurrency enthusiasts to create the groundwork for the beginning of electronic currency transfers, at the time known as blind money. He founded the company DigiCash, which produced units of currency based on this blinding algorithm. At this time, the currency was centralized, with the supply and value being solely controlled by DigiCash itself.
Initially, DigiCash dealt with individuals as opposed to corporations, but the Netherlands (where the company was located) central bank used its influence to crush the idea. This forced DigiCash to sell only to the bank, and the company went belly-up not too long after.
However, DigiCash’s work was not in vain. At the same time, Wei Dai published his white paper on b-money, which contained many of the fundamentals that underpin modern cryptocurrencies today.
Furthermore, one of Chaum’s associates, Nick Szabo, created and released a cryptocurrency called bit gold. This was the first to use a blockchain system, and again, was a vital step towards the modern cryptocurrency of today. However, both b-money and bit-gold failed to garner any traction.
After DigiCash, research and funds on electronic transfers in the digital space shifted focus to more conventional means, like PayPal.
However, as time went on, the idea of cryptocurrency continued to grow in the darkness, and in the mid-2000s, a currency known as e-gold gained popularity. E-gold was, for all intents and purposes, a digital gold buyer. Users sent old jewelry and the like to the e-gold company in Florida and in exchange received e-gold. Users could then trade that e-gold with other users or cash it out for real gold or U.S. dollars. At its peak, e-gold traded in billions of dollars yearly. However, it had laid back security protocols and became a prime target for hackers, leaving its users vulnerable. On top of that, it was being used increasingly for money laundering and other illegal activity. Facing growing pressure from authorities, the company ceased operations in 2009.
Now we get on to the big one, Bitcoin, which is perhaps the most important creation of the modern era. Regarded as the first modern cryptocurrency, Bitcoin set the standard for being the first publicly used means of exchange that combined user anonymity with a decentralized structure, built-in finite levels, and utilizing a blockchain system.
The whitepaper for Bitcoin was released in 2008 by Satoshi Nakamoto, which is a pseudonym for either an individual or group behind the currency. The currency launched in 2009 and was instantly picked up by a small group of people who began exchanging and mining it. Barely a year later, the beginnings of what would eventually be dozens of other coins started popping up, as well as the first public bitcoin exchanges.
Two years later, in 2012, Wordpress became the first major merchant player to accept payments in Bitcoin. This set a precedent, and soon after, other merchants, Microsoft included, followed suit, and of course, as time went on, so too did the number of companies that accepted Bitcoin and other cryptos as a form of payment.
Advantages and Disadvantages of Crypto
We touched on some positives and negatives to crypto earlier on, but let’s dive in a little deeper now.
Advantages
One advantage is the fact that each coin is finite. The code specifies how many units may ever exist, meaning there is no infinite supply. This protects it from inflation, which is a risk faced by all other major fiat currencies, as the central banks can print more of them at will.
Crypto is also a libertarian’s dream come true. It offers reliable and safe exchange outside of the prying eyes of financial monopolies involving banks and governments. It is a currency that has its roots in the people, as well as its infrastructure.
Miners are actually paid for the work that they do in the form of the newly minted coins. This provides an incentive for accurate record-keeping and means that they have a financial stake in ensuring that a coin’s operations run smoothly and without issues.
The privacy aspect has always been on the top of crypto enthusiasts lists of concern. This remains to be the case, meaning many coins, Bitcoin included, allow you to use pseudonyms completely disconnected from your real identity for trading the coin.
We mentioned it earlier, but it cannot be stressed enough; governments are going to have all kinds of trouble seizing your crypto assets or freezing your crypto accounts. Cryptocurrencies records and transactions are held in various nodes, where the blockchains are created around the worldm meaning that not only would state-induced control be impractical, but it would also be near impossible.
It is also generally cheaper to trade in crypto as opposed to traditional means. All of the security measures in place makes the need to use external transfer platforms like Visa or PayPal non-existent, which means that the transaction fees you’re subjected to are significantly lower than other transfer systems, lower than one percent in fact, as opposed to the three-odd percent of PayPal.
On top of that, you don’t have to deal with rip off exchange rates for trading crypto across borders. The currency is international and standardized; there is no “American Bitcoin,” and “European Bitcoin.” It’s just Bitcoin, meaning there are no additional fees for cross-currency money transfers.
Disadvantages
Due to the decentralized and independent nature of it, cryptocurrency has become a breeding ground for black market activity. The coins’ platforms facilitate black market transactions very well and have become the go-to for criminals trading. While that doesn’t affect the ordinary crypto user, it does raise some moral questions.
It also opens the door up to some tax evasion possibilities. Small business owners have been caught paying employees in crypto to avoid payroll tax, and the built-in levels of autonomy are a natural attractor for those looking to give the IRS the slip.
When it comes to the disadvantages of cryptocurrency, it would be wrong not to touch on the possibility of losing your key, similar to losing your wallet, if you kept your entire bank account in it at all times. Granted, you can split your crypto up into multiple wallets with multiple keys, but then you have more keys to keep track of.
Then, of course, there is the unpredictable nature of a coin’s value. Bitcoin rose to over $10,000 dollars per unit in its prime and dropped down thousands of dollars not a few months later. It has both made millionaires and put people out on the street. It is a risky business to jump headfirst into.
There is one large problem that lies at the heart of cryptocurrency and has yet to be solved, and that is the inherent impossibility for a chargeback. Say, for instance, you buy a new phone online and pay in bitcoin. The transaction goes through, and you never get the phone. That’s just hard luck; there is no built-in way to cancel that transaction. In fact, having such a feature would go against the very philosophy of crypto as a decentralized, unmoderated form of exchange.
There is also the fact that cryptocurrency mines eat up all kinds of power. A crypto mine needs some seriously intensive hardware. Not only did this drive up the price of high-end P.C. components like graphics cards and processors, making some of them nearly inaccessible for the commercial market, but it also uses up a lot of electricity.
In fact, it’s estimated that the combination of all Bitcoin mines uses up more electricity than the entirety of Denmark. There have been a few proposals on how to tackle this, including a community effort to reduce the value of Bitcoin to make mining less rewarding, which is probably never going to happen.
There was also a suggestion to cut the mining reward rate at a faster rate than is already implemented or to offer incentives to miners to set up shop in low carbon footprint countries, as opposed to the likes of China, where most mines are established.
Examples of Cryptocurrencies
Up to now, we’ve only really used Bitcoin as an example, but there are more types of cryptocurrency out there that are just as popular, just not as valuable yet.
Bitcoin
Just to get it out of the way. Bitcoin is the most popular cryptocurrency traded today, and it is also the most valuable, which is absolutely dwarfing the runner up by a factor of ten. It was the first to really start the crypto boom that we have seen in the last few years and has become the most mainstream of all the cryptos.
Litecoin
Litecoin uses the same principles and basic structure of Bitcoin, with the two biggest differences being a higher total supply and a different target block time creation. It is often in the top three most traded cryptocurrencies at any given time.
Ripple
The release of Ripple came with a consensus ledger system that sped up blockchain creation times significantly. In fact, the target creation time is mere seconds, as opposed to the two minutes of Litecoin. It also has an in-house currency exchange rate for the major fiat currencies, making it much easier to trade and convert in. However, it’s been noted that Ripple’s code is more susceptible to manipulation and that it doesn’t offer the same level of anonymity offered by some of its competitors.
Ethereum
Ethereum released only five years ago in 2015 and made some major improvements to the basic foundation of Bitcoin. It created a system known as smart contracts, which compels parties of a transaction to honor an agreement, and offers a mechanism for refunds should one party break the contract.
Dogecoin
Dogecoin is a variant of Litecoin and is a bit of an experiment in the cryptocurrency scene. The coin does not have a limited supply number, meaning it can be mined indefinitely. This means that it is an inflation prone crypto and a coin that investors and market analysts are watching closely.
