Despite its growing popularity and mainstream adoption, cryptocurrency can still be a confusing topic to some. To give you a better understanding of what cryptocurrency is and how it works, this guide will take you through the early stages of this new asset class, its underlying technology, different types of cryptocurrency, and how it will shape our future.
Let’s dive in!
Cryptocurrency, shortened as crypto, is a type of digital asset that functions as an alternative currency. Since its inception, crypto is designed to become a medium of exchange.
Notably, cryptocurrencies use cryptography as a means of security. They operate without the need for “middlemen,” such as central authorities or banks. Instead, they work through a distributed ledger called a blockchain to power every transaction.
While cryptocurrency’s true mainstream debut happened in recent years, cryptocurrencies have been researched long before Bitcoin came into existence.
In 1998, computer scientist Nick Szabo developed a type of cryptocurrency called Bit Gold. However, Szabo’s cryptocurrency was never fully launched, but it did pave the way for Bitcoin.
Ten years after Szabo coined Bit Gold, Satoshi Nakamoto, a mysterious person or group, released a whitepaper describing a decentralized network used to fuel a new cryptocurrency called Bitcoin. Slowly but surely, Bitcoin began to take the world by storm, sparking the blockchain and cryptocurrency revolution the world sees today.
Cryptocurrency transactions are safely held and recorded in a distributed ledger known as a blockchain. A blockchain consists of blocks that contain transaction data. Notably, transactions within the blockchain cannot be changed or cheated since each piece of information is timestamped and posted to the ledger for verification by other blockchain stakeholders.
If you own cryptocurrency, you don’t own anything tangible. What you have is a key that allows you to move a record from one place to another without a third party.
Read: What Is Blockchain?
People use cryptocurrency for several reasons. However, some of these uses are subject to the laws and regulations of the country or territory where the cryptocurrency user resides in.
People use crypto as a form of payment for products and services. Given the assets’ market value and rarity, people have begun to use them to pay for purchases they make, especially for online transactions.
Major companies such as Microsoft and PayPal, among others have started accepting cryptocurrency as payment for their goods and services.
Many people have already embraced crypto as the new era’s real money. In fact, studies show that a huge number of people prefer crypto over fiat money for making peer-to-peer (P2P) transactions. This is because cryptocurrencies have monetary value, and there are now platforms that enable their transfer.
Before cryptocurrency had a market value, users and supporters rallied behind the use of the asset because they believed that it solves a number of problems traditional money has, such as double-spending and hefty fees.
Satoshi Nakamoto specifically mentioned this in the Bitcoin whitepaper:
A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution… We propose a solution to the double-spending problem using a peer-to-peer network.
Many have invested in cryptocurrency as members of the crypto community consider digital currency a viable investment option. Veteran cryptocurrency holders who held old currencies like Bitcoin and Litecoin have profited from their investments even before they had market value.
Cryptocurrencies are prone to the market’s extreme conditions caused by the absence of a central body that dictates their price. Due to their volatility, there are times their prices plummet. Compared to other investment options, cryptocurrencies have more erratic market fluctuations. This is why seasoned crypto holders always suggest trading and investing with due diligence.
Cryptocurrency mining is the process by which transactions are validated digitally on a blockchain. Since blockchain transactions are encrypted when added to a block, miners need to verify the accuracy of each transaction before the network can continue adding transactions to the block. Miners do this by using their computing power to solve complex cryptographic puzzles to verify transactions in a block on the blockchain. The first miner to solve the problem and verify all of the transactions in a block is rewarded with a fee for their services. This method is known as proof of work (PoW).
Cryptocurrencies are generated by mining. For example, Bitcoin is generated using Bitcoin mining. The process involves downloading a software that contains the history of transactions that have occurred within the network.
Anyone with a computer and an internet connection can mine cryptocurrency. However, mining cryptocurrencies, especially popular ones like Bitcoin and Ethereum, requires considerable amounts of energy. Because of its environmental implications, the proof-of-stake (PoS) consensus was introduced as a more sustainable alternative.
Read: What is Proof of Stake?
There’s a reason why a lot of people from the sector believe that cryptocurrency is about financial freedom. Unlike fiat, which is printed and limited by governments, resulting in occasional fluctuations, cryptocurrencies have a defined monetary policy that cannot be changed by anyone. This makes cryptocurrencies a better choice for storing value for those living in countries with unstable economies and hyperinflation.
Cryptocurrencies are also more portable—meaning they are easier to transport and divide. Since they are digital assets, cryptocurrencies can be transported across any border.
The technology is not perfect, and it comes with risks. However, the gains and losses of cryptocurrency tend to occur much faster than with other currency investments. With cryptocurrency, it’s either a boom or bust. Smart traders and investors have built fortunes thanks to the volatility of this digital currency. However, there are still those who lost their funds quickly. In this space, you would often hear the phrase “don’t be greedy.”
In terms of storage, holders keep their cryptocurrency safe in a storage device called a wallet. Cryptocurrency wallets use encryption technology to ensure the safety of user funds against modern-day digital thieves.
There are different types of cryptocurrencies. As people’s knowledge of blockchain technology continues to grow, they come up with different approaches to using the technology. This resulted in the development and introduction of more types and subtypes of cryptocurrency.
Here are some of the cryptocurrency types.
Serving as a store of value and traded among peers, merchants, and organizations, payment currencies are the most basic types of cryptocurrencies.
Cryptocurrencies categorized under this type exist to address the challenges traditional payment means face, such as double-spending, slow confirmation, and expensive fees.
Examples of payment currencies are Bitcoin, Bitcoin Cash, Litecoin, Dash, and Monero.
A form of payment currency is what people from the industry refer to as stablecoins. These cryptocurrencies are intended to become digital money. Stablecoins are different than traditional payment currencies due to their “stable” nature. Their prices are pegged to an existing commodity such as fiat, stocks, or gold, among other things.
An example of a stablecoin is the famed stablecoin Tether (USDT), which is pegged to the price of the US dollar. Regardless of any price movements in the market, USDT will maintain the value of $1.
Ecosystem currencies are specifically created for specialized blockchain systems functions. While retaining the purpose of payment currencies, ecosystem currencies are necessary for various use cases beyond the facilitation of P2P transactions.
Crypto tokens function similarly to ecosystem currencies in terms of usage. They maintain token status because they are not the official currency of the blockchain ecosystem they are part of.
Smart contracts, a transaction protocol in a blockchain that automatically executes relevant events according to the terms of an agreement, create crypto tokens through their respective blockchain. Depending on their developers, some tokens exist on more than one blockchain. One of the most popular blockchains for creating crypto tokens is Ethereum.
To buy and sell cryptocurrency, you will need a cryptocurrency exchange or an online trading platform. There are many cryptocurrency exchanges available, like Binance, Crypto.com, eToro, Coinbase, and FTX. Currently, Binance is the world’s largest cryptocurrency exchange by trading volume.
The cryptocurrency market has trillions in total market capitalization. Legacy companies outside of the finance and banking industry have placed their bets on the new asset class, with the number of users that hold crypto growing daily. On an individual front, cryptocurrency may have the potential to disrupt our lives the same way the internet and mobile phones did before.
Despite regulatory uncertainty on the part of some governments and still skepticism from the average user, various use cases and applications have proved that cryptocurrencies are worth exploring. Study cryptocurrencies, invest in them, trade them—it would be better for you to personally experience what the technology can offer.