What Is Cryptocurrency?
A cryptocurrency is a digital form of payment that is secure through the use of cryptography. Unlike paper money, it is not issued by a central authority and is not prone to manipulation or fraud.
Understanding Cryptocurrencies
Cryptocurrencies are digital currencies that are secure through the use of cryptography. They can be used without intermediaries such as banks and credit card companies.
Although many websites accept cryptocurrencies for transactions, many of them do not allow retail transactions. Despite this, they are still very popular as a trading instrument.
Blockchain
Blockchain is a technology that enables people to transact without central authority. Its decentralized nature enables it to be secure and tamper-resistant. Each new block is verified by its individual member.
According to experts, blockchain technology can serve various industries such as supply chain and crowdfunding.
Types of Cryptocurrency
Bitcoin, which was invented by an anonymous person named Satoshi Nakamoto, is the world’s most valuable cryptocurrency.
Each cryptocurrency has its own unique function and specification. For instance, Ethereum’s ether is used to serve as a gas for the platform.
Since it was first introduced in 2009 by the public, it has remained the most widely used digital currency. As of November 2021, more than 18.8 million bitcoins have been in circulation.
Following the rise of Bitcoin, many other cryptocurrencies were launched. Some of these are so-called “altcoins”, such as Ethereum, Solana, and Litecoin. By November 2021, the total number of cryptocurrencies had reached more than $2.1 trillion.
Are Cryptocurrencies Legal?
Fiat currencies are considered fiat commodities. They are backed by the authority of a government or monetary authorities.
Although they are backed by public or private entities, cryptocurrencies are not considered fiat commodities and are not considered as having the same legal status in different countries.
Although they are not fiat commodities, they are subject to anti-money laundering regulations.
In December 2021, El Salvador became the only country in the world that allowed Bitcoin as a legal tender for transactions.
In Japan, Bitcoin is considered a form of legal property. Cryptocurrency exchanges are also required to collect information about their users. In China, the country has banned all cryptocurrency exchanges.
Cryptocurrency is now legal in the European Union. In June 2021, the Commission issued a regulation designed to regulate the use of cryptocurrencies in the financial markets. The US’ biggest financial exchange, the Chicago Mercantile Exchange, also accepts Bitcoin and Ethereum as payment options.
Advantages and Disadvantages of Cryptocurrency
Cryptocurrencies were introduced to the world with the intention of disrupting the financial infrastructure. However, their practical implementation is still in its infancy.
Some advantages and disadvantages of cryptocurrencies are as follows.
Advantages
Cryptocurrencies are decentralized and are not subject to the supervision of central intermediaries. Instead, their transactions are secure and can be conducted without intermediaries. This concept eliminates the possibility of a major institution failing.
Cryptocurrencies promise to make transferring funds easier and less time-consuming. Instead of using a third party, they use public and private keys to secure their transactions.
Faster transactions are possible with cryptocurrencies due to their decentralized nature. For example, decentralized loans, which are used for short-term transactions, can be executed immediately.
Over the past decade, the value of cryptocurrencies has increased significantly. As of 2021, Bitcoin has reached almost $2 trillion in market value.
The remittance economy is one of the first industries to test cryptocurrencies’ potential. For cross-border money transfers, Bitcoin and other cryptocurrencies are used.
Disadvantages
Unlike paper money, cryptocurrencies are pseudonymous. Their digital trail can be used by law enforcement agencies to monitor the transactions of ordinary citizens.
Cryptocurrency has also become a target of criminals. Due to their various uses, it has been used by hackers to carry out their activities.
Contrary to popular belief, cryptocurrencies are not decentralized and are not owned by the majority of investors. For instance, a study revealed that only around 45% of Bitcoin’s value was owned by investors.
One of the main advantages of cryptocurrencies is that they can be mined using a computer. However, they require a high amount of energy to mine successfully. Due to the unpredictable nature of the mining industry, many large companies have had to resort to using miners to mine successfully.
Despite the security measures that are in place, other decentralized platforms can still be hacked. This has resulted in the theft of millions of dollars worth of coins.
Cryptocurrencies are prone to price volatility. For instance, Bitcoin experienced a massive spike in value in 2017 before crashing in the following months.
Frequently Asked Questions
What Is Cryptocurrency in Plain Words?
Cryptocurrencies are digital assets and decentralized systems that allow for secure online payments.
How Do You Get Cryptocurrency?
You can buy cryptocurrencies from various online platforms and financial derivatives. Some of these include Bitcoin futures and Bitcoin ETFs.
What Is the Point of Cryptocurrency?
Cryptocurrency is a new type of money that aims to streamline the processes associated with money transactions. Its decentralized nature and technology make it possible to transact without intermediaries.
Can You Generate Cryptocurrency?
Unlike fiat money, cryptocurrencies are not backed by any physical commodities. Instead, they are generated through a process known as mining. The energy required to mine successfully outweighs the amount of coins created.
What Are the Most Popular Cryptocurrencies?
Bitcoin is by far the most popular cryptocurrency followed by other cryptocurrencies such as Ethereum, Binance Coin, Solana, and Cardano.
Are Cryptocurrencies Securities?
The US Securities and Exchange Commission has classified Ethereum and Bitcoin as securities.
Although it’s possible to make money from cryptocurrencies, investing in them is very risky and speculative. You should never rely on Investopedia or its writers to make any financial decisions.
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How Does Cryptocurrency Work?
A cryptocurrency is a digital medium of exchange that is decentralized. Unlike paper money, it doesn’t have a central authority and is managed through the internet.
Although cryptocurrencies are widely used to purchase goods and services, they are not as secure as traditional assets. While they are an exciting asset class, they are also very risky.
Bitcoin was the first cryptocurrency that was developed in 2008. Its creator, Satoshi Nakamoto, described it as an electronic payment system that is based on cryptographic proof.
That cryptographic proof comes in the form of transactions that are verified and recorded on a blockchain.
What Is a Blockchain?
A blockchain is an open ledger that records transactions. They are distributed across thousands of computers.
For Buchi Okoro, CEO of an African cryptocurrency exchange, the concept of a blockchain is like having a book full of notes.
A blockchain is like a book that records all transactions. Its distributed ledger is constantly updated with new information, keeping all transactions accurate and complete.
To prevent fraud, each transaction is checked using one of two main validation techniques: proof of work or proof of stake.
Proof of Work vs Proof of Stake
Both proof of work and proof of stake are validation techniques that are used to verify transactions.
Proof of Work
Simon Oxenham, a social media manager at Xcoins.com, says that proof of work is a type of verification that’s very challenging to solve.
Each participating computer is tasked with solving a math puzzle to verify a block. The first computer that successfully completes the puzzle is rewarded with cryptocurrency.
The race to complete the puzzle can require a high amount of processing power and electricity. Miners typically break even after taking into account the cost of processing power and computing resources.
Proof of Stake
Some cryptocurrencies like Bitcoin use a proof of stake method to reduce the amount of processing power needed to verify transactions. Instead of having to mine for every transaction, people who are willing to put up a small amount of money are chosen to participate in the process.
Due to the energy efficiency of proof of stake, it is typically faster to verify transactions.
If a stake holder is chosen to verify a new batch of transactions, they’ll be rewarded with cryptocurrency, while forfeiting a portion of their stake to prevent fraud.
The Role of Consensus in Crypto
Consensus mechanisms are used to verify transactions. Each transaction has to be approved by the majority of users in the network.
If a hacker gets at least 51% of the ledgers, they’ll be unable to alter the system’s configuration.
How Can You Mine Cryptocurrency?
Although it’s possible for average citizens to mine cryptocurrency, it’s hard to get by with proof of work systems like Bitcoin.
Due to the complexity of Bitcoin’s network, more people are opting to minimize their expenses by mining instead of trying to outsmart them.
Unfortunately, mining cryptocurrencies consumes a large amount of electricity annually, which is equivalent to the amount of power that Switzerland uses in a year.
The majority of people who mine cryptocurrency don’t earn cryptocurrency by mining. Instead, it requires a cryptocurrency ownership to participate.
How Can You Use Cryptocurrency?
Although it’s possible to buy goods from online retailers like Overstock.com, it’s not yet mainstream enough.
Until more people accept cryptocurrencies, it’s possible to use Bitcoin to purchase gift cards. You can do it through eGifter, which works seamlessly with retailers like Starbucks and Apple. In the U.S., there’s a BitPay card that lets users convert their crypto assets into dollars.
Aside from stocks and bonds, cryptocurrency can also be used as an alternative investment option. According to David Zeiler, the best-known cryptocurrency is Bitcoin.
How to Use Cryptocurrency for Secure Purchases
If you’re planning on buying something specific, you can use cryptocurrency to make purchases at stores that don’t accept it.
If you’re planning to use cryptocurrency to pay for goods and services, you’ll need a cryptocurrency wallet.
To transfer money from your wallet, enter the recipient’s address and the cryptocurrency’s QR code. Although transactions are not instantaneous, they can be done in a relatively short amount of time.
Transactions are secure because they use a network’s safeguards. A bad actor can’t get the necessary keys to alter a transaction.
How to Invest in Cryptocurrency
You can buy cryptocurrency on various peer-to-peer networks and exchanges. However, these services usually charge high fees for their small transactions. For instance, Coinbase charges a 0.5% fee for each transaction.
In May, the investing app Robinhood became the first to allow users to buy cryptocurrencies without the fees associated with many of the major exchanges.
Should You Invest in Cryptocurrency?
Although it’s a relatively safe and speculative investment, many financial advisors don’t recommend using it.
For instance, Bitcoin more than doubled in value during the course of 2020. However, after hitting an intraday high of $68,990 in November 2021, it steadily dropped to around $46,000 by the end of 2021.
Peter Palion, a financial planner in New York, says that it’s safer to hold on to the US dollar instead of investing in cryptocurrencies.
According to Sam Palion, a financial advisor, the volatility in Bitcoin and the US dollar has made it look like its last EKG. He said that investing in cryptocurrencies is like investing in stocks and bonds.
Ian Harvey, a certified financial advisor, helps clients put some money into cryptocurrency. He said that the client’s weight should be large enough to allow them to manage their long-term goals.
Mike Harvey, another financial advisor, advises investors to set aside a certain percentage of their portfolio to lose if the cryptocurrency goes south.
