What Is Cryptocurrency?How Does It Work?
What is Cryptocurrency?
You have probably heard a lot about cryptocurrencies such as Bitcoin, Ethereum, Bitcoin, Peercoin, Ripple, Cardano, Polkadot, Bitcoin Cash, Stellar (XLM), etc. More than 6,700 different cryptocurrencies are traded publicly, according to CoinMarketCap.com, a market research website. But, what exactly is cryptocurrency? How does it work?
A cryptocurrency is a digital or virtual asset based on blockchain technology. Cryptocurrencies are virtual or digital money that takes the form of tokens or coins. They are not generally issued by a central authority, like governments or banks; therefore, this defining feature of cryptocurrencies allows them to exist outside their influence and control. The name Cryptocurrency derives from the encryption techniques used to secure the network. “Crypto” refers to the various encryption algorithms and cryptographic techniques that safeguard these entries, such as elliptical curve encryption, public-private key pairs, and hashing functions.
Any investor can purchase cryptocurrency through crypto exchanges like Coinbase, Cash app, and more. Investors can make money by mining Bitcoin or selling their Bitcoin at a profit. The total value of all cryptocurrencies on April 13, 2021, was more than $2.2 trillion, according to CoinMarketCap, and the total value of all bitcoins, the most popular digital currency, was at about $1.2 trillion.
How Does It Work?
To buy cryptocurrencies, you will need a “wallet,” an online app that can hold your currency. Generally, you create an account on an exchange, and then you can transfer real money to buy cryptocurrencies such as Bitcoin or Ethereal.
If you are buying cryptocurrencies, actually you are buying the idea behind the coin, which is supported by blockchain technology. At its simplest, a Blockchain is a shared database (ledger) that everyone can access to verify transactions. It is extremely secure because the transactions are encrypted with 256-bit cryptographic keys. So all the information is kept in the decentralized ledger (the blockchain).
The ledger is public, but everything on the ledger is encrypted. This is how the system is able to be secure, but also public. Everything is encrypted using an algorithm that is, as of now, unhackable. Cryptocurrencies are inherently very safe but the vulnerability of cryptocurrencies lies not with the underlying technology but rather with people and institutions. Hackers trick the user into divulging access to the exchange, typically your email address and a password (via phishing) or the private key in your wallet. The most common way is to hack into your email account and then request a password reset to the exchange. To counter this risk, enabling multi-factor authentication has been recommended.
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The Pros of Cryptocurrencies
- They have been admired for their transparency, anonymity, inflation resistance, probability, and divisibility. The advocates highly value their benefits of privacy, like protection for whistleblowers or activists in repressive countries. Some cryptocurrencies are more private than others. For example, Bitcoin has less privacy. While other cryptocurrencies such as Dash, Monero, or ZCash are far more difficult to trace.
- They make it easier to transfer funds directly between two parties, without any need for a third party, like a bank or credit card company. In other words, a cryptocurrency is a medium of exchange that is digital, encrypted, and decentralized.
- They are not under the influence of a central authority such as governments or banks. There is no central authority that manages and maintains the value of a cryptocurrency. Instead, these tasks are distributed among a cryptocurrency’s users via the internet.
- Some cryptocurrency advocates love the technology behind it (called the blockchain) because it is a decentralized processing and recording system and can be more secure than traditional payment systems.
- Some investors like it because their value is going up increasingly. They see cryptocurrencies such as bitcoin as the currency of the future. Some people even refer to it as a bar of digital gold.
- Unlike the stock market, you can participate in the cryptocurrency market 24 hours a day, 7 days a week.
The Cons of Cryptocurrencies
- Their use for illegal activities, such as money laundering and tax evasion.
- Exchange rate volatility. The rate at which a cryptocurrency can be exchanged for another currency can fluctuate widely. Bitcoin has experienced some rapid ups and downs in value, climbing as high as $19,000 per Bitcoin in Dec. 2017 before dropping to around $7,000 in 2021. It should be noted that a currency needs stability; however, it seems that cryptocurrencies don’t have such stability for now.
- Vulnerabilities of the infrastructure underlying them.
- It is very costly to produce a Bitcoin, which requires an increasingly large amount of energy. It’s estimated that 0.21% of all of the world’s electricity goes to powering Bitcoin farms. That’s roughly the same amount of power Switzerland uses in a year. It’s estimated most Bitcoin miners end up using 60% to 80% of what they earn from mining to cover electricity costs.
- They are not immune to the threat of hacking. Several online exchanges have been the subject of hacking and theft.
- Cryptocurrencies are designed to be free from government manipulation and control. However, as they become more popular, this key aspect of the industry has largely been threatened.
If you like the idea of day trading, buying cryptocurrencies, like Bitcoin, and then selling them when their value moves higher is a good option. But remember that cryptocurrencies are very speculative and volatile buy. To put it in other words, it is a very risky or aggressive investing strategy and you should have a good knowledge and market savvy about it to fully understand how it works.
As this network grows, it becomes more complicated, and more processing power is required. But aside from these concerns, you should also know that just having cryptocurrency exposes you to the risk of theft, as hackers try to penetrate the computer networks that maintain your assets. You have to optimize your equipment and technology to outcompete. If you are interested and determined to take part in this market, you should learn many things and choose the right platforms to make the best investments.
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NB: The purpose of this website is to provide a general understanding of personal finance, basic financial concepts, and information. It’s not intended to advise on tax, insurance, investment, or any product and service. Since each of us has our own unique situation, you should have all the appropriate information to understand and make the right decision to fit with your needs and your financial goals. I hope that you will succeed in building your financial future.
Thanks so much for sharing a great article to learn more about what is Cryptocurrency and how it work? I’ve been following this for a couple of years but I have not doing, one reason is because I don’t understand how is done, and I must say your article helped me to understand this better, but I guess I will get one or two of the books you recommend here, as I want to understand this topic better, As you said, this has its pros and cons, and one day it can have a worth and the next day up to the sky or down down down.