Crypto Guide: What is Cryptocurrency?
Last Update: August 1st, 2022
Cryptocurrency, also known as crypto, has been changing the way that finance operates for several years now. Once deemed a fad by Bitcoin skeptics back in the early 2010s, crypto has now gone mainstream, being featured in the media and with some coins soaring to unfathomable heights, producing thousands of crypto millionaires and billionaires.
But what actually is cryptocurrency? In this article, we’ll run over the history, what blockchain technology is and how exactly you can get involved.
The first cryptocurrency (the Bitcoin system) was established in 2008 when the pseudonymous Satoshi Nakamoto invented a decentralized electronic cash system that uses a peer-to-peer distributed timestamp server to prevent double-spending. This distributed server generates computational proof of the chronological sequence of transactions.
In layman’s terms, it’s a digital payment system that doesn’t rely on banks or other intermediaries to verify transactions; all that’s needed are other computers that can verify transactions on a digital database called a blockchain. These transactions are recorded on a public ledger for anyone to see.
Every bitcoin transaction receives a digital timestamp when it is confirmed.
Revolutionary Blockchain Technology
In the process of inventing this payment system, Satoshi also pioneered the first blockchain database, which we previously mentioned. Since then, many other cryptocurrencies have emerged, many of which use a similar type of blockchain technology as Bitcoin.
This is generally the common thread between cryptocurrencies; they all rely on this public ledger technology to record and track transactions being sent across the network. A coin like Bitcoin, for example, has around 250k transactions a day as of July 2022, and all of these transactions are recorded automatically without any mistakes.
Essentially, the blockchain works like this:
- A user starts a transaction, signing it with their private key to prove it’s from their particular wallet. Think of it like a digital signature.
- The transaction is broadcast to the verifying nodes, which can be anyone with a computer or a set of verified nodes, depending on the cryptocurrency.
- The transaction is verified using a consensus algorithm. Bitcoin, for example, uses proof-of-work, which requires computational power to solve complex mathematical problems and verify the transactions. This ensures every node has a copy of the same ledger.
- Once the nodes verify the transaction, it’s placed in the ledger with a timestamp and transaction ID.
- When the block is completed, it gets attached to the previous block, forming a blockchain.
As the technology has progressed, we’ve seen hundreds of use cases emerge. From decentralized applications and smart contracts on Ethereum to Golem, which lets people rent out their computing power to form a supercomputer capable of running energy-intensive scientific calculations and CGI rendering, it seems endless what crypto can do.
How Are Transactions Validated?
Because there’s no oversight by central banks or authorities to verify transactions, it must be done on the blockchain. The nodes connected to the network must verify that they have the same copy of the ledger as everyone else.
But how does crypto make sure everyone participates honestly? By introducing incentives. This guarantees that there will always be individuals willing to invest their time, money, and computing power into validating transactions.
The process of gaining these incentives is often called mining. When validators participate honestly in the validation system, they earn newly minted cryptocurrencies.
There are a few ways that these incentives work, otherwise known as consensus protocols. The most common are proof-of-work (PoW) and proof-of-stake (PoS).
- Proof-of-work: This system uses an energy-intensive process that uses expensive graphics cards to generate the code that solves a computational puzzle. If they solve the puzzle, they are granted the right to add a new block of transactions; in doing so, they receive rewards in the form of the crypto they’re validating.
Any fees associated with the transactions included in the new block are also paid out to the successful miner. This is the system used by Bitcoin, Dogecoin, and the original version of Ethereum.
- Proof-of-stake: Here, computational power isn’t used, and instead, node operators only need to lock away the coin they want to validate, known as staking, showing their commitment to the longevity of the network. Many PoS cryptos require validators to lock away their coins for at least six months.
The protocol then randomly assigns validation tasks to pools of nodes, paying out rewards to successful validators. This is the system used by Cardano, Solana, and Polkadot. Ethereum 2.0 also uses PoS.
About Cryptocurrency Payments – Bitcoin Example
Bitcoin Transactions Are:
- Irreversible – After a bitcoin transaction has been confirmed, it can’t be reversed by anyone.
- Cheap – A bitcoin transaction can move thousands of dollars with a minimal transaction cost, which is on average a couple of dollars, depending on the size and desired speed of the transaction.
- Fast – The speed at which transactions can be processed depends on how much users are willing to pay. Bitcoin transactions can generally be confirmed within a few minutes.
- Global – Bitcoin can be sent to basically anyone, anywhere in the world.
Anonymous – Bitcoin wallets don’t have names associated with them, so in theory, anyone can send bitcoin completely anonymously.
As of July 2022, the top ten cryptocurrencies are (ranked by market capitalization):
Each promises to solve a particular problem. Cardano, for instance, aims to solve prior cryptocurrency issues, like scalability (ensuring low transaction costs, even with a busy network), interoperability (able to connect with other blockchains) and sustainability (proof-of-work, for example, is very energy intensive and elevates carbon emissions).
Three of these currencies are actually pegged to the U.S. Dollar: Tether, USD Coin, and Binance USD. These make it easy to transact dollar amounts and buy crypto without needing traditional finance.
Where Can I Buy Cryptocurrency?
There are several ways that investors can buy crypto, but here, we’ll tell you the easiest way to get your hands on some.
Cryptocurrency exchanges are like forex brokers with a twist. Instead of trading a contract on the underlying instrument, you actually get to own the cryptocurrency. It’s like being delivered the gold you traded, just digitally. Unlike a real gold delivery, exchanges often have minuscule fees, and coins are transferred instantly into your wallet.
Easy Access to Trading/Speculating With Cryptocurrencies
If you just want to trade crypto and don’t want to bother with the hassle of moving coins and potential security risks, your favorite forex broker likely offers contracts for difference (CFDs) that allow you to effortlessly trade cryptocurrencies.
This enables cryptocurrency traders to engage in both long (buy) and short (sell) crypto positions on the superb trading platforms offered by these brokers. To make crypto trading even more exciting, many forex brokers offer leverage on cryptocurrency trades that can enhance your profits (and losses – always employ proper risk management!).
Check out our handy guide, How to Choose the Right Cryptocurrency Broker.