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3 months ago

What Is Cryptocurrency?


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A cryptocurrency is a digital currency. It's a decentralized asset, which means that neither governments nor banks are in charge of transactions. Instead, cryptography, secure communication techniques are employed to verify the currency's reliability.


Contents

What is crypto?

A cryptocurrency is a kind of digital or virtual money. Again, these coins do not exist physically; instead, electronic ledgers keep track of how much cryptocurrency users own and who transfers it to whom. All the transactions are collected in these ledgers in an architecture, commonly known as blockchain technology.

Bitcoin, the first cryptocurrency, was invented in 2008 by Satoshi Nakamoto, a pseudonym for a person or a group of individuals. The main goal behind Bitcoin was to create an independent, peer-to-peer electronic cash system.

Cryptocurrency security must solve one major problem: prevent double-spending (to keep one person from spending the same digital asset twice). Usually, a central server operated by an entity such as a bank or government keeps records of all balances and can easily prevent double-spending. Cryptocurrencies leverage another system called a decentralized network.

Centralized and decentralized systems

In a decentralized network, you don’t have a central server, So you need an entire network of participants to verify that transactions are valid and correct, or if there is an attempt to double-spend. In other words, the system maintains integrity and consensus across independent and potentially malicious actors. Each peer tries to maintain the security of operations because the system incentivizes anyone willing to keep the network secure. On most networks, participants who help verify transactions and maintain network security are rewarded with cryptocurrencies for their efforts.

How does cryptocurrency work?

Governments and banks protect the dollar, euro, or other physical currency transactions in the traditional system. Thus, you can be sure that the transaction is secure. But what happens if neither the bank nor the government is involved as an intermediary? 

Peer-to-peer crypto transactions are based on a decentralized, authority-free system. With the aid of math and cryptography, people can make transactions safely. This technology is called the blockchain.

Blockchain is a distributed ledger that organizes a database of blocks arranged according to specific rules.

Imagine you and your friends exchange money frequently, for example, to split restaurant bills, rent, utilities, etc. It would be inconvenient to exchange cash all the time, so what you can do instead is keep a ledger.

cryptocurrency’s working principle

A communal ledger records payments you intend to make in the future. Plus, it’s public and accessible to anyone, so anyone can add new lines. Then, at the end of some period, you all look through the ledger and tally up. If you've spent more than you’ve collected, you put some money back into the pot (and vice versa if you received more). 

The only problem is trust: what stops John from adding an extra line like “Sam pays John $200”? The answer is digital signatures. Like with a handwritten signature, Sam can approve the line by adding a digital signature. 

In the real world, your signatures look pretty much the same no matter what the document is, but digital signatures are much more substantial. In a nutshell, successfully signing the ledger entry depends not only on your signature but on the message itself.

How a digital signature works

Every member has a pair of keys: a public key and a private key. As its name suggests, the private key is available only to you, so no one can copy your signature and use it for another message due to the private key. The public key indicates whether a signature was created by the private key associated with the public key you’re using for verification. 

But what if Sam signs a transaction and John decides to copy that transaction over and over again? The message/signature combination remains the same, right? 

When you sign a transaction, the message has to include a unique ID associated with the transaction. So, if Sam pays John $200 multiple times, each transaction has a new signature.

How does Blockchain technology work?

For proof of work (PoW) chains like Bitcoin, miners create a block and add transactions into it. The block contains information about the transactions: from whom, when, and how much was transferred. Multiple blocks connect to form a chain, hence the name of the technology. 

The blockchain is continuous because each block contains a link to the previous block. As a result, blocks cannot be changed, rearranged, or deleted; only new blocks can be added. This way, it’s always possible to reconstruct the history of how a particular asset has changed hands and determine its current owner. Now let's talk about how blocks are created.

What is crypto mining?

Some cryptocurrencies, such as Bitcoin, are designed to release new coins each time a block on the blockchain is verified. This is done through a system known as mining. To mine new coins, people use computer hardware to solve complex mathematical problems. Whoever solves a problem first adds a new block to the blockchain.

Miners perform several functions in the blockchain:

  1. They store copies of the blockchain and thereby protect information from loss or tampering.
  2. They confirm transactions.
  3. They verify transactions that other miners have registered.

As a rule, there is no limit to the number of miners. The more of them, the better: such a network is more reliable, and miners are rewarded for maintaining the system. Typically, these are commissions from all participants in the transactions recorded in the block and rewards from the network itself. The network generates these bonuses according to a specific algorithm.

A miner adds a new block to the chain, and new Bitcoins are minted. Currently, 6.25 Bitcoin are mined every block, which is cut in half about every four years. How does the network determine who gets the reward? The system produces specific challenges to determine the winner: whoever completes the task first receives a prize. The more computing power a miner or group of miners has, the better their chances of success.

Advantages and disadvantages of cryptocurrency

Let’s have a quick look at the pros and cons of cryptocurrency:

Pros

  1. Great liquidity. You can trade popular crypto for cash or other assets within seconds. Thus, some cryptocurrencies fit short-term trading strategies: you have a negligible risk of freezing your money due to low liquidity. On the other hand, high demand ensures unrivaled long-term potential.  
  2. Protected from inflation. Some cryptocurrencies are immune to inflation as they are specifically designed to be deflationary. Therefore, in theory, Bitcoin is less likely to lose its value, thanks to its deflationary monetary policy. 
  3. Scalable growth potential. Crypto is a brand new player on the scene with high demand and massive possibilities. 

Cons

  1. Highly volatile. Cryptocurrencies can drop their price in a matter of minutes. The Bitcoin plunge in March 2019 is a prime example. So in terms of return on investment (ROI), crypto may involve risks you may not be willing to take. 
  2. Hacking is possible. Blockchain technology is still developing, meaning that it has related vulnerabilities. For example, buying and selling Bitcoins through third parties provide fraudsters with plenty of opportunities for hacking. Moreover, the Federal Deposit Insurance Corporation (FDIC) doesn’t insure crypto.
  3. Lack of regulations. Not every government provides traders with a set of rules: some countries have a clear stance on the crypto market, others do not.  Consequently, frauds and shenanigans may thrive.
  4. Application limits. Digital currencies evolve steadily, unlike regulations and laws related to crypto. As a result, many businesses worldwide don’t accept Bitcoins or altcoins as a legitimate exchange.

Each of the existing coins falls into one of three main categories: Bitcoins, altcoins, and tokens.

Bitcoin

Bitcoin (BTC) is the first mainstream cryptocurrency. Despite the fame and hype surrounding Bitcoin as a potential future payment instrument, it’s only accepted as a form of currency in very few places, making it difficult to use on a daily basis. This is juxtaposed to fiat currency where the state sets and guarantees its value, regardless of the price of the material on which it’s made.

Like other currencies, Bitcoin involves some key risks to keep in mind: significant price fluctuations during trading and the external threat of how it will be regulated. This is a new concept that governments are trying to promote to keep consumers safe.

bitcoin price chart June 2021

Altcoins

The release of Bitcoin and its open-source code paved the way for other cryptocurrencies. As a result, over 5,000 currencies have been called "alternative coins" or "altcoins" because they’re alternatives to Bitcoin. Here are some examples of altcoins that have a large market capitalization:

  • Ether (ETH)  is the cryptocurrency widely used on the Ethereum blockchain platform. Vitalik Buterins proposed the platform’s concept in 2013 and established it two years later. The common objective of Ethereum lies within the financial sector: it’s used as a decentralized platform to treat finances across the world. However, some individuals and organizations utilize the platform to launch altcoins through initial сoin offerings(ICO).
  • Litecoin (LTC). Created by an MIT graduate in 2011, Litecoin was one of the first cryptocurrencies to emerge after Bitcoin. Litecoin is known for generating new blocks at a faster pace, allowing for a higher throughput of transactions.

Other altcoins exist, and new ones appear almost daily.

Tokens

Unlike Bitcoin and altcoins, tokens cannot exist on their own. Instead, they depend on the network of another cryptocurrency. This means that tokens don’t have a blockchain of their own; They’re built on an existing blockchain. Tokens are widely used for crowd sales fundraising, launching different start-ups, etc.

Here are some famous examples of different types of blockchain networks that host tokens:

  • Ethereum. The Ethereum platform currently hosts the most significant number of tokens.
  • NEO is often referred to as a Chinese competitor to Ethereum as a platform for smart contracts and DApps.
  • TRON has many deployed tokens, including the BitTorrent Token (BTT), which can speed up downloads over the BitTorrent file-sharing protocol.

Stablecoins

Stablecoins garnered a lot of attention since their value is tied to fiat money, gold, oil, gas, etc. Such a binding helps to stabilize the price of an asset, hence the term stablecoin.

  • Tether (USDT). Many cryptocurrencies have two substantial drawbacks. First, tangible assets don’t back them up. Second, the exchange rate’s high volatility. USDT solves both problems. Tether is backed up by the US dollar at a 1:1 ratio, which allows exchanges to trade relatively safely. Generally, USDT is a mainstream stable coin due to its daily trading volume and the pairs available.
  • Binance USD (BUSD). Binance USD is also backed up by the US dollar. However, unlike the USDT, it’s audited and regulated much more safely. Financial organizations ensure that every BUSD is stored in FDIC-insured US banks.  Generally, BUSD is a safer stablecoin.

How can you buy cryptoсurrency?

To find the right platform, you can use an aggregator site like coinmarketcap.com. All you need to do is enter your parameters into the search engine, and it will show you the best platforms in terms of that parameter. For example, you can set the trading volume as the primary search criteria. The more money that flows through a platform, the more reliable it is. The commission is another significant criterion: high fees can reduce your profits by 5-10% of the invested funds.

Don’t use shady services to buy Bitcoin. It can cost you a lot of money. Scammers often create exchanges and services for buying/selling cryptocurrency to steal your data and funds. Transferring money to such a platform is a farewell song to your money in most cases.

What online brokers offer cryptocurrencies?

Many brokers offer cryptocurrency trading. We’ve picked & compared five reliable brokers for you.

Platform
Deposit
Funding
Main Advantage
Main Disadvantage
Commission
Overall Score

eToro

$200

  • Bank transfer
  • PayPal
  • Credit card

Negative balance protection & social trading

Their support could be more helpful

0.75% for BTC

A+

Plus 500

$100

  • Bank transfer
  • PayPal
  • Credit card

User-friendly interface & good support

Poor research tools

Variable spread

A+

Capital.com

$30

  • Bank account
  • Credit card
  • Apple Pay
  • Wire transfer
  • Sofort
  • WebMoney, and more.

Great CFD trading platform & small initial deposit

Limited pool of crypto

0.5% for BTC

A

Markets.com

$250

  • Bank transfer
  • PayPal
  • Credit card

Educational materials & support

The initial deposit is relatively high & the choices of crypto are limited

Variable spread

A-

Coinbase

$50

  • Bank account
  • Fedwire
  • Wire transfer
  • SWIFT

Wide pool of crypto: more than 50 positions available

High fees

0.5% for BTC

A-

Best сryptocurrencies for trading

Some cryptocurrencies have greater potential than others. We’ve prepared a list of major coins on the cryptomarket. Consider the following cyber currencies: 

  • Bitcoin (BTC). This coin has the largest market cap.
  • Ethereum(ETH). Etherium is the second biggest cryptocurrency in size in terms of market cap.
  • Cardano (ADA).  This Third-generation cryptocurrency combines the strengths of Bitcoin and Etherium. 
  • Dogecoin (DOGE). Created as a meme coin, Dogecoin first gained popularity among Reddit users and then trickled down to the general public. The coin now holds the 6th largest market cap among all coins available.   
  • Ripple (XRP). This network allows mutual transfers anywhere in the world in just a few seconds. 
  • Binance Coin (BNB). An engine that can process 1,400,000 transactions per second makes Binance a coin worth your attention.

Please note that none of the above are investment recommendations.

You can read more about how to trade cryptocurrency on our blog.

FAQ

This depends on the country, but even though some countries don’t officially accept cryptocurrency as a new payment method, they are legal in most places around the globe.

The wide range of cryptocurrencies, the low commissions, and the high level of security make cyber currencies a popular tool for trading. If you’re not sure what trading is, check out the 3commas blog.

Where can I trade cryptocurrency?

Exchanges are the best way to trade digital assets. There, you can always sell or buy a cryptocurrency and take advantage of additional tokens like options, such as leverage, to manage additional capital.

How do I safely trade cryptocurrency?

To buy, store, and sell cryptocurrency safely, don’t deal with third parties such as exchanges. You can read our detailed article about crypto wallets to make sure your coins are safe.