How Cryptocurrency Works: Top Questions, Answered
- What is cryptocurrency?
- Is Bitcoin the first cryptographic digital money?
- What’s so revolutionary about the blockchain?
- What are the advantages of using cryptocurrency?
- How many crypto coins exist at the moment, and what are they worth?
- How I can get cryptocurrency?
- Where I can spend cryptocurrency?
- Where are cryptocurrencies banned?
- How much money can I make with crypto?
- Where do I start with cryptocurrency?
The cryptocurrency market has quickly grown from a niche for devoted crypto enthusiasts to a billion-dollar industry followed closely by everyone from casual day traders to governments and multi-national companies. Yet even as Bitcoin and other cryptocurrencies get more press, much about how cryptocurrency works remains unclear to the average observer or traditional investor.
In this article, we will dig into the phenomenon of cryptocurrency and the blockchain technology behind it to answer the most common questions.
What is cryptocurrency?
In a nutshell, cryptocurrencies are digital currencies that exist without being represented by physical bills or coins. Although transactions between bank accounts can, like cryptocurrency transactions, be made without a physical bank card, cryptocurrency has a significant distinctive feature — it is decentralized, which means that a central authority has no control over it. At the same time, cryptocurrencies use strong cryptography to control the creation of new tokens and to secure financial transactions on the network.
Is Bitcoin the first cryptographic digital money?
There were a number of digital cash technologies prior to the launch of Bitcoin. In fact, the first anonymous cryptographic electronic currency, called Ecash, was invented by the American cryptographer David Chaum back in 1983. The idea behind Ecash was to keep its users anonymous and untraceable by banks. However, it still relied on a central server.
Bitcoin was the first digital currency to do away with this, being based on the decentralized blockchain, instead. Blockchain and Bitcoin are tightly bound together — both went public in 2009 when the Bitcoin network was created after mining the first block of the chain, known as the genesis block.
What’s so revolutionary about the blockchain?
The first versions of digital money, such as Ecash, had a bigger flaw than reliance on a central server: it was possible for the same single digital token to be spent more than once. Tokens that had been duplicated or falsified by exploiting this flaw were devaluing these digital currencies, diminishing user trust alongside the currencies’ circulation and retention.
This issue, called double-spending, was later addressed with a cryptographic technique known as the blind signature. This digital signature, while preserving users’ anonymity in a transaction, relied on a centralized third party that verified whether or not a token had been spent. The central party, however, represented a single point of failure. In other words, if the central party failed, the entire system would be negatively influenced.
By 2007, a number of distributed technologies for the prevention of double-spending had been proposed to eliminate the shortcomings of the systems with centralized control. In early 2009, Bitcoin was the first cryptocurrency to implement a new solution with a cryptographic protocol called a proof-of-work system. This protocol negated the need for a trusted third party to validate transactions. Instead, transactions could be recorded and validated by being included in a public ledger called a blockchain. This revolutionized digital currency, making the difficulty of double-spending increase in correlation with the overall network growth. A further benefit introduced by decentralization was resistance to attacks and fraud.
What are the advantages of using cryptocurrency?
There are many advantages of using cryptocurrencies. These are just some of them:
- No barriers — Cryptocurrencies make international transfers more accessible, cost-efficient, and fast by eliminating the need for banks and third-party providers. And since cryptocurrency is not bound by the exchange rates, interest rates, and transaction charges of any country, it can be used internationally without the limitations imposed on fiat money.
- Privacy and anonymity — While Bitcoin is not entirely anonymous, there are so-called “privacy coins”, like Monero and Dash, that hide information about a wallet’s activity. These coins now provide the anonymity that was the main selling point of earlier iterations of digital currencies, like Ecash.
- Global access — At the moment, there are 2.2 billion people with access to the Internet but without access to traditional financial institutions. The market of crypto assets offers them the previously unavailable opportunity to invest, exchange, and transfer their money.
- Security — Once a cryptocurrency transfer has been authorized, it can’t be reversed. This feature makes cryptocurrencies different from credit card transactions, which can be reversed using chargebacks, a feature often exploited by fraudsters.
- Investment opportunities — Last year’s bear market did not shake general confidence in cryptocurrencies, which continue to be considered chiefly as an investment option. Because investing in crypto can, at times, be risky, a significant number of investors have turned to crypto derivatives to hedge that risk.
How many crypto coins exist at the moment, and what are they worth?
Currently, more than 2,200 cryptocurrencies are being traded publicly. And the number of cryptocurrencies is only growing as more projects raise money for their coins through initial coin offerings or token sales. As of mid-July, the total value of all cryptocurrencies stood at about $282 billion, with Bitcoin taking around 66% of the total market cap, or $186 billion (as of July 15).
In total, the top 20 cryptocurrencies account for more than 92% of the whole market value. Some industry experts claim, however, that the market share of Bitcoin is set to increase even more to about 80-90%, which could potentially lead to the fall of altcoins. But the position of such altcoins as Litecoin, Ripple, and Ethereum is thought to be far too strong to crash anytime soon. Plus, many get added value from the additional features they provide to users, such as smart contracts functionality (Ethereum), a decentralized remittance platform (XPR), and a transaction confirmation time (Litecoin) four times faster than Bitcoin.
How I can get cryptocurrency?
New crypto-coins are generated by mining, which is a competitive and decentralized process that rewards crypto enthusiasts for their mining services. Mining is needed for processing transactions and securing the network. The initial reward for Bitcoin mining of one block was 50 BTC in the early days of Bitcoin. In 2012, the reward amount was halved to 25 BTC, and currently, it is down to 12.5 Bitcoin. This is still significant, however, considering the changed position of miners in the market.
In the early days of the market, only cryptography enthusiasts served as miners, but now huge enterprises are involved in the business and serve as mining pools. Currently, while mining is still technically possible for anyone, it isn’t profitable on a small scale unless the miner has access to free or cheap electricity or is a part of the top Bitcoin mining pool. Because mining is no longer accessible to the majority, most people obtain crypto by buying it on a trusted exchange platform using fiat money (USD, GBP, EUR) to purchase Bitcoin or any altcoin.
Where I can spend cryptocurrency?
Most people consider Bitcoin and altcoins as an investment tool rather than a way to pay for goods and services. Nevertheless, opportunities for using cryptocurrencies are opening up. Many large companies, such as Microsoft, AT&T, PayPal, Subway, and Shopify are now accepting Bitcoin as a payment method. According to Chainalysis, consumers spent $190.2 million worth of Bitcoin monthly on merchant services in 2017, compared with a monthly average of just $9.8 million in 2013.
However, spending cryptocurrencies on small everyday transactions is not yet practical. Many regulators see cryptocurrencies as assets, not currency, so converting fractions of crypto coins into cash to buy your morning Starbucks would mean paying taxes at capital gains rate. On top of that, transaction fees for most cryptocurrencies are quite high. But with the further growth of the cryptocurrency market, it’s likely that these limitations could change.
Where are cryptocurrencies banned?
Overall, Bitcoin remains in a legal gray area for much of the world. Since Bitcoin is not issued, endorsed, or regulated by any central bank, many governments are worried about the negative influence of crypto coins on their national currency. Besides being independent of governments, cryptocurrency allows its users to remain anonymous. And while Bitcoin, at least, has developed into a well-established digital currency system, there are still no uniform international laws that regulate this cryptocurrency or any other coin.
Because of this, many countries are still experimenting with regulations on cryptocurrency usage. Estonia and Malta are among the most proactive in their approach, adopting regulations aimed at encouraging the growth of blockchain and the crypto business. In the US, by contrast, compliance laws are confusing at times and contradictory, with the IRS, CFTC, SEC, and the Dept of Treasury all classifying Bitcoin differently. And there are countries that have said “no” to cryptocurrency altogether. Among these are Algeria, Egypt, Morocco, Bolivia, Colombia, Ecuador, Saudi Arabia, Iran, Bangladesh, Nepal, Pakistan, China, Cambodia, and Indonesia.
As governments play with ways to best regulate cryptocurrency, the map of crypto-friendly states will likely expand.
How much money can I make with crypto?
It is tough to predict the market since high volatility is one of the main features of cryptocurrencies. Some financial experts predict that Bitcoin will reach $100,000 before the end of 2019; even more ambitious predictions say Bitcoin will jump to $1M in 2020. If these analysts are correct, then buying one Bitcoin now could yield a 100% ROI by next year. However, these kinds of predictions should be taken with a grain of salt — ultimately, you are the one responsible for your investment, not big-name financial gurus.
That’s the best thing and, at the same time, the worst thing about investing in crypto. You can make huge gains, but the potential losses can also be significant. For example, one of the largest cryptocurrencies, Ripple, was being traded for $0.23 in the first half of December 2017. Shortly afterwards, its value increased by over 1,500% in less than a month. However, in February the price was back down to $0.59, yielding profit for those who had bought it earliest but not for those who had bought at the top of the market.
These price changes are a fundamental part of the cryptocurrency market. The best advice here is to invest within your means and to mitigate risk by diversifying your portfolio.
Where do I start with cryptocurrency?
Today, buying cryptocurrencies is as easy as purchasing a flight ticket online. Start with registering on the Lex Exchange platform, which offers 18 top coins.
Because the exchange is compliant with anti-fraud and anti-money laundering AML/KYC regulations, all users are required to have their identities verified before trading on the platform. Verification can be done quickly and electronically in three steps: email confirmation, mobile number confirmation, and submission of proof of ID, residence, and a selfie.
From there, starting to trade is simply a matter of putting a deposit on your crypto wallet in fiat or cryptocurrency and selecting the coin you want to buy. Go to Lex Exchange’s website to get started.