Add3, Content
August 1, 2023
18.6 min reading
You’ve probably heard of cryptocurrency by now. But what is it? In this article, you’ll find a complete guide to understanding “what is cryptocurrency” and how to use it.
Cryptocurrency is a digital currency that uses cryptography to secure its decentralized ledger. Bitcoin, the first cryptocurrency, solved the “double spend” problem that previous digital currencies couldn’t solve. We’ll discuss that more later. But first, think of cryptography as a virtual asset you would document on a decentralized blockchain using cryptography.
There are both advantages and disadvantages to crypto.
Because it is trustless, cryptocurrency doesn’t need the backing of any government or central authority. This means that no trusted party needs to issue or guarantee its value like fiat currency. For example, your dollar has a guarantee by the Federal Reserve, which promises that dollars will remain valuable. This, however, requires complete trust in the Federal Reserve by anyone who uses dollars.
Crypto is also immutable, which means that once a transaction is documented on the blockchain, somebody cannot reverse it. In contrast, credit card or bank transactions can be changed by the credit card company or the bank. Immutability makes cryptocurrency both reliable and precarious. Therefore, it’s essential always to ensure you’re sending crypto to the correct place since it cannot be reversed.
Another benefit of crypto is that you can transfer it anywhere. Unlike fiat currencies, which have to be exchanged, crypto can go anywhere in the world, peer-to-peer (P2P). So there’s no need to wire money across borders with crypto. Instead, individuals can send it directly to each other digitally.
Crypto’s P2P nature is also an advantage. Billions of unbanked people who don’t have access to financial services can use crypto, transferring it directly between individuals. In addition, people worldwide who have been excluded from financial services can participate in crypto. All they need is an internet connection.
There are downsides to crypto, however.
One of the biggest challenges for new crypto users is understanding exactly how it works. But that’s why guides like this exist. And the user experience for crypto is quickly improving. Today, buying crypto is easy. You can even buy it with a credit card.
Another downside to crypto is the lack of regulatory clarity in the industry. Many crypto purists see this as a benefit. But many average people and institutions want clarity around what is and is not legal. This will help people understand how crypto can fit into the rest of the economy.
Security can also be a roadblock for crypto users. Keeping wallet keys secure and preventing transaction errors or hacks can be difficult. However, most crypto users discover securing their tokens takes time and effort.
Lastly, most cryptocurrencies tend to be highly volatile. This can make them challenging to use for everyday transactions or even for investments.
Cryptocurrencies exist on a distributed ledger called a blockchain. You must add the transaction to the blockchain to send virtual currency directly between two parties. This process uses encryption algorithms and cryptographic techniques to secure ledger entries.
The Double Spend Problem
Before Bitcoin, there were other digital currencies. But none of them were able to solve the “double spend” problem. Like any digital information, before Bitcoin, it was possible to copy digital currencies. This meant that somebody could spend one coin multiple times by copying it.
Bitcoin solved this problem with its proof-of-work consensus mechanism. As a result, every transaction submitted to the blockchain has to be verified by the decentralized network. And once a transaction is added to the blockchain, it cannot be modified.
Blockchains also timestamp transactions so that every transaction can be traced in chronological order in the chain.
A blockchain is an ever-evolving database. But it stores information differently than traditional databases. Blockchains collect data as “blocks” chained together in an immutable timeline. The process involves stringing together chains of blocks, which is where the name “blockchain” comes from.
Blockchain “nodes” maintain the database by adding new transactions. And, because each node has a copy of the entire database, it becomes decentralized or distributed. This means that to modify the database; all nodes must verify and update a transaction.
The more nodes in a blockchain network, the more difficult it is to compromise. This is because every blockchain has a consensus protocol that determines how the network agrees on and verifies transactions. Some blockchains, like Bitcoin, use a mining consensus protocol called proof-of-work. Others, like Ethereum, use a proof-of-stake protocol.
Many people see the potential of blockchain technology for many uses besides cryptocurrencies. For example, blockchains can be used for supply chains, governance methods like voting, crowdfunding, and even cybersecurity applications. However, cryptocurrencies are still the most commonly understood use of blockchain.
As mentioned, Bitcoin was the first cryptocurrency to spring up in 2009. Since then, thousands of crypto tokens have been launched for various purposes and on multiple blockchain platforms.
There are also different types of cryptocurrencies. However, here are some of the most common ones:
Examples of utility tokens are XRP and ETH. XRP is the native token of the Ripple blockchain. You can use XRP as a bridge token to transfer currencies at a meager cost. Ethereum is a smart contract blockchain that allows self-executing code. ETH is used for decentralized applications (dApps) and smart contracts on the Ethereum network.
Tokens that you use for payments and asset transfers are transactional tokens. Bitcoin is the most widely used transactional token. It has limited utility beyond use as a currency, but Bitcoin’s blockchain is considered the most secure in the world.
Governance tokens are used for things like voting and unlocking other privileges on a blockchain. Uniswap is an example of a governance token that can be used to participate in voting and making decisions about the project.
Platform tokens are built on a blockchain and used to deliver dApps. Dai, for example, is a stablecoin. But it’s also considered a platform token because it is built on the Ethereum blockchain.
Security tokens represent property interests or asset ownership. For example, Meridio investors can trade tokenized real estate shares. They may also represent other tokenized assets like art or stocks.
Unlike fiat currencies, cryptocurrencies are not issued or backed by a government or central bank. Currencies like the dollar are created by and controlled by the government. They also have legal tender status under the law. Crypto, however, is not backed by any central entity.
One of the reasons crypto was created was to offer a currency that operates outside traditional financial systems. Early cryptographers had a cypherpunk and anarcho-capitalist philosophy. Today, many governments don’t recognize crypto, and some actively work to regulate it.
The legal status of cryptocurrencies impacts people’s ability to use them for everyday transactions. For example, in June 2019, the Financial Action Task Force (FATF) recommended that wire transfers of cryptocurrencies be subject to the requirements of its Travel Rule, which requires anti-money laundering (AML) compliance.
In 2021, El Salvador became the first country to accept Bitcoin as legal tender. As of 2023, the Central African Republic is the only other country that has given crypto legal tender status. In the rest of the world, crypto regulations vary.
Japan’s Payment Services Act defines Bitcoin as legal property. And in the European Union, crypto is legal, though not legal tender. In June 2021, the European Commission released the Markets in Crypto-Assets (MiCA) regulation. It provides safeguards for regulation and sets rules for companies offering financial services that use cryptocurrencies.
In the United States, regulations are still murky. Until now, the Securities and Exchange Commission (SEC) has said that cryptocurrencies like Bitcoin and Ethereum are not securities. This may soon change, however, with more public attention on crypto in recent years. In 2022, SEC Chair Gary Gensler said he believes cryptocurrencies are securities.
Many crypto experts believe that harsher regulations for crypto are coming in the United States. Currently, the Internal Revenue Service (IRS) treats them as financial assets or property for tax purposes.
Depending on whom you ask, cryptocurrency can be seen as an exciting or hazardous investment. However, there are many stories of crypto millionaires who bought Bitcoin or Ethereum early and saw massive gains.
However, crypto is also notoriously volatile. And even more, people have yet to consider the risks seriously enough to lose money investing in crypto. So not only does the market value of crypto move dramatically regularly, there are more risks to consider.
It’s still a bit complicated to figure out how to use cryptocurrency today. For most people, there’s a learning curve. On top of that, because blockchain transactions are immutable and permanent, a failed transaction is unrecoverable. So if a user sends money to the wrong place or a transaction doesn’t go through, there’s no central party to ask for help.
Because the regulatory landscape worldwide is still being determined, crypto’s future is flexible. Anyone holding crypto assets may find themselves in a precarious situation if there is a sudden regulatory crackdown in their jurisdiction.
Many crypto holders have discovered the dangers of allowing exchanges and platforms to custody their assets. If those platforms are hacked or compromised, you can lose all your assets in their custody.
The crypto industry is also notorious for scams and incompetent managers. And since regulation is still unclear, it’s possible to lose investments in poorly managed projects. Rug pulls, scams and unethical practices are all a risk.
While blockchain is a very secure technology, there are still possibilities for code vulnerabilities. Bugs that allow smart contracts to fail, be exploited, or be hacked are a real risk.
Whales with a significant market share also create the risk of market manipulation. It’s easy for retail investors to lose their investments to market manipulators, given how volatile crypto is.
Buying crypto is much easier than it was just a few years ago. Today, it’s relatively easy to buy crypto with fiat, trade for it on an exchange, or receive it from an individual.
Coinbase and Binance are two of the largest crypto exchanges in the world. Before its collapse, FTX was also considered one of the major crypto exchanges. Depending on where you live, some exchanges may be easier to use than others.
Some of the ways to buy crypto include:
To buy crypto, you’ll also need a crypto wallet. Most centralized exchanges will custody crypto for you. But security-conscious users make sure to transfer their crypto assets to a self-custody wallet.
One of the original goals of cryptocurrency was to create alternative currency options outside of traditional financial systems. The cypherpunks wanted a way to hold assets without government interference. And crypto offers a solution for billions of people worldwide who don’t even have access to banking and financial services.
In addition to providing decentralized financial services to the unbanked, crypto can streamline existing economic infrastructure. Blockchain can help reduce transaction costs and remove trusted third parties. Crypto can also reduce transaction times and make transfers more secure.
Bitcoin is the most popular cryptocurrency. It’s so ubiquitous that any other crypto token, not Bitcoin, is called an altcoin. But, next to Bitcoin, Ethereum is far more popular than any other altcoin.
Here’s a list of the top 10 crypto coins according to CoinMarketCap:
As of May 2023, the market cap of Bitcoin was $530,024,123,655.
There are many categories of crypto tokens. Some of the popular ones are meme-coins and stablecoins. Memecoins are coins like Dogecoin and Shiba Inu, which were started with certain memes. Their popularity is tied to the meme, and they can skyrocket during “shitcoin season,” when speculators try to make fast gains.
Stablecoins are pegged to the value of another asset, like a fiat currency, gold, or a basket of assets. USDT, for example, is tied to the value of a dollar. PAXG, conversely, is pegged to the value of gold.
Cryptocurrencies have become more prominent in the public consciousness in the last several years. As a result, many retail and institutional investors are beginning to add crypto to their portfolios. At the same time, governments and regulators are taking notice of the crypto landscape.
At its peak in November of 2021, the total market capitalization of the crypto market reached $3 trillion. Crypto started as computer nerds and cryptography enthusiasts trading digital internet money. Today, it’s spreading across the globe at breakneck speed.
The promises of crypto and decentralized networks are significant, but there are roadblocks. Two of the significant hurdles crypto still faces are adoption and regulation. Even though most people have heard of cryptocurrency by now, only a tiny percentage own it. A cryptocurrency needs to gain wider adoption to become an unstoppable force.
Before individuals and institutions fully embrace crypto, many also believe the world needs regulatory clarity. However, once we understand how crypto fits into the more significant financial economy, more people and institutions will adopt it.
There is a lot to understand about how cryptocurrency and blockchain technology works. You could spend months and even years understanding the technical details of each. However, it’s easier than ever to invest in crypto without needing the complex technical knowledge required in the past.
Like most people don’t fully understand how their computers or smartphones work, crypto is becoming simpler. By abstracting away the complexities of new technologies, users can more easily understand and use them.
If you plan to get started investing in or exploring cryptocurrency, there’s no better way to dive in.
