They used to inhabit the lesser-known corners of the internet, but today cryptocurrencies are mainstream news. Curious to learn more? Read on for a primer on the basics, with some helpful links for further reading.
So what is cryptocurrency?
Blockgeeks defines cryptocurrencies as, when everything is stripped away, “limited entries in a database no one can change without fulfilling specific conditions.” These entries just so happen to exist as digital cash, with a monetary value that is confirmed by an absolute census on a decentralized network.
This network is called blockchain. It’s a collaborative system, like we see with peer-to-peer file sharing. Instead of having one centralized authority (like a bank) to act as the arbiter of balances and transactions, each node in the network needs to agree on all of the balances it contains, or the whole chain is broken.
This system addresses what was the major stumbling block of all previous digital cash payment networks: the need to prevent “double spending” – when one entity spends the same amount twice. Instead of the third party acting as the guarantor, every user shares this role equally.
What kinds of cryptocurrencies are out there?
It all started with Bitcoin, initially proposed by a mysterious software developer (or group) under the pseudonym Satoshi Nakamoto, who introduced the system that holds everything together. Bitcoin has become the gold-standard for other cryptocurrencies, which as a group are called altcoins. Altcoins have tried to promote themselves as modified or improved versions of Bitcoins, with varying results.
Currently there are over 700 different cryptocurrencies in existence. A few of the other more successful variants are Ethereum (ETH), Ripple, Litecoin, NEM, and Bitcoin Cash - each with their own advantages and disadvantages for users, exchanges, and miners.
The above infographic illustrates some basic properties common to all cryptocurrencies:
1. Unlike transferring money from one bank account to another, you cannot reverse a transaction once it has been confirmed. There is no going back, no safety net. There are no insurance policies in place for account holders. If you get scammed or hacked, no one can help you. Do your research, make sure you know who you’re sending money to, keep your wallet secure.
2. Fancy yourself a man (or woman) of mystery? Well good news, using cryptocurrencies means that your identity can stay in the shadows. Coins are sent to so-called wallet addresses, identified as a chain of around 30 unique characters. Analysing transaction flows, while possible, does not automatically connect cryptocurrency addresses to physical identities.
3. International wire transfers are expensive for the sender, with painful wait times for the recipient. Cryptocurrency transactions are near-instant, and confirmed within minutes. As everything takes place in digital space, the geographic location of sender and recipient is no longer a factor.
4. All hail the magic of big numbers and strong cryptography. More and more lately, we’ve seen that the current system of third-party institutions has multiple weak points for hackers to exploit. Because of the public key – private key cryptocurrency system, your personal address is more secure than your bank.
5. Using cryptocurrency is available to anyone with a computer. It’s open-source, free software that you just have to download, install, and you’re ready to go.
Why do cryptocurrencies have value anyways?
Well, because of their decentralized nature, these currencies derive their value from the community of users, instead of from a centralized authority like a bank, credit card company, or government regulation. This is one reason why we’ve seen values fluctuate so much, based more in supply and demand like a stock or commodity instead of a traditional currency.
What they need to have value is a general agreement that cryptocurrencies will be used as a medium of exchange – or a shared belief that they will be used as such in the future. The variation between these two factors also plays into the volatility we see in crypto values today.
How do you get cryptocurrency funds?
Once you have the software installed, you can receive funds as payment for goods or services, you can buy them at a digital exchange, you can exchange them with anyone, or you can earn them through mining. Assuming your country of residence hasn’t regulated or outright banned the use of cryptocurrencies...
What is mining, and how does it work?
Mining is the process of verifying transactions and adding them to the public ledger, executed by hundreds of thousands of specialized computers throughout the world. Every ten minutes or so, mining computers collect a few hundred pending bitcoin exchanges into a block, which is then turned into a mathematical puzzle. From there, it’s a race to solve the puzzle. The first to solve it announces the answer to the other miners on the network, who then check to confirm that the sender of funds has the right to spend the money, and if the solution provided is indeed correct. When enough miners grant their approval, the block is cryptographically added to the decentralized ledger that exists on each node of the network, and everyone moves on to the next block.
Why the race to be first?
Well, the miner who initially solved the puzzle is awarded 25 bitcoins, but only after another 99 blocks have been added to the ledger. Big incentives for all miners’ continual participation in the system – participation that demands huge outputs of computing power, resulting in many miners forming pools to consolidate their number-crunching resources and increase their chances of reward.