Cryptocurrency

Cryptocurrency: What It Is and How It Works?

Introduction

Crypto was the buzzword of 2021, receiving significant media attention over the last few months. Social media has been awash with reports of Bitcoin (BTC), Ethereum (ETH), and Dogecoin (DOGE) recording impressive gains that far surpass the stock market.

Unless you’ve been living under a rock, there is a high probability that you’ve heard about cryptocurrencies – the new asset class promising to change the world. This article will attempt a deep dive into cryptocurrencies to understand how it works and how it is any different from other asset classes.

Since their invention, the industry has exploded with a ton of activity. Over 5,000 virtual currencies have been created and keeping up with their rapidly changing prices may be a daunting task. Fret not! The use of a coin price tracker like CoinStats is a way around the debacle. The portfolio tracker offers instant price alerts, a news aggregator, military-grade encryption, and an intuitive dashboard to track all your crypto and DeFi holdings in one place.

What are Cryptocurrencies?

Cryptocurrencies are virtual or digital currencies that operate without a third party like central banks and make use of cryptography for their security. A key point to note in the nature of cryptocurrencies is its decentralization which allows for peer-to-peer (P2P) transactions to be carried out without approval from intermediaries.

Cryptocurrency leverages distributed ledger technology (DLT) for its decentralization. Details of transactions are stored in a public, immutable ledger that is accessible by anyone with the simple requirement of an internet connection. 

Being digital assets, they do not require the use of physical wallets to store them, rather, they are stored in digital wallets. 

History of Cryptocurrencies

Satoshi Nakamoto, an elusive computer programmer created Bitcoin (BTC) in 2009 as the first cryptocurrency to be invented. Nakamoto’s motivation for the invention stemmed from the need to avoid a repeat of the 2008 financial crisis caused by banks and large financial institutions. Slowly and steadily, a community of like-minded individuals formed around Bitcoin, sending BTC on a bull run and expanding its use cases.

In no time, other cryptocurrencies were created based on Bitcoin’s model. Others took things further by adding new features like smart contracts to their networks like Ethereum and Solana (SOL). The proliferation of more cryptocurrencies triggered increased adoption and an influx of capital from investors. Ten years later, the market capitalization of cryptocurrencies stood at almost $3 trillion and their number stood at over 5,000.

Their use cases grew as some were used primarily as a store of value while others were used for their utility in decentralized finance (DeFi), gaming, or for entertainment like meme coins.

How Does it Work?

As stated earlier, establishing cryptocurrencies work by running on distributed ledger technology (DLT). DLT, also known as the blockchain, is a “growing list of records” linked together through cryptography.

All cryptocurrency transactions are stored on the blockchain in blocks with each new block containing information from the previous block. This feature makes it tamper-proof and impossible to alter the information since they are publicly available and hard coded.

New cryptocurrencies are created through mining in Proof-of-Work (PoW) consensus mechanisms. This means that computing power is used to solve mathematical problems to confirm transactions with the reward being the creation of new tokens. For Proof-of-Stake (PoS), validators are selected by the value of their holdings to verify transactions to circumvent the use of computing power of PoW systems.

Newer blockchains make smart contracts a core part of their offering to expand their use cases. Smart contracts are contracts that are automatically executed upon the meeting of certain predetermined conditions. Smart contracts are the building blocks for non-fungible tokens (NFTs), decentralized applications (DApps), and DeFi.

Benefits of Cryptocurrencies

Flowing from the above, it is easy to identify some benefits of this asset class. Let’s explore some of the benefits associated with the use of cryptocurrencies

Financial Inclusion

The absence of third parties like banks and financial institutions to approve transactions improves financial inclusion. These legacy institutions have certain metrics that must be met before creating an account with them but DeFi platform requirements offer a chance for the unbanked to access financial services.

Privacy

Cryptocurrency transactions have the reputation of being privacy-focused. Although the details of the transactions are publicly available, the identity of the sender and recipient are unknown unlike in traditional finance where Know Your Customer (KYC) regulations have eliminated private transactions.

Cross-border payments

Virtual currencies have revolutionized the way we carry out cross-border transactions. Before the rise of digital assets, third-party platforms like Western Union were used to send funds across multiple nations but with crypto, cross-border payments are settled instantly with low fees.

Investing in Crypto

For users looking to get started with cryptocurrencies, the easiest way to get started is through the use of crypto exchanges. These platforms allow individuals to buy and sell cryptocurrencies in addition to other perks like a P2P marketplace, leverage, and trading futures.

Examples of leading exchanges include Binance, Coinbase, Gemini, Crypto.com, and Kraken. Another alternative to get started with virtual currencies is through the use of brokerage firms like eToro, Robinhood, or SoFi.

Investors can also get exposure to the asset class through Bitcoin trusts, or via Exchange Traded Funds (ETFs).

Conclusion

Cryptocurrencies are now considered a mainstream asset in less than 10 years since their creation. Trillions of dollars have flowed into the asset class since they came into the scene with publicly listed companies and even countries holding them as part of their balance sheets.
At its core, virtual currencies operate using blockchain technology to store and verify transaction records in an immutable format. The use of advanced cryptographic techniques provides advanced-level security with ever-increasing use case scenarios.

The benefits of cryptocurrencies are numerous including low costs of transactions, improved cross-border transactions, and privacy amongst others. While there is a wide range of benefits, users should be wary of the downsides associated with using cryptocurrencies. For starters, the industry lacks government regulation, prone to volatility and some crypto protocols are vulnerable to hackers.

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