What is Cryptocurrency? [Beginner’s Guide]

cryptocurrencies

Cryptocurrency is a purely digital form of money that makes itself happen using cryptography in its functions and is completely decentralized (peer-to-peer, in other words). Eg, Bitcoin, Ether, XRP, LiteCoin, etc.

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Invention of Money

We, as humans, are interdependent for daily needs, as we are for love and care. While the feeling for love and care are inbuilt within each of us by nature, the former needed an intelligent solution. We did come up with the solution that goes by the name – Barter System. It was a system where goods and services were exchanged for other goods and services. It served the purpose for quite a while before humans created Money.

Money is one of the unique and most practical human inventions that let us exchange it for goods of value or services. Money, as we use it today, is purely regulated by centralized financial institutions. In the last couple of decades, the emergence of digitization has an impact on everything (well, almost!), including and especially money.

As a result, money evolved from being used as hard cash in a transaction into digital value transfer. However, the underlying concept around it stayed the same. It means that money did not become digital, but its value can be digitally transferred.

Issues with current money system

In banks and other financial institutions, there is always a middle man, if not multiple. Having a middle man makes the transaction expensive in the form of their cut. It also makes the transaction slower to process.

Nearly 3 billion people don’t have bank accounts, which is around half of the population of this earth. Therefore, they can not access financial services.

Financial inequality is on the rise across the planet.

Bank account hacks and money being siphoned off are frequent occurrences in the financial world.

Introduction of Digital Currency

But lately, a new class of currency has emerged which is purely digital in nature, cryptographically secure, and decentralized. And we call it Cryptocurrency.

  • Being completely digital means, it lives on the internet and is not available as physical cash.
  • Being cryptographically secure means it uses cryptography to support its various functions such as transfer mechanism, creation of fresh units of that cryptocurrency, transaction verification, etc.
  • And being decentralized mean that it is not governed by any financial institution or any other institution for that matter.

How does a digital currency gains its value?

Well, for something to have value, it should meet the following 2 criteria (at the very least):

  • It must be relatively scarce.
  • It must be accepted for payments by others.

Fiat currencies like USD, EUR, GBP, etc. have their supplies controlled by governments. Other resources like precious metals (gold and silver), diamonds, and even oil derive their high values by being scarcely available in nature.

In the context of cryptocurrencies, they are usually capped to a certain number which makes them a scarce entity. Bitcoin, for instance, is capped at 21 million units. It means that there will ever be 21 million Bitcoins as specified by its developer(s).

Secondly, as and when a specific cryptocurrency starts gaining public attention and confidence, organizations also step forward and embrace the cryptocurrency by letting people pay for their products with it. Furthermore, cryptocurrencies are traded on cryptocurrency exchanges, pretty much like stocks and commodities. Higher the traded volume, the higher the value of that cryptocurrency. (Read Binance to know more about cryptocurrency exchange).

Cryptocurrency Generation

If there is no regulatory authority overlooking cryptocurrency then how does new cryptocurrency generate?

Going back to the example of commodities like gold, silver, diamonds, and oil, we know that these resources are acquired through mining. Now, mining them is not simple but requires a substantial amount of effort and resources.

Cryptocurrency Mining Rig

Same way, cryptocurrencies are generated through a special type of mining. New units of cryptocurrencies are periodically released and can be owned by solving hard mathematical problems. These mathematical puzzles are not the kind that can be solved by a personal computer. Instead, they consume high computing power and thus electricity, to arrive at the solution. Participants who take a crack at solving these problems are known as Miners.

Miners usually have a multitude of processors that work exhaustively to solve the computational problems. Only the miner who solves it first mints the cryptocurrency tokens as a reward. Therefore, it’s safe to say that process of mining cryptocurrency is costly and occasionally rewarding.

So, should you decide to have cryptocurrency, you have the following 2 ways to do that:

  1. Mining (keep in mind, it’s not all romantic)
  2. Buy them (using a credit card)

Once you have tokens of a cryptocurrency in your possession, you can use to make payments for goods and services. Additionally, you can trade them with other cryptocurrencies using a cryptocurrency exchange service like Binance.

Why do we have so many cryptocurrencies?

The cryptocurrency was initially invented for the elimination of the monopoly of any centralized authority while enabling peer-to-peer operation of digital money at the same time. Since then, this cause has evolved into a much-sophisticated approach to solving problems using its underlying technology – Blockchain.

Many of the new cryptocurrencies are aimed at a specific product and service. For instance, a project named IOTA is started to revolutionize IoT (internet of things) by coupling connected devices and distributed ledger technology (a.k.a. blockchain). They have named their cryptocurrency token after their project – IOTA.

Tokenization

Like mentioned before, it’s not just the creation and transfer of digital currency that blockchain has enabled. Blockchain has also enabled the registration, storage, and transfer of physical assets using blockchain technology, and it’s done through Tokenization. Tokenization is a way of representing any asset (physical or digital) as a token which makes use of blockchain technology to register and transfer that asset. In other words, a token is the digital representation of anything on the blockchain.

Therefore, every cryptocurrency created is not meant to represent money. Some of those cryptocurrencies have enabled the tokenization of real-life assets.

Some of the instances are:

  • SolarCoin: It’s a project which has led the tokenization of solar energy using their SolarCoin token. Users can share an excess of generating solar energy and claim SolarCoins for it, which then can be stored, exchanged, or spent. This is an innovative concept which rewards its users for generating and sharing excess solar energy within their neighborhood.
  • Golem: Golem coin tokenize the computer processing power of users. Here, unused computing power can be shared through a decentralized network of users and Golem coins can be claimed for this. CPUs and GPUs of participating nodes are connected in a decentralized network where users in need of computing power can rent it from the providers within the network.
  • Steemit: This social media platform incentivizes its users for their posts by rewarding them with STEEM tokens. While conventional social media platforms keep the profit to themselves, Steemit rewards content creators for the contribution they make to the platform. Obviously, the post needs to be attention-worthy to claim STEEM tokens.

Tokens uses in each of the above projects are blockchain-backed cryptocurrency tokens.

Additionally, anyone with programming skills can create their own cryptocurrency. We know that Bitcoin was the world’s first cryptocurrency and it was released as an open-source project. Being open-source means that anyone can use to create their own cryptocurrency by forking the Bitcoin open-source implementation.

Forking? Now what is that?

Forking is known as a way of creating a new project from an already existing open source project. It eliminates the need to develop everything from scratch. It lets a developer or a team of developers focus on new protocols that are built on the existing ones.

As an example, LiteCoin is a fork from Bitcoin where the developers added new protocols to existing code with the aim to reduce the transaction time considerably.

There are 2 types of forks:

  1. Hard Fork: It’s an upgrade of the existing protocol that forces the user to upgrade the software. In other words, a hard fork is a change that is not backward compatible. Anyone who does not update the software with new protocols cannot participate in the network and is kicked out eventually.
  2. Soft Fork: It’s an upgrade of the existing protocol that does not force the user to upgrade the software. A soft fork is backward compatible. Users can continue to use the software without upgrading to the new protocols.

Most of the cryptocurrencies in the market are either the hard fork or the soft fork of another open-source project.

Initial Coin Offering (ICO)

ICO is a way of raising capital for a project where a certain number of cryptocurrency tokens are issued to investors. For clarity, ICO can be compared with another equity market term – IPO (Initial Public Offering) but with a difference. In IPO, investors purchase the share of the company by betting their money and trust in the future performance of the company.

In ICO, however, investors do not get shares of the company. Instead, they get to buy cryptocurrency tokens at a fixed price. Here, investors are betting their money and confidence in the performance of cryptocurrency value in the future. If their confidence pays off, tokens can be sold at a higher price later or simply be traded with other cryptocurrency tokens.

Conclusion

With the emergence of Blockchain technology and the mind-bending surge in Bitcoin value in the recent past, the cryptocurrencies market is flooded with new cryptocurrencies. Every month hundreds of new cryptocurrencies are launched in the market. While creating your own cryptocurrency is the easiest part, bringing it to the light of public acceptance for actual use in transactions or trade is the toughest part.

Sure enough, most of the cryptocurrency projects are slated to fail. In reality, it’s a crypto-chaos out there and everyone wants the piece of the action. It’s very unlikely to subside unless more public participation follows.

what is cryptocurrency infographics
Infographics explaining basics of cryptocurrency

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