Blockchain technology and cryptocurrencies are relatively new concepts in finance. These virtual concepts have attracted a lot of talks from investors, the central banking system, the government, and other major societal pillars.
To understand these discussions, you need to know cryptocurrency’s meaning and how the industry operates. Here is what you need to know:
What is Cryptocurrency?
Cryptocurrency (crypto) is a digital asset based on blockchain technology. These digital assets are decentralized and were invented to be a currency free of central government control; thus, they can be used anywhere globally.
Bitcoin was the first blockchain protocol and globally viable cryptocurrency launched in January by Satoshi Nakamoto.
Difference Between Crypto and Fiat Currency,
The main difference between cryptocurrency and fiat currency is that crypto is exclusively virtual and has no physical representation. In addition, crypto is not minted by the government or central bank — instead, the coins enter circulation after getting mined by volunteers with enough computing power.
Cryptocurrency does not have a single control center, hence decentralized, and anyone can earn them. The crypto market is mostly unregulated, and the rules vary by jurisdiction even when regulated.
Crypto transaction speed occurs in minutes, unlike fiat currency which has to follow various protocols and can take up to several days for a single transaction to be successful.
Unlike fiat currency with an unlimited supply, cryptocurrency has a limited predictable supply determined by a unique algorithm. Most cryptos’ supply is limited through a code– Bitcoin has a maximum supply limit of 21 million tokens that are mined at a predictable rate. The protocol will stop releasing new Bitcoins once the total tokens in circulation reach 21 million.
Unlike fiat reversible transactions, crypto transactions are immutable, meaning permanent and final.
Types of Cryptocurrency
Bitcoin was the first viable cryptocurrency developed in 2009. The Bitcoin protocol set an example for other networks developed on the technology supporting Bitcoin.
The crypto variants developed as controls to improve the Bitcoin standards are often referred to as altcoins, alternatives to Bitcoin.
Prominent altcoins include:
- Ethereum
- Solana
- Cardano
- XRP
- Polkadot
- EOS
- Litecoin
- Bitcoin Cash
Coin names are not synonymous with crypto types. There are different categories that each coin identifies with, including:
- Platform tokens: Designed to support applications built for blockchains, e.g., Solana.
- Transactional tokens: Developed to be used as a payment method, e.g., Bitcoin
- Utility tokens: Made to serve designated functions on their blockchains, e.g., ETH and XRP
- Governance tokens: Made to represent special rights such as voting on a chain, e.g., Uniswap
- Security tokens: That represent ownership of an asset that has been tokenized, e.g., MS Token, which is a token for stock ownership in Millennium Sapphire.
How are New Cryptocurrencies Made?
Cryptocurrencies are made through the block mining process. Crypto mining is an extensive energy process that requires high computing power from computers that solve complex puzzles to verify the authenticity of the blocks and transactions on the blockchain. The successful miners receive cryptocurrency as a reward.
Mining nodes have to validate the blocks and blockchain transactions through consensus processes. The miners use two main protocols to validate the transactions, including:
Proof of Work
Proof-of-work (PoW) is a computer-intensive consensus protocol where miners compete to generate the winning codes through powerful computers. The correct code allows miners to add a new transaction block to the main chain.
The miners then receive incentives, newly minted crypto referred to as block rewards, after adding the right block. The successful miner also receives any fees attached to the news block. Crypto networks that utilize the Pow incentive system include Litecoin, Bitcoin, and Dogecoin.
Proof of Stake
The Proof-of-stake (PoS) incentive system is a less power-intensive consensus mechanism than the PoW protocol. The miners on this protocol do not need to invest in powerful mining equipment. Instead, all they need is to deposit a specific amount of cryptocurrency on the blockchain to show their commitment to the course of the network.
The protocol randomly picks the mining nodes in the pool that have committed their funds and gives them different tasks. The nodes that fulfill their tasks successfully are rewarded with newly minted crypto tokens. Examples of PoS protocol blockchains include Ethereum 2.0, Cardano, and Polkadot.
How to Use Cryptocurrency
Cryptocurrency was first developed as an alternative to fiat currency. However, these digital assets are yet to realize that mission, except for the digital assets connected to fiat currencies.
Alternatively, crypto has been exploited for its investment potential. Investors are buying and ‘hodling’ crypto as they anticipate higher asset prices to profit from trading.
Crypto traders earn money by buying the tokens at a high price and selling at a higher price, depending on market fluctuations.
Crypto holders can use their coins to pay for goods and services through crypto wallets. The wallets are offered by crypto exchange platforms and are made to store the crypto. You transfer your coins to the receivers’ wallet through predefined addresses to pay for goods and services. The receiver can hold the crypto or trade it for fiat currency.
Pros and Cons Trading and Investing in Cryptocurrency
Investors and role players have conflicting opinions about cryptocurrency, mainly because it is a relatively new concept in the market. Some believe cryptocurrency is a mind-blowing and transformational technology that will shape the financial scene differently. In contrast, others think it is just a passing wave will a solo goal of disrupting the system.
Regardless of the opinions, the crypto industry has its advantages and disadvantages.
Cryptocurrency Advantages
- The value of cryptocurrency is not affected by inflation since it is independent of the central banks.
- Decentralized platforms like blockchains have more robust security features than traditional payment and money storage mediums.
- Cryptocurrencies are a good foothold for societies underserved by the traditional financial system because governments have little or no control over cryptocurrency.
- Cryptocurrencies offer holders passive income through investment, trading, and staking.
Staking is where a crypto holder uses their coins to verify blockchain protocol transactions.
Cryptocurrency Disadvantages
- Governments have yet to fully understand cryptocurrency, and they may impose excessive regulations on the industry once they have it figured out.
- Blockchain technology has yet to be widely adopted; most crypto projects are untested. Investors might incur losses if the chains do not realize their ultimate potential.
- Short-time investors and traders are always at risk of losses as markets fluctuate.
- The crypto market s erratic nature beats the cryptocurrency purpose of financial support, i.e., traditional traders might reject Bitcoin payments because it might lose value overnight.
- Cryptocurrency mining has a negative environmental impact due to its extensive power consumption.
Is Cryptocurrency a Good Investment?
Cryptocurrency is a high-risk investment. Although you can mitigate the high risk by diversifying your crypto portfolio, you cannot be 100% guaranteed success in crypto. This is not to discourage you, as the industry has lows and over-the-roof highs.
Insulate yourself from the loss by doing due diligence before investing or moving into this industry. Understand the basis of your blockchain of interest in looking into:
- The major investors in the project
- Does the platform offer stakeholder chances?
- Is the project well-established, or is it just rolling out?
Having well-known investors in a blockchain project is a good sign, similar to a well-developed project which projects investors’ confidence in it. It will take a lot of your resources to determine the legitimacy of the blockchain, which unfortunately doesn’t directly correspond to the success of the blockchain. Ensure you take all to protect yourself from fraudsters ad be market savvy for higher success chances.