Cryptocurrency

The Simplest Guide to Understand Cryptocurrency in 2022

The Simplest Guide to Understand Cryptocurrency in 2022
The Simplest Guide to Understand Cryptocurrency in 2022

Introduction

A cryptocurrency is a form of money that is decentralized and uses blockchain technology as its foundation. One of the most important aspects of cryptocurrency is that it is secured using cryptography. Therefore, cryptocurrency remains protected from malicious attacks despite the presence of its network on multiple computers spread across the Internet.

Cryptocurrency is not centralized like fiat currencies such as the US dollar. Therefore, it remains out of the control of governmental organizations such as federal banks. The first cryptocurrency, Bitcoin, was launched as a peer-to-peer electronic cash system. Although many people doubted Bitcoin initially, it surprised everyone with its interest among the general public and celebrities.

Nowadays, cryptocurrencies are all the rage, and we see many altcoins in the market. For the uninitiated, altcoins are all other cryptocurrencies apart from Bitcoin. If you want cryptocurrency explained in a more detailed and simple way, you should read through the next sections. The guide is meant to clarify cryptocurrency meaning so that you can have a better understanding of the cryptocurrency market.

Cryptocurrency and Blockchain

‘Double Spending’ is an inherent challenge of cryptocurrencies. For instance, theoretically, it is possible to double spend digital cash by altering the system (after meeting certain conditions) on which the information is stored. However, blockchain is explicitly created to solve this problem.

A blockchain serves as the backbone of a cryptocurrency system like Ethereum and ensures the security and fidelity of the data records. In essence, a blockchain is a shared database distributed amongst multiple nodes of a network consisting of multiple computers. It serves as an extensive database and stores vast information.

Blockchain collects information in blocks that have finite storage. When the limited storage of a block is filled, it is connected with another block. As new information keeps on emerging regularly, new blocks are created and then linked together to create a long blockchain.

Technically, a blockchain consists of a cryptographic hash, a timestamp, and, most importantly, the transaction data (data about cryptocurrency transactions). Each piece of data is vital for maintaining the integrity of blockchain on a peer-to-peer network.

A Simple Explanation of Blockchain

In layman’s terms, a blockchain can be thought of as a book where we write all the information about our expenses on cryptocurrency. Now imagine everyone with cryptocurrency having a copy of that book. And each copy of the book is updated simultaneously whenever a new transaction takes place. Therefore, the records kept in the book always remain unified, accurate, and identical. No one using the ‘copy of the book’ can retroactively (at a later date after the transaction is made) edit the information on that page without alerting other owners of the ‘copy of the book’.

Consensus Mechanisms: Proof of Work vs. Proof of Stake

The validity of a transaction is essential when it comes to cryptocurrency. A consensus mechanism is needed to ensure every transaction is as per the agreement of everyone in the blockchain. Currently, we have two popular consensus mechanisms: Proof of Work and Proof of Stake.

The proof of Work (POW) model requires a group of miners to participate in a competition where everyone has to use their powerful computers to solve challenging problems. When the competition is over and there is a clear leader, they get the authorization to add a new block of transactions to the blockchain. Upon adding the block, the participant is rewarded with the digital currency that they have mined.

In contrast to Proof of Work, the Proof of Stake (POS) model does not require powerful computers. Instead, the miners’ stake’ their cryptocurrency on the line to claim the right to validate transactions. Whether a miner gets the right to validate transactions is decided by the amount of currency they have pledged and the time period they have staked the currency. The ultimate decision on selecting a miner is made after analyzing their relative power against one another using a weighted algorithm.

POW vs. POS: Energy Consumption

POW is still the most reliable consensus mechanism despite the growing use of POS. However, due to high power consumption and environmental impact, POW has faced backlash from national governments from across the globe. For instance, the energy cost per transaction of Bitcoin is 830kWh or 130TWh per year. Similarly, ETH costs 50kWh of energy per transaction, which amounts to 26TWh per year. The energy cost of ETH is considerably lower, but it is nowhere near what is required. Therefore, POW becomes an automatic choice for the future. Currently, many cryptocurrencies floating in the market are being sold as Tezos. When it comes to energy, the Tezos cost just 30mWh per transaction and 60mWh per year, which is considerably lower than POW currencies.

Risk Analysis: POW vs. POS

Cryptocurrencies are decentralized and not controlled by institutions. Decentralization is the strongest virtue of cryptocurrencies as it eliminates the need for a central data location, which can ultimately become a target for hackers. Therefore, it is assumed to be more secure than other currencies like fiscal currencies that are managed by federal reserves.

Despite their strengths, POW cryptocurrencies like Bitcoin and Ethereum are still vulnerable to attack in certain situations. For example, if a group of miners manages to gain more than half of the network’s total power, they will be able to stop transactions from being validated. And, at the same time, they will be able to double spend the coins. As a result, a fork will be created in the blockchain, i.e., two different versions of the blockchain will come into existence. And hence, it will be impossible for other participants to guess which version of the blockchain is valid.

On the other hand, the POS consensus mechanism involves staking cryptocurrency before one can validate transactions. During the staking period, one cannot sell the cryptocurrency in the market. So, the people staking money have the incentive to ensure fair transactions because their own money will be impacted if there is any forking of the blockchain. Therefore, we can say there is less of a risk in POS currencies such as Avalanche and Tezos when compared with POW currencies such as Ethereum and Bitcoin.

A Few Examples of Cryptocurrencies

Currently, cryptocurrencies are divided into two categories: Bitcoin and Altcoins.
All cryptocurrencies that were released after Bitcoin are known as altcoins. Among the different classifications of cryptocurrencies, there is a less volatile type of cryptocurrency called stablecoin. The stablecoin is pegged against a fiat currency such as the Dollar to prevent its price from rapid fluctuations. A few examples are of stablecoins are Tether and Terra.

Let’s have a look at some cryptocurrencies that are widely prevalent in the market:

Bitcoin: The First Cryptocurrency that Started it All

Bitcoin was released on January 3, 2009. The founder of Bitcoin is Satoshi Nakamoto. Nobody knows whether the name represents a person or a group. Many believe it to be a pseudonym that has been used to hide the real identity of the Bitcoin founder. At the time of writing, Bitcoin is the

Ethereum: A Crypto that Powers Next-Gen Economics

Ethereum is the brainchild of a young whiz kid (28 at the time of writing) named Vitalik Buterin. Vitalik, along with Charles Hoskinson, Amir Chetrit, and Mihai Alisie, collectively founded Ethereum in 2015. Since its inception, Ethereum has become the blockchain technology of choice for next-gen crypto technologies such as Non-Fungible Token (NFTs) and Decentralized Finance (De-Fi). Ethereum also works on the Proof of Work (POW) consensus mechanism. However, it has been gradually moving towards the Proof of Stake (POS) consensus mechanism. The move to POS is expected to be completed in the middle of 2022.

Tether: A Stablecoin that is Less Volatile than Regular Cryptocurrencies

Tether is a cryptocurrency that is also called stablecoin. The name stablecoin derives from the cryptocurrency’s being designed to be pegged with the US dollar. As a result, it is less volatile than regular cryptocurrencies. Tether wasn’t the chosen name of the currency in the beginning. It was first called as RealCoin in July 2014, but later in November, it was rebranded as Tether. Currently, Tether does not have its blockchain, and it is hosted on Bitcoin and Ethereum blockchains.

Solana: Powered by the Fastest Blockchain in the World

Many people consider Solana to be one of the fastest blockchains in the world. Due to its lightning speed, the Solana blockchain has become the breeding ground for several next-gen technologies such as NFTs, DeFi, and even Web3. Solana was launched in March 2020 but rapidly evolved into a powerful cryptocurrency with a mass following.

How to Invest or Trade in Cryptocurrencies?

Cryptocurrencies offer tremendous trading opportunities because they tend to rise rapidly and fall in price. But there are many cryptocurrencies like Bitcoin, Ethereum, and Stablecoins that have withstood the test of time and offer good long-term investment opportunities. In addition, the quick price appreciation of several cryptocurrencies like Shiba Inu has already created many success stories. So, many people are interested in trading/investing in them.

Just like in stocks, cryptos are suitable for both bulls and bears. But to maximize earnings, one needs to have a clear understanding of how to invest in cryptocurrencies.

Below is a step-by-step guide on how a beginner can make investments and start earning from cryptos:

  1. Select a Suitable Platform

To maximize earnings via cryptocurrencies, you need to select the right platform. Currently, there are two options that you can explore in order to purchase and earn from cryptocurrencies.

  • Buy from conventional brokers

A conventional broker is not restricted to cryptocurrencies. For instance, a traditional broker will also sell bonds, Stocks, and ETFs along with cryptocurrencies. Traditional brokers offer a low trading cost for cryptocurrencies. But when you buy from a traditional broker, you would access comparatively fewer features than a regular crypto exchange.

  • Purchase from cryptocurrency exchange

With each passing day, the number of cryptocurrency exchanges is rising fast. As crypto exchanges solely deal with cryptocurrencies, you will have more features and options on a business when compared with a regular broker. Some of the best cryptocurrency exchanges are Robinhood, Coinbase, and Binance.

All exchanges come with their own unique features that might or might not suit you. For example, an exchange might offer greater security but might charge you a high trading fee. So, it all boils down to your preference when it comes to selecting an exchange. Sometimes, the best cryptocurrency app or the cryptocurrency exchange that you choose becomes as important as the crypto to invest in.

The quality of cryptocurrency exchanges often dictates your cryptocurrency trading experience. So, before investing in cryptocurrency, you should choose the best crypto exchange based on your preferences.

Cryptocurrency exchanges are divided into two categories: Centralized exchanges (account for 99% of transactions) and Decentralized exchanges (account for only 1% of transactions)

Decentralized exchanges, also known as DEX, do not charge any transaction fee, but they also don’t allow for the purchase of cryptos through fiat currency such as the US Dollar. Therefore, they are not preferred by users. A few examples of DEX are AirSwap and Blocknet. A few examples of Centralized exchanges are Coinbase and Kraken.

  1. Adding money to your cryptocurrency account

As most crypto exchanges allow for fiat currency transactions, you can easily fund your account through your national currency. However, it is worth noting that some exchanges do not allow transactions via credit cards. This is because many banks consider crypto transactions to be volatile and hence restrict or forbid the use of credit cards.

For adding money to your account, you can also use methods such as wire and ACH transfers. However, you should always keep the fees charged by an exchange in your mind before selecting one over another.

  1. Make an order for your favorite cryptocurrency

After adding money into your account, you can ‘purchase’ the cryptocurrency you want to trade in. Once you enter the amount you want to buy, you can click on the purchase button to transfer the cryptos into your account.

Alternatives for investing in cryptos:

Instead of buying directly, you can also buy a cryptocurrency such as Bitcoin via mutual funds, trusts, and ETFs. For instance, you can buy shares of Bitcoin trusts through a common brokerage account. Another way of indirectly buying cryptos is via blockchain companies that have expertise in the technology powering crypto transactions and cryptocurrencies.

Store Your Cryptocurrency in a Secure Manner

Of late, we have seen a lot of thefts related to cryptocurrencies. So, you must know how to store cryptocurrencies securely to prevent thefts.

Two primary options for storing cryptocurrencies are:

  • Cold Wallet Storage

Cold wallets are offline wallets that provide a secure option to store one’s private keys for cryptocurrency assets. The cold wallet is not accessible online, so it is immune to hacking attempts.

  • Hot Wallet Storage

Hot wallet storage places the private keys online. It utilizes online software to encrypt and safeguard the keys on the Internet. Hot wallets are readily accessible and provide a faster way to transact.

In most cases, hot wallets are free. However, there is a fee for storing private keys on a cold wallet. Most cryptocurrency exchanges provide their customers with wallet service, but it is not guaranteed. So, an investor or a trader should read the instructions thoroughly before opting for any one of the wallet storage options.

Mainstream Cryptocurrency Utilization

Cryptocurrencies were designed to work like regular currencies; however, it hasn’t been the case so far. But slowly and steadily, we see a preference for cryptocurrencies amongst users. For instance, Billionaires such as Elon Musk have advocated the use of cryptocurrency. The world’s richest man has even initiated transactions in cryptocurrency via their business platforms. For example, now one can book Tesla cars using cryptocurrencies. Another mainstream utilization of cryptos was seen during the Ukraine-Russia conflict when both sides used cryptocurrencies to fund their war efforts.

Below are some notable use cases of cryptocurrencies being used as mainstream currencies in the world:

Top-Tier Automobile Companies

Apart from Elon Musk’s Tesla, we are already seeing many top-class automobile companies accepting payments in cryptocurrencies. Some cars that you can purchase with cryptos stored in your wallets are Audi R8, Toyota SUV, and Mercedes Benz E Class.

High-End Commodities Like Watches

Swiss watchmaker Hublot has already announced that it will be accepting cryptocurrencies as a regular mode of payment. Even Rolex watches can be bought using Bitcoin via retailers such as Bitdials, which deal in luxury items.

Non-Fungible Tokens Like BAYC

Non-fungible tokens (NFTs) are all the rage nowadays as they promise great returns for digital artists across the globe. The only way to buy digital art in the form of NFT is through cryptocurrency, specifically Ethereum. As all NFTs are stored on the Ethereum blockchain, cryptocurrencies have become a popular mode of transaction amongst celebrities.

Insurance, Event Tickets, and Even Coffee

The number of items that you can buy using cryptocurrencies is not restricted to a particular domain. Companies from different walks of life have started accepting cryptocurrencies. Now, you can purchase insurance from AXA, which accepts Bitcoin as a payment mode. Moreover, it has become possible to book events in – real-world and metaverse – via cryptocurrencies. With Starbucks joining the crypto brigade, you can even order your coffee with the cryptocurrencies stored on your digital wallets.

Summary

Nowadays, cryptocurrencies are everywhere. We can see the images of cryptocurrency ads on hoardings, and hear about it on the news, and also from the mouths of our friends and families. There is no way to escape the crypto reality we live in. So, if you are feeling tempted to invest in cryptos, don’t do it based on random instincts and intuition. Firstly, understand the fundamentals of cryptocurrencies, research the crypto exchanges, and only make an investment after thoroughly studying the virtual assets.

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Disclaimer

Any references on this website or blog are an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.

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