You have heard about it on the news or from a friend, but what exactly is cryptocurrency? Don’t feel down if you don’t yet have a firm grasp on this new asset class. Cryptocurrencies can be difficult to understand if you don’t know the basics.
To give you a better understanding of what cryptocurrency is and how it works, let’s go through the history of this relatively new technology, an overview of its inner workings, different types of cryptocurrency, and where this industry could go in the future. Once you get some background information on these subjects, you will gain a much more solid understanding.
Cryptocurrencies have gone down a long, winding road in the past decade. Even though the general public has only stumbled upon cryptocurrencies over the past several years, there has been significant work that has led to this point. In fact, cryptocurrencies have a history that dates back more than a decade, to a time when Bitcoin didn’t even exist.
Was Bitcoin the first cryptocurrency?
Cryptographers had been playing around with the idea of cryptocurrencies decades before Bitcoin came into existence. At the time, the question of ‘what is cryptocurrency?’ wasn’t yet fully answered, but that didn’t stop people from attempting to create their own. The most well known of these attempts came from Nick Szabo, a computer scientist who developed a cryptocurrency called Bit Gold in 1998. While Bit Gold was never fully launched, it is credited as paving the way for Bitcoin.
When was Bitcoin created?
In October of 2008, a white paper by the mysterious Satoshi Nakamoto was released. This paper described a decentralised network used to fuel a new cryptocurrency called Bitcoin. It would take years before merchants would begin to accept the new form of money as payment, but slowly Bitcoin began to catch on. Over the next several years, more cryptocurrencies would be launched on the back of Bitcoin and ride the emerging cryptocurrency wave.
Cryptocurrencies go global
By 2014, there were already dozens of cryptocurrencies popping up. Some of these, like Ethereum, would continue to grow and thrive over time, yet others would go bust as quickly as they came into existence. When 2017 rolled around, cryptocurrencies were becoming the darling new niche of the financial world, hailed as a saviour from the “corrupt” financial system. They were bought and sold on new trading platforms. Hundreds of tokens, another name for cryptocurrencies, had been created and their values were quickly rising. By the end of 2017, Bitcoin had skyrocketed in price from $900 to $20,000, and the entire industry hit a valuation of $600 billion. By 2018, it was clear: Cryptocurrencies were here to stay.
What is cryptocurrency?
A cryptocurrency is a digital currency that uses cryptography as a means of security. Most cryptocurrencies operate without the need for a central authority like a bank or government, and operate instead through a distributed ledger to spread power among its community. A cryptocurrency has a set, defined monetary policy, whether it be a fixed limit of tokens or allowing the creation of new tokens based on predetermined rules.
How does it work?
The distributed ledger that holds cryptocurrency transactions is known as a blockchain. A blockchain consists of blocks, which hold individual transaction information. This information is timestamped and posted to the ledger so that each transaction can be verified by other blockchain stakeholders and never be altered. In order to conduct a transaction on the blockchain, users agree to pay a small fee, which helps maintain the security of the blockchain itself.
Let’s say you want to send your friend a small amount of Bitcoin. You create a transaction using your Bitcoin wallet and request to send Bitcoin to your friend’s wallet, agreeing to pay a nominal transaction fee along the way. After you make the transaction request, your transaction gets grouped with other transactions into a block on the Bitcoin blockchain. This block is verified by miners and posted to the blockchain, making the transaction complete.
Through this process, you can send cryptocurrency to anyone, anywhere around the world, with low transaction fees. Want to send $1 million Ethereum to your family in Brazil? Go right ahead! Not only will the transaction usually be completed in a matter of seconds or minutes, it will only cost you a fraction of the fee you would have paid using a traditional money transfer service.
What is cryptocurrency used for?
One of the early appeals of cryptocurrency was that it offers you the opportunity to transfer large amounts of your wealth anonymously without any government or institutional interference. These days, cryptocurrency is used by some owners to take care of routine matters such as paying bills. Others use it as collateral to obtain online loans.
Still others put their digital currency to use by investing in business start-ups. The combination of innovative tech ventures and cryptocurrency seems like a natural fit. You can also use your digital currency to travel the world. Arrive at your destination in the luxury vehicle you purchased with your cryptocurrency or on the airline that readily accepted your Bitcoin.
What is cryptocurrency mining?
Cryptocurrency mining refers to the reward gained from verifying transactions on a blockchain. Blockchain transactions are encrypted when added to a block. Therefore, these transactions need to be verified for accuracy before the blockchain can continue adding transactions to the next block. This is where miners come in. Miners use their computing power to solve complex mathematical problems to verify transactions in a block on the blockchain. The first miner to solve the problem and verify all of the transactions in a block is rewarded with a fee for their services. This method of securing a blockchain is known as proof of work (POW).
Think you are ready to earn cryptocurrency by mining? Don’t fire up your laptop just yet. These days, it takes specialised and expensive computer hardware to mine quickly enough to solve the puzzle before other miners and receive a cryptocurrency reward. In fact, entire businesses are created to mine cryptocurrency and profit from the rewards.
Why is cryptocurrency popular?
With cryptocurrency, there is a new way of transacting and storing value that is markedly better than traditional fiat and gold. In fact, cryptocurrencies fare better in many of the properties that are needed for sound money:
- Portability — How easily the currency can be transported
- Divisibility — The degree to which currency can be divided into smaller amounts
- Censorship Resistance — The ability for governments and regimes to censor its use
- Scarcity — How prevalent it is in society and its future supply
- Security — How secure it is to use
- Backing — Who is backing the legitimacy of the currency
|Backing||Cryptography and mathematics||Governments||Global economy|
With fiat currencies, nations can print and restrict the printing of money however they please, so the value can occasionally fluctuate. For those living in countries with hyperinflation and unstable economies, cryptocurrencies may be a better choice for storing value than fiat currency. Cryptocurrencies have a set, defined monetary policy that cannot be changed by anyone, regardless of who they are. For example, there will only ever be 21 million Bitcoin created, with no exceptions. Knowing this creates a sense of stability that cannot be found in the monetary policy of fiat currency.
Cryptocurrencies are also easier to transport and divide. As opposed to lugging around pounds of gold or huge wads of cash, cryptocurrencies are just pieces of information that are used to keep track of transactions and values. These can be transported across any border without censorship, and even be divided into fractions of a penny if desired.
Why do cryptocurrencies have value?
It seems strange to some people that cryptocurrencies have value when most of them are not official products of a sovereign nation. However, the misunderstanding goes hand in hand with a misunderstanding of the definition of currency. Simply put, currency is anything that buyers and sellers agree will serve as a form of exchange between them.
There are enough investors and traders of cryptocurrency to make it an attractive form of currency to people around the world.
Is cryptocurrency safe?
Let’s look at two aspects of cryptocurrency safety: investment and storage.
Of course, cryptocurrency carries risk like any other investment. However, the gains and losses of cryptocurrency tend to occur much faster than with other currency investments. Successful traders and investors have built digital fortunes thanks to the volatility of Bitcoin. However, others who weren’t so lucky, lost their funds quickly.
Once you have acquired digital currency, you will want to keep it safe in a crypto storage device called a wallet. The encryption technology that these storage devices use to keep your currency safe continues to evolve to stay ahead of 21st-century digital thieves.
Types of cryptocurrency
You may be wondering how cryptocurrencies have value at all. To better understand this, you first need to understand the different types of cryptocurrencies on the market. Each of these types of cryptocurrencies holds value for its own reasons, and as such, it is not accurate to compare and contrast cryptocurrencies with different functions.
Fiat money is a currency that does not hold any intrinsic value in and of itself, but is set as a medium of exchange as agreed upon by the public. If this is the case, then what is a fiat cryptocurrency?
Cryptocurrencies were originally intended to be a store of value and/or medium of exchange. These digital currencies were the original use case for cryptocurrencies and are represented by some of the earliest projects in the industry. Fiat cryptocurrencies do not attempt to do anything more than create a better form of currency which is cheaper, more decentralised, and easier to use than fiat currencies.
Fiat cryptocurrencies include:
- Bitcoin – The original fiat cryptocurrency
- Bitcoin Cash – Similar to Bitcoin with some technical differences
- Litecoin – Often referred to as the silver to Bitcoin’s gold
- Monero – A cryptocurrency that provides additional anonymity and security for users
Unlike fiat cryptocurrencies, which create their own form of money, stablecoins are tied to the price of another asset (or grouping of assets) in order to minimise volatility, while maintaining the benefits of a cryptocurrency. The argument for stablecoins is that even though fiat cryptocurrencies are better than fiat currency because of their portability, security, and anonymity, they are unusable because of extreme fluctuations in their price.
The most well-known stablecoin is Tether, whose price is tied to the US dollar. With Tether, users can transact or hold their assets in a cryptocurrency that has its value tied to a stable asset, that is, the US dollar.
Some cryptocurrencies are used to power business and other functions on a blockchain network. These utility tokens aren’t necessarily currency in and of themselves, but because they have a predetermined use which has demand, they hold monetary value.
Some of the most popular utility tokens include:
- Ether — Pays for computational power on the Ethereum blockchain
- XRP — Facilitates the transfer of any digital asset on the Ripple blockchain
- EOS — Similar to Ether, EOS is used to perform tasks on a decentralised network
What might the future hold for cryptocurrency?
Is cryptocurrency going to continue growing? No one really knows the answer for sure. Still, you can rest assured that as long as there are use cases for cryptocurrencies and these assets provide an improvement over fiat currencies, they will hold a place in the global economy.
First, cashless and mobile payments will continue to grow globally, helping in cryptocurrency adoption and usage. Cryptocurrencies, like Bitcoin, will see their technology advance and use cases grow, leading more and more merchants to accept cryptocurrencies as a form of payment. Utility tokens will undergo their own battle to convince regulators they are not securities, while stablecoins will prove that you can have cheaper, faster transactions using cryptocurrency rather than fiat.
The main issue with cryptocurrencies is their ease of use. Today, it still requires some level of technological understanding to utilise cryptocurrencies to their fullest potential. As more projects and developers work on user interface and design, cryptocurrency offerings will become easier to use for the average person with little to no technical knowledge. Once this happens, watch out, because there will be no limit to how high cryptocurrencies can grow.
How to spend cryptocurrency
In addition to transferring money, you can also use cryptocurrency to make purchases. The list of items that you can buy with digital currency increases as more merchants see the advantage of offering a wider variety of payment options.
People have used cryptocurrency to purchase everything from high-end real estate (with Bitcoin payment service providers like BitPay) to pizza (services like Pizzaforcoins allow you to order from chains like Domino’s, Pizza Hut, and Papa John’s). In fact, the first purchase ever made with Bitcoin was two pizzas for 10,000 Bitcoin.
You can even use your Bitcoin to hitch a ride into space aboard Virgin Galactic. If your lifestyle is a bit more down to earth, you can now spend cryptocurrency at online retailers like Overstock.com (Overstock has partnered with Coinbase for Bitcoin payments.)
How to buy and sell cryptocurrency
Now that you know what cryptocurrency is, it is time to buy some for yourself. Unfortunately, cryptocurrency can’t just be bought on any exchange; it requires the use of a cryptocurrency exchange or online trading platform to make a purchase.
There are many cryptocurrency exchanges available for you, but few are as easy and secure to use as eToro. With eToro you can buy and sell the most popular cryptocurrencies — such as Bitcoin, Ethereum, Bitcoin Cash, XRP, and more — in an instant and with low fees.
In order to buy cryptocurrency on eToro, follow these steps:
Verify your account.
Complete your investor profile.
Deposit Fiat currency & Trade.
Once you have purchased cryptocurrency, you can then use the eToro Wallet to securely store your cryptocurrency until you are ready to sell it, spend it, or send it to a friend. The eToro Wallet uses a multi-signature solution to keep your cryptocurrency safe, while also allowing you to transfer cryptocurrencies from the eToro platform.
Welcome to the wonderful world of crypto
You understand how cryptocurrency works. You know the difference between the types of cryptocurrencies. You even know how to buy and sell cryptocurrencies on an exchange. What are you waiting for? The wonderful world of cryptocurrencies is waiting for you. Through this new technology, you will find a new financial paradigm that is ready to change the world. The only question now is, are you ready to join the party?
This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments. This material has been prepared without regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past performance of a financial instrument, index or a packaged investment product are not, and should not be taken as a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.