A 101 Introductory Guide to Cryptocurrencies
Everyone is crazy about cryptocurrencies. In my opinion, cryptocurrencies have moved from being a hype to a financial and technological reality that the current generation has to understand and live with. It is impossible to imagine that there are still people who haven’t heard about cryptocurrencies. The truth is that many people have heard of them but only a few know what they are.
What Are Cryptocerrencies and Why Do They Matter
When I first heard about cryptocurrencies a while ago, I thought it was just an internet gimmick that was meant to scam people and con them of their hard-earned cash. I think that people are just hard-wired to approach a new piece of technology with suspicion and caution. This works fine in the normal world but in the business, you need to have guts and invest in the new and emerging technologies before anyone notices their value.
Think of Facebook and Peter Thiel. When Facebook started and still in its infancy, a few people believed that it would be of any value in the future. However, Peter Thiel, probably driven by his business and investment acumen, invested $500,000 in the startup. In less than a decade, Peter Thiel’s $500,000-investement transformed into almost $1 billion.
Coming closer to home (cryptocurrencies), there is an inspiring story of the Winklevoss twins. The twins bought Bitcoins worth $11 million in April 2013 at a price of $120 per coin. As of December 2017, the twins’ Bitcoin investment had soared to almost $1.3 billion. This sounds unbelievable but is true.
Is there any similarity between Facebook and cryptocurrencies? The obvious answer is no. However, the similarity lies in the investment stories given above. The technologies have turned millionaires into billionaires. At the moment, cryptocurrencies have the potential to turn an ordinary person into a rich crypto investor/trader.
Before we get ahead of ourselves and ride the exciting wave of the crypto investment world, let’s first take a look at what cryptocurrencies are and what their significance is to the present generation is. Do not worry if you have no idea what a cryptocurrency is, this article will give you all the information that you need.
What are cryptocurrencies?
This is probably one of the most interesting questions to answer. A cryptocurrency is a virtual/digital currency used to facilitate trade. Cryptocurrencies belong to the families of virtual currencies, digital currencies, and alternative currencies. However, cryptocurrencies are not just ordinary currencies. They are digital currencies backed by technology (mostly blockchain). Cryptocurrency transactions are secured using cryptography.
Putting it all together, cryptocurrencies are a form of digital currency that exists in the virtual world but is used to facilitate trade in the real world. Unlike fiat money that we can touch and feel, cryptocurrencies exist in binary format and their value is facilitated by the technology behind each currency. I can also add that a cryptocurrency is a currency whose value is determined by the quality of the white paper behind it. More on that later.
History of cryptocurrencies
The history of cryptocurrencies is quite fascinating. When computers began to find their use in the world, people realized that they could turn an ordinary mail into an electronic mail. Soon, the world was introduced to email. Subsequently, people wanted a form of electronic or digital money. This is what set the foundation for cryptocurrencies.
Along the way, many prominent figures in the computer science field embarked on several projects that were aimed at discovering and implementing digital money. From the NSA to notable people like Nick Szabo, the race to find the world’s first true and usable digital currency was secretly and officially underway.
Needless to say that although these several forerunner projects were not entirely successful, they laid down a solid foundation for the development of cryptocurrencies.
In August 2008, Satoshi Nakamoto, an unknown programmer, published a white paper entitled “Bitcoin: A Peer-to-Peer Electronic Cash System.” The Bitcoin network came into existence in January 2009. Oddly enough, Satoshi Nakamoto remains a mystery and has not come forward to reveal his/her identity. Personally, I think it is difficult for someone to claim to be Satoshi Nakamoto because people would think that he/she is trying to claim an easy victory. However, there are suggestions that Satoshi is a Japanese although some believe he/she is an American or European person.
For some time, Bitcoin and cryptocurrency meant the same thing as Bitcoin was the only cryptocurrency on the market. Along the way, some people realized that there were flaws and loopholes in the Bitcoin technology and they went on to create new cryptocurrencies based on the Bitcoin technology but with some changes. These new cryptocurrencies were called alternative coins because there were and still are alternative coins to Bitcoin.
The role of Bitcoin in cryptocurrencies
By all standards, Bitcoin is the firstborn of all cryptocurrencies. It is one of the most popular cryptocurrencies. The most important thing about Bitcoin is that it introduced the world to cryptocurrencies and what they are capable of. Bitcoin has had turbulent times but it always sails through.
Moreover, Bitcoin was built on blockchain technology – the pioneering technology behind the success and attention around cryptocurrencies. Of late, some Altcoins have used technology that is different from the blockchain, IOTA being a prime example.
Bitcoin managed to decentralize and advocate for the democratization of money. For the first time in many years, money was no longer owned, issued, and controlled by governments. Money was no longer a political tool but a commodity issued and controlled by ordinary people. Bitcoin and subsequently Altcoins are on their way to change the way money is controlled.
Bitcoin vs. Altcoins
The battle between Bitcoins and Altcoins is akin to the Biblical battle between David and Goliath. However, in the financial world, it is Bitcoin (Goliath) that defeats Altcoins (David). Bitcoin is the largest cryptocurrency by market capitalization. It has been in existence from the beginning of cryptocurrencies and seems to be going strong.
Although there are flaws in its system, it continues to be the biggest cryptocurrency. It is estimated that there are over a thousand Altcoins. There is just too many of them. Along the way, something of them will become obsolete as only a few will be relevant. Some will continue to be in circulation but they will have little to no value.
The dominance of Bitcoin is also not guaranteed to last forever. A few Altcoins are catching up with Bitcoin in terms of technology, market capitalization, and they have the potential to dethrone Bitcoin. This might actually take a while to happen.
How cryptocurrencies work
The way cryptocurrencies work is very different from the way traditional money. If you take the time to learn how it works, you will begin to appreciate it and enjoy using it. Before we delve much deeper, there are some basic concepts that you need to understand first. As always, I will willingly share the information with you.
It is literary difficult to talk about cryptocurrencies and not mention blockchain technology. The two are like bolts and nuts. A blockchain is a secure, anonymous, decentralized, distributable, immutable, and incorruptible ledger that is used to record and store anything of value ranging from financial transactions to healthcare data.
By far, blockchain technology is the heart and spinal cord of cryptocurrencies. Without it, it is possible that we would still be looking for a way to develop cryptocurrencies.
Although there are fundamental differences between coins and tokens, the two will be treated as the same for the purpose of this article. Coins/tokens are the currency issued by a cryptocurrency. They are the reward that people receive for mining a particular currency or taking part in its Initial Coin Offering (ICO).
In many cases, cryptocurrencies have a blockchain network or other protocol that allows transactions to go through. Public ledgers are used to store confirmed transactions on the network. Encryption techniques are used hide the identity of the cryptocurrency owners.
The cryptocurrency network allows you to send money (or crypto coins) from one person to the other. This process is known as a transaction.
Remember that cryptocurrencies are not physical money. They are not issued or printed the same way that fiat is printed. The majority of cryptocurrencies (including Bitcoin) are issued using a process called mining. Mining is a process of solving complex mathematical equations using special software and hardware and earn crypto coins as a reward for your activity. This is the method used to issue crypto coins and is equivalent to the printing of money by central banks and governments.
Mining is an efficient way to give people incentives for being involved with a particular cryptocurrency. However, mining is a very expensive process that uses a lot of electricity and requires expensive hardware. People now join mining pools in order to make the process easier but they also compromise on the reward received. Mining is a way of issuing and circulating cryptocurrencies.
Proof of work and proof of stake
Proof of work is the work that someone (or miner) has to do in order to gain ownership of Bitcoins or Altcoins. Proof of stake is a way of achieving distribution consensus by means of validating transactions
It is a computer algorithm that enforces a digital contract without needing a third party for verification. It is more of an If-statement.
Some cryptocurrencies such as Ripple are not mined. They are pre-mined. This means that the cryptocurrency developers mine the coins/tokens before the releases of the currency.
There are three types of pre-mine:
Initial coin offering (ICO)
Initial coin offering (ICO) is a Crowdfunding method in which a cryptocurrency project raises money by offering investors tokens/coins. The investors benefit when the token/coin increases in value and they sell at a higher price. However, the investors do not own shares for the company and are not entitled to any company dividends.
Token Generation Event (TGE)
A Token generation even is similar to an Initial coin offering. A token generation event is done by currencies that offer tokens while an ICO is done by currencies that offer coins.
It is a highly technical paper released to the public by developers willing to develop a cryptocurrency. The white paper outlines the core technology behind the currency. Many people use the white paper to gauge the value of the currency. A currency with a technically detailed white paper is more likely to garner a lot of investors during its ICO. It is important that developers write good white papers. They were pioneered by Satoshi Nakamoto’s famous white paper.
Pump and dump
It is a securities fraud tactic that the creators of a cryptocurrency use to sell their lowly priced token/coin at a higher price by misleading the public. The creators of the currency will sell their tokens/coins at a higher price and before long, the currency will crash. The people who bought the currency will be at risk of losing their investment.
A digital wallet is a software you use to store your cryptocurrencies. There are hundreds of wallets out there.
Learn more about Wallets in the article:
Market capitalization is a method of measuring a cryptocurrency’s relative market size. It is obtained by multiplying by the price of the currency by the number of the coins/tokens in circulation.
Putting it together
If there is any problem or business opportunity that can be solved by new technology (or improvement of existing technology), developers develop a network or protocol to solve that problem. In order to raise the funds required to fund the project, the creators of the currency hold an ICO or Token Generation Event in order to attract investors.
The creators of the currency release a white paper that outlines in detail how the new technology will solve a particular problem. If investors are convinced that the technology is worth investing in, they fund the project in exchange for tokens/coins. They buy the tokens/coins at a discounted price hoping that the coins/tokens will appreciate in value and sell them later.
The coins/tokens are also used as a way of rewarding people who actively participate in the cryptocurrency community. In order to control how the coins/tokens are issued, a process known as mining is employed. This process involves the solving of complex mathematical equations using dedicated software and hardware. These people who do this are known as miners. When they receive the coins, they can exchange them for fiat money or other cryptocurrencies.
In some instances, the coins/tokens are not mined, they are pre-mined. This means that the creators of the currency issue the coins/tokens before the launch of the cryptocurrency. It is mostly not preferred by investors as they think that the creators can scam them through “pump and dump.”
The cryptocurrencies are then listed on exchanges where they are traded in the same way that stocks are traded on stock exchanges. The value/price of the token/coins will go up and down depending on the value of its technology and how people react to it. Investor sentiment is important in moving the prices of cryptocurrencies up and down.
The evolution of cryptocurrencies
The success of cryptocurrencies depends largely on the need for a decentralized monetary system that is not controlled by any government or central bank. Many people believe that there are too many restrictions on fiat money and they don’t subscribe to the way governments control or issue money. For example, if central bank prints more money, there will be inflation.
However, most cryptocurrencies have a hard cap. This means that for any cryptocurrency, there is a finite number of tokens/coins that will ever be produced. There is also a controlled way of issuing the tokens/coins. Normally, this process is called mining. Some are pre-mined and are largely controlled by the creators of the currencies.
However, the evolution of cryptocurrencies and their meteoric rise depends on two institutions that have been deemed to be the enemy of the public. Governments and banks. You may be wondering how this is possible.
Governments are created to rule a demarcated geographical area. Each country has its own currency whose value is measured by political stability and the perceived strength of the country’s economy. Unfortunately, people do not know where the real value of money comes from. The general consensus in the crypto sphere is that the current financial system is broken and needs an overhaul.
Another contributing factor to the success of cryptocurrencies is the rules and regulations that govern fiat money. Governments are responsible for printing money whenever they feel like. In a way, this reduces the value of money. Also, governments are able to freeze people’s money. Another factor is that there is censorship in using the current monetary system.
Banks are the entities that we trust to store and safeguard our money. However, as they are for-profit organizations, they charge people to use their services. Making global payments using banks is very costly and according to Ripple, an estimated $1.6 trillion is spent annually on cross-border payments.
This is what cryptocurrency are fighting. They make cross-border payments fast, instantaneous and almost free. On the other hand, they allow anonymity of the users. Cryptocurrencies are simply a digital means of decentralizing money. This means that control and regulation of money will not lie in the hands of an elite few but in the hands of the public majority. This will usher the world into a new financial dispensation.
Where do cryptocurrencies get their value from?
This is one of the most important questions to ask. The world is focused on creating and producing valuable goods/services. Money is supposed to have a value. The value of cryptocurrencies is governed by a number of factors. The majority of the factors are given below:
Play it safe
Cryptocurrencies are a new and emerging market. As with everything else that involves money, there is the possibility of scams. Newcomers, in particular, are encouraged to exercise caution when dealing with cryptocurrencies. Some people have lost their investments.
Here are some examples why cryptocurrencies pose a risk:
7 benefits of using cryptocurrencies
There are several benefits associated with using cryptocurrencies.
The future of money: cryptocurrencies are significant
Cryptocurrencies have a solid place in the current monetary system. With some flaws in the current financial system, cryptocurrencies have the potential to fill the gaps and do a whole lot more. Unfortunately, some countries such as China are really cracking hard on Bitcoin trading. This has negative consequences of the prices of the currencies. This should not come as a price because China wants to have a control of the banking system.
In some other countries, Bitcoin machines have been installed and fully operational. This shows that cryptocurrencies are now slowly being accepted as a currency that can be used on the same scale as fiat money. With time and with more people warming up to the technology, it is expected that the number of cryptocurrency users will increase significantly.
Without any hesitation, I can safely say that cryptocurrencies are the future of money. They are less than a decade old yet they have so much promise for the future.
Minting it together in a few words
Remember, we are here to give as much information about cryptocurrencies as possible. According to Sir Richard Branson
“In the meantime, there is a big industry around Bitcoin…”
– Sir Richard Branson
Cryptocurrencies represent the future. They are now being extensively used due to the benefits and advantages they offer. However, they are also met with suspicion and caution. There are also several myths surrounding the digital currency. Some people think that the currency is tangible but this is far from the truth.Cryptocurrencies are as good as fiat money if not better. They are not a bubble or a hype but a reality.
This was an introductory article aimed at getting you started with cryptocurrencies. Feel free to share it or ask questions.