How Cryptocurrency Works

What Is A Cryptocurrency?

New virtual currency

Bitcoins –  BTC the new virtual money

The world is moving at an incredibly fast pace these days. I don’t mean that time is speeding up although sometimes it feels that way with all the changes that new technology is bringing into our lives. Enter the terms Bitcoin, Cryptocurrency & Blockchain into our vocabulary. If you mentioned these words in a discussion 9 years ago (circa 2007) 99.9% of people would wonder what you were talking about.

However right now in 2018, unless you have been hiding under a rock these terms have become mainstream. The price of BITCOIN has rocketed exponentially over the past 12 months to be currently valued at over $8,000 per. Bitcoin and has been as high as $20,000 (click here for live pricing) at the time of writing. These words are now heard on daily basis and believe me this is a trend that is going to continue for years to come now. Yet the majority of us are still not really sure what the above words all mean and how it all works.

So Please Explain How Cryptocurrency Works:

 A great way to get your head around what & how Cryptocurrency functions is to view Bettina Warburg’s explanation who manages to break it down into 5 levels of difficulty –  watch this.    

We now know that people are talking about it on a daily basis and that that Bitcoins are extremely valuable. There are some shady hackers who have made some serious money out of it and that it is proving a very convenient way for criminal organisations to launder their ill gained fortunes. Governments are scratching their collective heads on how to deal with this new currency. But you are not reading this to hear about government legislation issues – so we will move on to the meaning of cryptocurrencies, and how they work in a way that everyone can gather a basic 101 understanding.

The Beginning Of Cryptocurrency

Cryptocurrency as a theory has existed much longer than most of us are aware of. Attempts at creating a sustainable cryptocurrency were made back in the early 80’s – all of which failed miserably due to the limited technology at that point in time.  However, cryptocurrency as we know it today started with the creation of Bitcoin. In November 2008 a phantom man going by the name of Satoshi Nakatomo posted a research paper where he described his design for a new digital currency called Bitcoin. I have called him a phantom because nobody knew his real name, and until recently no one could prove his existence. However, it is now thought that Satoshi Nakatomo is a pseudonym for a group of people.

Later on, in January 2009 the mysterious Nakatomo “mines” the first blockchain which is called the genesis block (I will explain that in a later article) and puts in motion the whole Bitcoin craze. The initial exchange rate of bitcoin was 1,309.03 BTC to one U.S. Dollar. In other words, one bitcoin was worth about eight-hundredths of a 1 cent. This rate is derived from the cost of electricity used by a computer to generate, or “mine” the currency. For a year or so, this creation remained operated within a tiny group of early adopters. But slowly, word of Bitcoin started to spread beyond this closed circle of cryptography enthusiasts. In 2012 WordPress became the first major company to accept payment in Bitcoin. Others, like Dell, Expedia and Microsoft followed and initiated the expansion of Bitcoin as a certified payment method. Satoshi (the man or group of people) are now reputed to be worth in excess of USD$17B as at November 2017 based on the current market value of Bitcoin.

Although bitcoin is the first and the most significant cryptocurrency, it is important to know that there are now over 1500 other cryptocurrencies like Ethereum, Litecoin, Zcash which are also active and have attained a certain value.

How Does The Blockchain Work In Cryptocurrency?

The main problem that prevented cryptocurrencies from functioning was a little thing called the double-spending problem. That means that if a digital currency is just information, free from a conventional physical structure like paper or metal, nothing can prevent a person to copy and paste it as he wishes. Well, the blockchain is just that, a decentralised database serving as a kind of digital ledger that keeps track of every cryptocurrency transaction. It makes sure that when a digital currency is spent once, it cannot be spent again. It keeps a record of every transaction ever made and allows access to information. On the other hand, it protects any data from being copied or deleted.

Blockchain technology exists as a shared database that is duplicated thousand times on a network of computers. That means that it does not exist in a specific location, which makes its records public and easily verifiable. This computer network is formed by users willing to devote their hardware and CPU power and run a special software that maintains that network. Those people are called “miners”. In that process, Miners will generate cryptocurrency and that way are rewarded for their efforts. The drawback of mining is that cryptocurrencies are designed to have a finite supply, which makes them similar to gold, or other precious metals. It means that miners will receive fewer units as the blockchain is mined deeper towards its final algorithm. (It is currently estimated that Bitcoin has a finite supply of 21 million “coins” – with approximately 16 million now in circulation) That is the main difference between cryptocurrencies and fiat currencies (paper money produced by governments of each country) which supply is, theoretically, unlimited.

How Secure Is Cryptocurrency?

Since blockchain technology serves as a kind of open database, you are probably wondering about security issues. Well, that is one of the best properties of this technology, it is virtually un-hackable. If a hacker wants to hack into a certain block of the blockchain he needs to hack, not only the desired block but all of the preceding blocks. That way he would need to go back to the entire history of the blockchain. He would also need to do this on every ledger on the network. And if that is not enough, he would need to do all that simultaneously. All in all, this makes blockchain technology truly hack-proof.

Advantages

  • Their scarcity and similarity to precious metals make them inflation protected which cannot be said to fiat currencies.
  • Cryptocurrencies offer a reliable way of exchange outside the direct control of national banks. Although it is expected that world governments will need to co-opt cryptocurrencies in the long run.
  • Mining is designed to be a kind of built-in quality control and monitoring instrument for cryptocurrencies. Since miners are paid for their efforts, they have a financial motivation for keeping accurate and up-to-date transaction records. That way they are securing the integrity of the system. It also stabilizes the value of the currency.
  • Privacy protection and anonymity are one of the main advantages of cryptocurrencies. All cryptocurrency users are using pseudonyms that cannot be connected to any information, accounts, or stored data that could identify them.
  • It is impossible for governments to seize or freeze accounts as is the case with fiat currencies. The decentralized nature of cryptocurrencies with all of its funds, transactions, and records stored all around the world makes it immune to these kinds of actions.
  • Transactions re cheaper than with traditional currencies. Their security features eliminate the need for a third-party payment processor needed to authenticate every electronic financial transaction. It is also cheaper to make international transactions since cryptocurrencies treat all transactions as domestic.

Shortcomings

  • Probably the main drawback comes from a feature that makes one of the advantages. The lack of regulation makes them perfect for implementation of illegal transactions on the dark
  • The lack of regulation also attracts tax evaders. Many small employers pay their employees in bitcoin. That way both parties evade paying taxes.
  • Since cryptocurrencies do not exist in any kind of physical form, they have a potential for financial damage due to data loss.
  • Many cryptocurrencies cannot be exchanged directly for fiat currencies. Just those with highest market capitalizations.
  • Although miners are in some way intermediaries for cryptocurrency transactions, they are not responsible for resolving disputes between transacting parties. In one word you have no one to appeal to if you are cheated or not satisfied with a specific cryptocurrency transaction.

Summary:

There is a vast amount of information about cryptocurrencies on the internet. By investing in Bitcoin or other Cryptocurrencies you may be able to make a fortune if you are careful and buy wisely. However the market in cryptocurrencies is extremely volatile and can fluctuate wildly. So be smart and don’t invest more than you can afford to possibly lose.

Follow us for more upcoming articles on cryptocurrency information.