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What Is a Cryptocurrency? A Beginner’s Guide

09/17/2018
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  • Cryptocurrency
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In the 2010s, the cryptocurrency is the talk of the town; it is depicted as a new secret of getting rich overnight, of earning a passive income without any serious effort, of getting altcoins for $1 and selling them in one year for $10,000… But is that all true? What is crypto currency in sober fact, and how has it transformed the world? What does cryptocurrency mean for laypersons and professional miners and traders? This article will share all about cryptocurrency as an innovation, covering the history of cryptocurrency emergence, mechanisms of its work, the range of its practical applications, regulation of the crypto-market, and the future forecasts for this new financial concept.

Cryptocurrency for Dummies: An Introduction

It is a good point to start the beginner cryptocurrency guide is to answer the fundamental question, “what is cryptocurrency?”Indeed, it’s vital to make sense of the cryptocurrency definition first to continue the discussion, as it is quite a complex technical phenomenon that even professional traders (and some miners) do not capture totally.

So, what do you mean when saying the word “cryptocurrency”? Probably, the digital version of real money. And to a certain extent, you are right.

In simple words, laypersons may look at crypto-currency as a digital version of regular fiat currency, something that the government legally endorsed but did not back it with any physical commodity (apart from real currency supported by the state’s gold reserves). Thus, when you define cryptocurrency, you probably mean a medium of exchange similar to traditional currencies (e.g., USD) designed for exchanging digital information via cryptography-enabled processes.

Another definition of cryptocurrency depicts it as electricity converted into digital value units by means of solving mathematical equations for the sake of using those units for online payment.

Some famous cryptocurrency examples include Bitcoin, Ethereum, Ethereum Classic, Monero, Ripple, and a bunch of other coins that flooded the world after the Bitcoin miracle. The benefits that digital cryptocurrency provides to users include:

  • A decentralized cash system. With real money, you have to use a bank or another financial institution to make a transfer (unless you can meet another person and hand in the cash). This is what crypto allows to avoid; the system of cryptocurrency represents a network powered by its users, without any third party like the central bank or government. Thus, you are always in control of your coins, with no centralized authority over you;
  • Altcoins are very hard to forfeit, which means that you avoid the risk of getting flash notes instead of real money. However, that does not mean that the crypto-world is risk-free; just the opposite. Since cryptocurrency has no physical backing, cyber-hackers steal it from exchanges and large-scale investors without any possibility of being tracked and punished;
  • The impossibility of double spending. That’s what really makes cryptocurrency attractive! Numerous fraudulent schemes exist to spend the same money twice, which is impossible with crypto coins. Thus, when you buy or sell them, you may be sure that the transaction is validated and irreversibly completed for the security of all participants;
  • A great degree of anonymity. Cryptocurrency transactions are almost impossible to track, which guarantees full confidentiality and anonymity to all participants of the transaction process. While governmental authorities interpret this feature more like a drawback, stating that cryptocoins enable financing of terrorism and crime, some users still appreciate the anonymity given by crypto for non-criminal reasons – basically, it is a great opportunity to evade taxes and transaction commissions;
  • Greater flexibility. While with real currency, the maximum parts into which it can be divided are typically one hundred (there is hardly any significant value lower than one cent for, let’s say, the USD), cryptocurrencies may be divided into many more parts for flexibility of payouts.

However, together with the enumerated benefits that cryptocurrency offers, it also possesses some inherent disadvantages that everyone considering it should know. For instance,

  • Crypto coins still suffer a stained reputation because of being used for criminal and illegal purchases. So, many people are reluctant to mess up with transactions in cryptocurrency because they stereotypically associate holders of crypto-assets with crime;
  • This type of currency is much easier to steal or lose. Once your exchange is hacked or your hard drive crashes, you may lose the private key and thus all your crypto-belongings;
  • There are still numerous limitations on the circulation of cryptocurrency, with very few retailers accepting it as a medium of payment. Thus, you will have to go through a complex process of exchanging this currency into fiat money, withdrawing them from the exchange (probably with a commission fee) and only then paying for the goods you need.

Now that you got an initial idea of what is cryptocurrency, it’s high time to proceed to the cryptocurrency history.

How Did It All Start? The Bitcoin Cryptocurrency

For many people, the answer to the question, “what is a cryptocurrency?” is identical to the question, “what is Bitcoin?” That’s natural, since for a long time, the concept of cryptocurrency has been associated exclusively with it. Thus, the relationship between cryptocurrency and Bitcoin is tight and long-standing. However, in fact, Bitcoin is not the beginning of the digital cash era:

  • The first effort to introduce digital money was made in the 1980s in the Netherlands to solve the problem of frequent night robberies of gas delivery drivers;
  • In 1983, an American cryptographer David Chaum invented the formula for creating electronic cash;
  • Chaum moved to the Netherlands and started the DigiCash project together with a group of mathematicians Bryce “Zooko” Wilcox-Ahearn, Nick Szabo, Marcel “BigMac” van der Peijl, Garry Howland, Niels Ferguson, and Stefan Brands. However, the start-up failed in 1998;
  • After DigiCash, over 100 projects followed to create and disseminate e-cash but failed because of the rise of web-based money, creation of PayPal, etc. Public attention shifted from creating electronic money to transferring their funds into a web-based format;
  • In the USA, all efforts to popularize e-money were suppressed in the aftermath of 9/11, as they were seen as a hotbed for drug dealers, terrorists, and criminals avoiding the gaze of formal financial and legal enforcement institutions.

However, the things changed forever with the advent of Bitcoin. Here are some relevant points that help to understand what Bitcoin is and how it works:

  • Bitcoin cryptocurrency became the first of its kind, created in 2009 by a mysterious developer Satoshi Nakamoto;
  • Nakamoto mined the first block in January 2009 with a reward of 50 bitcoins;
  • The first transaction of ten bitcoins was made by Nakamoto to Hal Finney – the ardent supporter of the project who downloaded the BTC software to his computer on the day of its release;
  • Cryptocurrency Bitcoin emerged as digital assets whose ownership is recorded on an electronic ledger instantly updated on over 10,000 independently operated and connected computers around the globe;
  • Updates to the ledger are done on the basis of the protocol, recording the transfer of BTC ownership from one person to another one;
  • The protocol is enabled by apps run on the participants’ computers referred to as nodes;
  • Bitcoin changed the world of financial transactions forever by becoming a feasible means of passing value from one person to another one without involving any physical movement of items and engagement of financial intermediaries.

So, when you face a question, “Is Bitcoin a cryptocurrency?”, the answer is that it is the purest and most original of all cryptocurrencies existing to date.

An A-Z Guide to Cryptocurrency

To understand what is cryptocurrency for dummies, you need to capture some basic definitions first. After you learn them, you’ll always sound like a crypto-expert! And to a certain degree, you will indeed become one. So, what terminology should any course on cryptocurrency for beginners include?

Blockchain

The block chain represents a growing list of cryptographically linked records containing hashes of the previous blocks, timestamps, and transaction data. This is a primary method of cryptocurrency mining and the basic principle of crypto-world’s operation.

Cryptography

Cryptography refers to the science and practice of ensuring secure communication online. Based on the principles of cryptography, two or more persons sharing a secret key can communicate securely; at present, even public-key techniques let two parties generate shared secret keys.

Digital Signatures

A cryptographic mathematical technique enables one user to attach a digital signature to a digital file or message; this is done for the sake of the message’s originality and ownership validation by other users of the system. With the help of digital signatures, recipients of the messages can be assured of the evidence of those messages’ origin, as well as the status of the document.

Digital Tokens

Digital tokens represent securities in the digital form; essentially, they are digital assets with a certain value that traders can invest in. Businesses trade digital tokens as software presale tokens, donations, and crowdsales.

Encryption and Decryption

These are two interconnected processes enabled by cryptography. The procedure of encryption lets a user to turn a plaintext, readable human message into a cyphertext, which is looks like a jumble and represents an encrypted message incomprehensible for an outsider. Once the recipient gets that message, he or she involves the process of decryption, which turns the jumbled message back into readable text. Decryption is usually done with the secret key, while efforts to decipher a message without that key presuppose hacking or breaking it.

Forks

A cryptocurrency fork is a term used to refer to a fork of a codebase and a fork of a live blockchain. When you fork a database, this means that you create an entirely new ledger. This usually takes place when a new coin is created, but it has a shared history with an already existing coin. Thus, the process means forking the code behind the node software. Forking of a live blockchain is also referred to as “chainsplit”, meaning that new blocks in a blockchain are made accidentally or deliberately incompatible with the rest of the blockchain.

Hashes

Hashes, or a hash function, is a sequence of mathematical steps or algorithms performed with input data to produce a fingerprint (aka digest, or hash). Blockchain uses cryptographic hash functions; they are deterministic by nature, quick to compute the hash value, irreversible, immune even to slight changes, and unique.

ICOs

Initial Coin Offerings (ICOs), or token sales, represent an innovative method of fundraising by businesses that don’t wish to dilute company ownership or pay money back to investors. ICOs became popular in 2017, and by now, over $11 billion have been raised on them.

Technical Guide to Cryptocurrency

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Those thinking of what is cryto currency frequently hear the word “blockchain” together with the cryptocurrency terms. That’s because the entire universe of mining and trading coins is based on cryptography enabled by blockchain. Thus, it is impossible to come to grips with cryptocurrency – understanding what is it and how it works – until the principles of blockchain are understood. After that, the fundamentals of mining may become much clearer and simpler.

Blockchain Technology

Blockchain (initially “block chain”) is a concept inherently connected with cryptocurrency meaning . The blockchain technology represents a set of rules and standards as to how a specific coin’s ledger is created and maintained. This pertains to the rules of participation in the network, specifications on transaction creation, methods of data storage, and a variety of consensus mechanisms. Examples of blockchain technologies include the Bitcoin, Ethereum, NXT, Quorum blockchains.

Here is a simple presentation of the Bitcoin blockchain process for cryptocurrency beginners:

  • Install the Bitcoin Core or any similar software to your computer;
  • Connect with other Bitcoin network participants;
  • Download blockchain from others;
  • Store it;
  • Keep an eye open for new transactions;
  • Validate them;
  • Store them;
  • Relay valid transactions to other modes in the network;
  • Track the emergence of new blocks and validate them;
  • Store the blocks as a part of the blockchain;
  • Relay valid blocks and create new ones;
  • Mine the new blocks;
  • Manage addresses to create and send transactions.

Here you are with a new piece of Bitcoin! Other blockchains work on a similar basis but depending on the type of cryptocurrency you are planning to mine, the blockchain principles and rules may vary.

The Mining Process

The technical question worrying most of those interested in cryptocurrency – how to get some of it? – may be answered in a number of ways. A traditional method of earning coins or buying them is suitable, similar to traditional money, but with cryptocurrency, you also receive a unique opportunity: to make your own crypto-money on your own via mining. This is what is unique about cryptocurrency – you may not only get already existing coins, but can also produce your own ones, which is really fascinating!

So, in simple words, the mining process looks as follows:

  • New miners install the mining software on their computers and get the ledger;
  • Each transaction and change of ownership of each cryptocurrency is recorded on the blockchain (ledger);
  • Miners use powerful computers to operate the blockchain by tallying and confirming all transactions on the network;
  • Miners’ core function is updated upon the completion of any transaction; they also guarantee the authenticity and security of transactions;
  • Miners use their powerful software to solve blocks which contain the transaction data by using cryptographic hash functions;
  • As a result, they add new blocks to the blockchain and validate other users’ operations.

So, if you consider making mining a source of your income, that’s a really feasible option, as mining is highly similar to any other grid computing project. But anyway, cryptocurrency is more about progress and innovation than becoming rich in the first place, so we recommend involvement in mining mostly for those who wish to build technological experience. This is quite a complex process requiring much powerful equipment, so engaging in mining without specialized technical expertise may be quite problematic, especially in the context of all blockchain operations getting ever more complex and technologically intensive day to day.

How to Use Cryptocurrency?

No guide on cryptocurrency for dummies may do without a section about the functions and applications thereof. If crypto coins are intangible and cannot be held in your hands, while most shops and financial organizations don’t recognize and accept them, what is the purpose of cryptocurrency after all? In this section, we are responding to the question “what is cryptocurrency used for?” The information will be topical for those already having some amount of crypto-money and for those who only think of getting some.

In the traditional understanding, cryptocurrencies can perform one of the three functions:

  • The medium of value. The crypto-market is on the rise, so people have confidence in the coins that is increasing from year to year. The fantastic success of Bitcoin in 2017 proved that cryptocurrency may make you rich, as its value increases are not tied to any broader political or economic changes as fiat currencies are. Thus, for some individuals, buying some coins and keeping them until the time is right is the best investment strategy;
  • Medium of exchange. If you have crypto-assets, you may find dozens of service and product providers online that will accept them as a mode of payment. It is true that you will be unable to cash them in a bank or buy food for them in the supermarket, but the online market is much friendlier to payments in crypto;
  • The medium of speculation. Traders use cryptocurrencies as a very lucrative object of trading and investment. To date, there are hundreds of crypto-exchanges at which miners and traders exchange cryptocoins, buy and sell them at varying rates, and make other operations. This is a booming market since crypto coins are similar to securities with a rising value nowadays. Hence, even individuals without any in-depth technical knowledge work with crypto on a daily basis and earn pretty well on trading.

A friendly reminder! No matter which option you will choose and how you wish to apply your crypto-belongings, we recommend keeping in mind that the concept is relatively new, thus investing in it conceals many unknown hazards. Thus, it’s advisable to make a thorough research before investing, as over 60% of investors lose their funds in the crypto-market.

The Future of Cryptocurrency

Is cryptocurrency here to stay? Definitely, yes! Though many doubts surrounded the recognition of altcoins as a valid payment method alternative to real money, and many influential financial institutions made bold statements about banning cryptocurrency, its entry to the traditional market of exchange is unavoidable. Hence, those who have a weak or medium cryptocurrency interest to date – beware, the momentum to acquire coins at a favorable price is now, as tomorrow may be too late!

Hopefully, this cryptocurrency beginner guide has lifted the veil on the weird, mysterious concept. Keep in mind that to become an expert miner or trader, you need to study the topic in more depth to make informed decisions. Don’t risk your funds and research the area thoroughly before making any investment – the crypto-market is immensely volatile.

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