Introduction to Cryptocurrency: What is it & how is it used?

Cryptocurrency has in the recent year taken the world by storm. Most people were quite unsure of its success when it first started out, heck most are still skeptical of its stability and wonder for how long it will be around. But despite all the skepticism surrounding it, cryptocurrency is here to stay.

Cryptocurrencies have become a global phenomenon. They are by far the most talked about subject on finance talk shows and social media sites. However, despite all the airtime, and focus it has been given, very few people completely understand it.

In this article, we’ll go through step-by-step what cryptocurrency is.

What is the impact of cryptocurrency?

Being able to transact without having to go through a bank makes it first and foremost very easy and efficient. Since the bank is essentially just a middle-man, whose job is to make sure the transaction goes through smoothly and that the numbers on each end are correct It would be way more efficient if we could do it without having a person look on it that also requires a salary, which makes us get transaction fees.

With cryptocurrency, there is no middle-man, there are miners (essentially computers dedicated to solving math problems and once those are solved, a transaction is approved), these computers can be run by anyone on the planet (see our article on the best Bitcoin miners here). One other impact that cryptocurrency has is that you easily can send money to anyone in the world without any exchange fees, this makes it a very interesting currency for those who want to send money abroad.

Due to the fact that cryptocurrency is decentralized, it is totally anonymous. While this is good for security reasons, this has led to Bitcoin and other cryptocurrencies being used when buying illegal products. This resulted in a bad reputation of Bitcoin, but in the last few months people have realized that it is in fact not only a currency for criminals, there are actually a lot of other use cases for cryptocurrency.

The History of Cryptocurrencies

This might come as a shock to many, but the emergence of cryptocurrencies was as a result of a different product altogether. The inventor, Satoshi Nakamoto, whose identity has not been identified, did not have the intention of creating something with such revolutionary effect. As a matter of fact, his intention was not to come up with a new form of currency.

So, what was this Nakamoto was trying to invent? When he was announcing his new idea, Bitcoin, back in 2008, Nakamoto spoke of having developed a form of a peer-to-peer electronic cash system. Part of this new invention was a genius way of decentralizing the digital cash system. Back in the 90s, many had tried to make a decentralized cash system but failed miserably.

Seeing and studying the failures of those who tried to hack the system before him, he decided to build a cash system devoid of a central body (i.e. a central bank). It would act and behave more like a peer to peer network that allows for file sharing on a basic computer network.

It is this basic idea that birthed cryptocurrency. Funny enough, cryptocurrency was the missing puzzle piece to the realization of digital cash. Now fair warning, the reason why cryptocurrency was the missing piece is a bit complicated. However, it is critical to understand this if you wish to have a firm grasp on the whole digital currency idea.

Why it was the missing puzzle

First things first, for digital currency to become a reality, a form of payment network complete with transactions, balances, and accounts have to be present. Now, to make the system stable, the network has to do one main thing; ensure that there is no double spending. In essence, one should not be able to eat his cake and still have it. So how is this achieved? Well, the current currency model solves this issue by having a central server (central bank) that keeps all the records regarding the balances.

But here is the thing; a decentralized network cannot have a central bank because then, it is in fact not decentralized. Instead, it requires that every participant in the network carries his/her own weight to ensure that double spending does not occur. Every peer should countercheck all transactions for validity and prevent double spending.

If you are following closely, the question in your mind right now is, how does such a large network ensure a consensus on such recording matters? Isn’t there a lot of chaos?

It is a given, in a peer to peer network, a consensus is imperative. If the network does not agree on a small balance, the entire system comes tumbling down. The system requires nothing but complete consensus – there are no two ways about this.

With a centralized system, all processes and transactions are passed through a central body which reviews and confirms the authenticity of the current balances. In a decentralized system, there cannot be a central body since then they have the power of the whole system, which means that it isn’t decentralized.

The ability to authenticate processes in a decentralized system was for the longest time deemed impossible. Well, until Satoshi proved everyone wrong. Cryptocurrency is the building block of a decentralized system.

So cryptocurrency is a complicated system?

Not really. When we disregard all the complications, tech and finance gurus bring into the definition, cryptocurrency is basically digital currency. You can also define it as limited digital entries made to a database that no one can effect change on without meeting a specific set of conditions.

Let’s consider the cash you already have in your normal bank account. If you think about it, it is nothing more than simple entries made to a database that can only be changed when certain specific and strict conditions are met. You can add or take physical money from the bank. To make these database entries, you either have to own the physical money (for deposits) or have an equivalent figure in the database (for withdrawal). Broken down into layman’s terms, money is a bunch of verified entries in some form of a database of transactions, balances, and accounts.

How does cryptocurrency work?

Now that we understand what cryptocurrency is let’s have a look at how cryptocurrency works.

The process begins when a peer on the network requests a transaction. The transaction that is requested is then broadcasted to every peer on the network automatically.

While the request is broadcasted to every peer on the network, only one peer gets to accept it and complete the next step of validation. Now during this validation process can include contracts, cryptocurrencies, records or any other piece of information.

Once the validation process is complete, the next step is combining the validated request with other transactions in the system. This takes roughly 10 minutes, in comparison to a bank that will require 1 or up to 5 business days to complete the transaction. This combination will create a new data block that will be recorded in the public ledger.

The new block is later added to an existing blockchain and made permanent. At this point, the cryptocurrency process is deemed complete.

The moment a request for a transaction is made, it is known by every peer in the network almost instantaneously. However, it takes a while before the process is verified and confirmed. I should point out that the confirmation process is the backbone of cryptocurrencies. Provided a transaction remains unconfirmed, it is liable to forgery. But once it is confirmed, it is made permanent, and no further changes can be made to it. The process at that point becomes irreversible and is added to an immutable history of records that are referred to as blockchains.

Quick question, who does the confirmations? Miners are the only individuals allowed to confirm the transactions. It is the role they play in the peer-to-peer network. They receive the transactions, test them for legitimacy and spread them throughout the network. Once a miner confirms any transaction, every peer on the network has to add the transaction to the database as it has become part of the blockchain.

For the important role that they play in the cryptocurrency network, the miners are given some form of reward. Most of the time, the reward is in the form of Bitcoins (more about this later on).

Deeper Look At What Miners Do

Is there a qualification to be a miner? No, that is like asking if there are personal qualifications to start a freelance business. The only thing one needs is to understand how mining works, have a passion and treat it like a business like any other. This means that one has to invest in the necessary mining resources to become a miner and a profitable one at that.

Now, given that the cryptocurrency network is decentralized, meaning that it does not have one single authority calling the shots and delegating the said transaction request, Nakamoto developed a mechanism that prevents any single individual from abusing this freedom. It would be chaotic and the system would fall if one individual could pool together peers who can then spread forged legal looking cryptocurrencies.

So here is what Nakamoto did. He came up with a rule that each miner would have to invest in a given amount of work with the help of their computers if they are to take part in the mining process. Every miner has been delegated the responsibility of finding a hash. A hash is simply a product of the mathematical problem the computer has to solve. This connects every new block with its initial block family. This entire phenomenon is referred to as Proof-of-Work.

As mentioned earlier, there are some incentives given to the miners in the form of bitcoins for the critical role they play in the system. After all, Bitcoin can only be created when miners solve the mathematical problems.

It is important to note that the complexity of these problems increases with time. As such the processing power a miner needs to invest increases with time too since each problem requires a specific amount of time to solve.

Properties of Cryptocurrency

It is irreversible

After every transaction request is verified, it becomes permanent and irreversible. No one can make changes to it. Heck, Satoshi, the one behind it all cannot make the changes. Once money has been sent, it cannot be reversed. So in the event, you send funds to a scammer or a hacker stole the currencies from your PC, they are gone. The entire currency system does not have a safety net.

This is why it is important to store your cryptocurrencies in wallets. Here’s a guide on the best wallets for Bitcoin, and here is a guide on the best wallet for Ethereum.

It is pseudonymous

The accounts and the transactions are not connected to real people. Well in a sense they are, but there is no way of actually tracking who is behind the transaction. When you receive bitcoins, they come in what people refer to as addresses. These are just random chains of about 30 characters. Yes, you can analyze the flow of the transaction with these, but they are not sufficient to provide you with a real-world identity.

Global and Fast

The transactions go through the validation process in the network very fast. Actually, it only takes a couple of minutes to make their confirmations. Of course, this depends on the processing power of the computer performing the task. And given the fact that the network is made up of computers spread out in the whole world, the transactions are indifferent to the location. And as such the amount of time is not dependent on whether you are sending cash to your neighbor or an individual on the other side of the world.

It is secure

The funds in the system are locked in what is referred to as a public key cryptography system. Only the owner of a given public key can send the currency. The strength of the cryptography coupled with its large size makes it impossible to hack the system. However, exchanges and wallets, which in you store these public keys can be hacked. This is why it is necessary to invest in a secure wallet for your cryptocurrencies.

Requires no permission

You do not need anyone’s permission to transact with cryptocurrencies. All you need is that you have a wallet, with cryptocurrency in it, so that you have an address to send your cryptos from. After buying Bitcoin and putting them in a wallet, you can send and receive cryptocurrencies.

Types of cryptocurrencies

Now, before you even heard about cryptocurrency, you must have heard about Bitcoins. Today, Bitcoins is the most popular cryptocurrency. So much so that it is almost synonymous with the word cryptocurrency.

But contrary to popular belief, there are several different types of cryptocurrencies. Bitcoin just so happens to be the most popular. Below is an in-depth look at some of the most popular cryptocurrencies.

Bitcoin

This was the very first cryptocurrency. Ever since its inception, it has grown in popularity and fame. In the entire world of cryptocurrency, Bitcoin almost serves as the golden standard. It is used by many as a global payment method and is even used in cyber-crime on platforms like ransomware and the darknet market, this is what initially scared the public eye away from investing in Bitcoin, but now it has gone from a currency for criminals to being an accepted payment method on a few e-commerce stores, and many more to come within a few years.

Bitcoin has been in existence for more than seven years now. During this time, its value has gone from $0 to an impressive $19,600. It is also transacted about 200,000 times on a daily basis.

Ethereum

Ethereum was created by Vitalik Buterin, one of the geniuses in the cryptocurrency space. This particular cryptocurrency has over the years risen through the ranks to third place after Bitcoin and Ripple. It is the same as Bitcoin but only with a minor difference. Its blockchain is not designed to validate only balances and accounts. It is also used to validate states. In short, this is to mean that this cryptocurrency can process not only transactions but also some complex programs, applications, and contracts.

This ability provides Ethereum with additional flexibility in the application of blockchains. However, this flexibility, like any other convenience, comes at a cost. When the DAO (read more on DAO here) was hacked, the developers of Etherum decided to perform what they referred to as a hard fork without having a consensus. This led to the development of the Ethereum Classic.

Speaking of which, it is important to point out that Ethereum features several clones. These include Augur and DigixDAO. As such, when you think about it, Ethereum is more like a collection of cryptocurrencies rather than a single cryptocurrency in itself.

Ripple

The first thing a professional will say about Ripple is that it is not a real cryptocurrency. While this is not entirely true, it sheds some light on how persons perceive Ripple. Of all cryptocurrency types, Ripple is by far the most hated.

Why is this the case? Well, the currency is mostly dedicated to acting as an IOU rather than a cryptocurrency. XRP, the native Ripple cryptocurrency does act as a medium of storing value or exchanging value. It was designed to help protect the cryptocurrency network from spamming.

The Ripple Labs came up with the XRP token and bears the responsibility of distributing them as they please. So yes, they are pre-mined, and for this reason, they are not considered to be a real cryptocurrency.

But while people seem to look down on this type of cryptocurrency, banks seem to be in love with Ripple, and thus, it’s the second most valuable cryptocurrency to this date.

Litecoin

Litecoin was the second cryptocurrency to be developed after Bitcoin. For a long time, it was considered as the silver cryptocurrency as Bitcoin was the digital gold. It was designed to be slightly faster than the Bitcoin and features a new mining algorithm. It also came with more tokens.

Upon its creation, it was the best thing yet. Its creation facilitated the creation of other cryptocurrencies including Feathercoin and Dogecoin.

Today, since Litecoin did not exactly find a place and use, it has lost its second-place status in the world of cryptocurrencies. It, however, is still being developed, traded and hodled. Most do this in the hopes that it will be developed further to beat Bitcoin in the race to become the best cryptocurrency.

Monero

This is a prominent cryptocurrency with the CryptoNight algorithm. The CryptoNight algorithm was developed to provide privacy features that Bitcoin did not. With Bitcoin, while one may not know the exact person behind the bitcoin transaction, it leaves a trail following its validation and documentation. The CryptoNight algorithm, however, with the help of the ring signatures, solved this issue.

The CryptoNight algorithm was first tried on Bytecoin. This was pre-mined heavily, and as a result, the cryptocurrency community rejected its use. The Monero was the very first Bytecoin “clone” that was not pre-mined, and that garnered a lot of awareness and popularity. After Monero, there have been other clones that have followed, but none have had the success that Monero has enjoyed.

The popularity of Monero went through the roof in 2016 when it was accepted as some form of payment in a transaction in the dark markets. The price has since been steadily rising even though its usage is still meager.

Altcoins

So far we have looked at only four cryptocurrencies aside from Bitcoins. However, this is not in the least a representation of the number of cryptocurrency types there are. There are currently 1400+ cryptocurrencies, all designed to provide a feature that Bitcoin does not.

So what is altcoin? An altcoin is simply a Bitcoin alternative. It literally describes any and all cryptocurrencies aside from Bitcoin.

The Bitcoin diehard fans insist that altcoins are unnecessary and that they have no chance of succeeding. There is just no way they can rival the infrastructure that Bitcoin enjoys. Well, while this might be true to some extent, altcoins cannot be dismissed as they do play important roles in stabilizing the entire cryptocurrency system. One of the features that Bitcoin prides itself on is decentralization. Well, the altcoins help to further decentralize the cryptocurrency and give it more stability.

Most cryptocurrencies are made for a specific type of market, business or usage.

What can cryptocurrency be used for?

Cryptocurrencies can be used for different things. Below are just some examples to give you a taste of the new world it opens up.

Buying Goods

A while back, getting a merchant who would accept cryptocurrency was close to impossible. Today, however, the situation has changed and more and more merchants, restaurants and bars are accepting this new payment method.

Investing

Since Bitcoins’ inception, it has grown from $0 to more than $19,600 in value and is still growing. While all cryptocurrencies increase in value with time, they do so at different rates and depending on their popularity.

If you are thinking of investing in Bitcoins, you should know that they are a high-risk investment. Their value fluctuates insanely unlike other assets. And given the fact that they are decentralized and unregulated by any institution or individual, they also run the risk of being banned in certain parts of the world.

Mining

As stated earlier, this is the backbone of cryptocurrency. Mining can be compared to trading. It is an investment that helps to keep the cryptocurrency world running.

Want to learn more about cryptocurrency?

Below you will find our latest posts on cryptocurrency. You can also go into our cryptocurrency news section if you want to read up on the latest in the market.