What Is Cryptocurrency And How Does It Work: Part 1
What is cryptocurrency, how does it work, is it legal? In this series, well break down of the pressing questions you have about crypto!
Cryptocurrency is a hot topic right now. While virtual currency existed in different forms since the 1980s, its becoming more mainstream today. So what is cryptocurrency, how does it work, and is it legal?
I’ve Done The Math Forget Mining Is There A Less Onerous Way To Profit From Cryptocurrencies
As mentioned above, the easiest way to acquire Bitcoin is to simply buy it on one of the many exchanges. Alternately, you can always leverage the “pickaxe strategy.” This is based on the old saw that during the 1849 California gold rush, the smart investment was not to pan for gold, but rather to make the pickaxes used for mining.
To put it in modern terms, invest in the companies that manufacture those pickaxes. In a cryptocurrency context, the pickaxe equivalent would be a company that manufactures equipment used for Bitcoin mining. You may consider looking into companies that make ASICs equipment or GPUs instead, for example.
What Makes Cryptocurrencies Different From Fiat Money
Fiat money money like the American or Canadian dollar is issued by the government, meaning theres a central authority that controls its value, interest rates, and supply . Many view this degree of government involvement in the mechanics of the free market as manipulation and as an archaic attempt to manage a vast and complex economic system. A noble intention at best, a catalyst of hyperinflation that makes wealth building very difficult for the average person, at worst.
Cryptocurrencies, on the other hand, are decentralized all transactions are done peer-to-peer or through smart contracts and theres no authority overseeing them. Many people consider this a massive advantage over traditional money, because it gives them full control of their assets.
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Adding Transactions To The Digital Ledger
Thus far we have worked with the assumption that every node on the network has an accurate copy of the digital ledger of all transactions. In other words, we have assumed the presence of distributed consensus. But this is a big assumption how exactly can we ensure distributed consensus? Well be able to answer this question by looking into how person As transaction, which is now in the validated transaction pool, is confirmed and added to everyones digital ledgers.
Within the cryptocurrencys P2P network there are some specialized nodes called miners, who are responsible for confirming transactions. They begin by grouping unconfirmed transactions from the transaction pool into candidate blocks the number of transactions in a candidate block differs based on the cryptocurrency. Remember how person A specified a transaction fee in his message? This gives miners an incentive to put person As transaction into a candidate block and confirm it fast but in general, the higher the transaction fee, the quicker the confirmation.
Buying And Selling Cryptocurrencies Via An Exchange
When you buy cryptocurrencies via an exchange, you purchase the coins themselves. Youll need to create an exchange account, put up the full value of the asset to open a position, and store the cryptocurrency tokens in your own wallet until youre ready to sell.
Exchanges bring their own steep learning curve as youll need to get to grips with the technology involved and learn how to make sense of the data. Many exchanges also have limits on how much you can deposit, while accounts can be very expensive to maintain.
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Increased Regulation In 2021
The rise in the popularity of cryptocurrencies and their adoption by financial institutions has led some governments to assess whether regulation is needed to protect users. The Financial Action Task Force has defined cryptocurrency-related services as “virtual asset service providers” and recommended that they be regulated with the same money laundering and know your customer requirements as financial institutions.
The European Commission published a digital finance strategy in September 2020. This included a draft regulation on Markets in Crypto-Assets , which aimed to provide a comprehensive regulatory framework for digital assets in the EU.
On June 10, 2021, The Basel Committee on Banking Supervision proposed that banks that held cryptocurrency assets must set aside capital to cover all potential losses. For instance, if a bank were to hold bitcoin worth $2 billion, it would be required to set aside enough capital to cover the entire $2 billion. This is a more extreme standard than banks are usually held to when it comes to other assets. However, this is a proposal and not a regulation.
Why Would You Use A Cryptocurrency
Cryptocurrencies are known for being secure and providing a level of anonymity. Transactions in them cannot be faked or reversed and there tend to be low fees. Their decentralised nature means they are available to everyone, although they can be complicated to set up and few stores accept them for spending.
Perhaps the most popular use of cryptocurrency is as a speculative investment, with users buying up the coins in the hope they will go up in value, or that one day might be useful as an alternative to traditional currencies.
Bitcoin’s volatile price has led to sudden peaks in interest as its value goes up. This has caused a surge in professional and amateur speculators investing in bitcoin and other cryptocurrencies, seeing them either as a quick way to make returns or as part of an investment portfolio.
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Is There A Good Time To Buy
There is no general rule when to buy cryptocurrencies. Usually it is not a good idea to buy in at the peak of a bubble, and usually, it is also not a good idea to buy it when prices are crashing. Never catch a falling knife, as the traders wisdom says. The best time might be when the price is stable at a relatively low level.
The art of cryptocurrency trading is a vast topic in and of itself, and determining precisely when a crypto is in a bubble and when it has reached a local bottom after falling is not an exact science. What is easy to say in retrospect is a hard question to answer in the present. Sometimes a coin starts to rise, and after it passes a key line of historical resistance, and many believe it to be at the peak of a bubble, the real rally just begins.
For example, many people did not buy Bitcoin at $1,000 or Ether at $100, because it seemed to be overpriced. But years later these prices now appear to be an incredible bargain that will never again appear to the market.
This is definitely not financial advice, but some general guidelines to help you decide when to make an investment include:
What Is A Paper Wallet
To keep it very simple, paper wallets are an offline cold storage method of saving cryptocurrency. It includes printing out your public and private keys in a piece of paper which you then store and save in a secure place. The keys are printed in the form of QR codes which you can scan in the future for all your transactions. The reason why it is so safe is that it gives complete control to you, the user. You do not need to worry about the well-being of a piece of hardware, nor do you have to worry about hackers or any piece of malware. You just need to take care of a piece of paper.
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Where Did Cryptocurrencies Come From
Ready for some interesting history about cryptocurrencys beginning, and its contribution to electronic currency transfers?! Cryptocurrency existed as an idea way before any of the technology existed to build it. Cryptos technical start dates back to the 1980s. An American cryptographer named David Chaum invented an algorithm that web-based encryption uses today. The blinding algorithm provided secure, unalterable information to exchange between users. This paved the beginning of electronic currency transfers! Pretty cool, huh?
As the years progressed and electronic payment transfers evolved, a 2008 white paper published by Satoshi Nakamoto described the first modern cryptocurrency bitcoin. In early 2009, Nakamoto released Bitcoin to the public. By 2010, other cryptocurrencies started appearing, as well as the first public trading of bitcoin.
The field of cryptocurrencies is expanding. In early 2021, more than 4,000 cryptocurrencies exist. Many different types of cryptocurrencies exist for different types of investors, as well as business and trading needs. For example, some cryptos may offer a faster transaction confirmation time, or provide solutions for blockchains to work together easier.
Blockchain Also Has Potential Applications Far Beyond Bitcoin And Cryptocurrency
From a business perspective, its helpful to think of blockchain technology as a type of next-generation business process improvement software. Collaborative technology, such as blockchain, promises the ability to improve the business processes that occur between companies, radically lowering the cost of trust. For this reason, it may offer significantly higher returns for each investment dollar spent than most traditional internal investments.
Financial institutions are exploring how they could also use blockchain technology to upend everything from clearing and settlement to insurance. These articles will help you understand these changesand what you should do about them.
For an overview of cryptocurrency, start with Money is no object from 2015. We explore the early days of bitcoin and provide survey data on consumer familiarity, usage, and more. We also look at how market participants, such as investors, technology providers, and financial institutions, will be affected as the market matures.
For a deeper dive into cryptocurrencies, we recommend that you read the following:
Carving up crypto provides an overview of how regulators are thinking about cryptocurrency in financial services, both in the United States and abroad.
In Cryptocurrencies: Time to consider plan B, we explore possible avenues for accounting treatment on cryptocurrencies.
For a deeper dive on specific topics related to blockchain, we recommend:
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It Is Not Money But A Financial System
A financial system cant work like that, because no one would get paid.
So if I only have enough money to pay Reagan or Slaga ten ten, but I try to pay them both, theres
a check built into the Cryptocurrency system.
Both the Cryptocurrency network
and your wallet automatically check your previous transactions to make sure
you have enough Cryptocurrency to send in the first place.
But theres another problem that might happen with timing:
Because lots of people are keeping copies of the blockchain all over the world, network
delays mean that you wont always receive the transaction requests in the same order.
So now youve got a bunch of people with a bunch of slightly different blocks to pick
from, but none of them are necessarily wrong.
Is Bitcoin Mining Legal
The legality of Bitcoin mining depends entirely on your geographic location. The concept of Bitcoin can threaten the dominance of fiat currencies and government control over the financial markets. For this reason, Bitcoin is completely illegal in certain places.
Bitcoin ownership and mining are legal in more countries than not. Some examples of places where it was illegal according to a 2018 report were Algeria, Egypt, Morocco, Bolivia, Ecuador, Nepal, and Pakistan. Overall, Bitcoin use and mining remain legal across much of the globe.
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How Does Cryptocurrency Compare To Traditional Investing
As cryptocurrency investing gains popularity, more people are apt to choose the option that is more convenient. Therefore, many who might otherwise invest in a more traditional way have turned to cryptocurrencies instead. This means less business for banks and investment firms, which in itself has far-reaching consequences.
However, because the value of cryptocurrencies isnt backed by anything, investments can be highly unpredictable. Thats one of the reasons why these currencies cannot take the place of a local bank. While they provide an investment opportunity, they cant offer stability, which is what you need when it comes to your cash. Furthermore, this currency cant secure mortgages, loans, or other services youll need throughout life. This is why continuing to work with your local bank is important, even if cryptocurrency strikes your interest.
How To Buy Cryptocurrency On A Centralized Exchange
The exchange serves as one of the most critical functions in the crypto ecosystem. It basically acts as a portal between the fiat world and the crypto world the on-ramp if you will. Centralized exchanges help you buy Cryptocurrencies in exchange for fiat money . Coinbase is a perfect example of this kind of exchange. Coinbase lets you exchange your fiat for crypto with its easy to use app.
If youre wondering why you have to go through the lengthy and arduous process of signups and verifications to purchase crypto, the answer lies in the various Know Your Customer and Anti-Money Laundering laws that centralized exchanges are legally obligated to comply. Some exchanges avoid this process by simply not allowing you to deposit your fiat dollars into the exchange, and limit transactions to be between crypto-to-crypto, as opposed to the fiat-to-crypto that requires AML laws to be observed by the exchange.
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Cryptocurrencies: How They Work
The virtual currencies that have gotten the most attention are cryptocurrencies, which are used to transact business directly between two parties without going through a banking system.
Using a cryptocurrency is very different from paying with traditional currency. Its a process with its own unique digital features, a distinctive underlying technology, and a highly specialized vocabulary.
To understand how cryptocurrency works, lets look at a situation where it may be used.
Lets assume you are selling a mountain bike to your cousin, using Bitcoin for the transaction. Each of you would each have a digital wallet that contains your private keyan alpha-numeric code of at least 16 characters that is far more comprehensive than a PIN. The private key, which should be kept entirely secure, enables you spend the Bitcoins allocated to your account.
Assuming your cousin agrees to the purchase, that transaction is added to a list, or block, that is automatically recorded by all the computers on the Bitcoin network. The block contains all the cryptocurrencys recent transactions. In the case of Bitcoin, this means all the transactions that have occurred during the last 10 minutes or so. The block becomes part of a chain, or blockchain, which is also what the underlying technology is called.
Next up: How money is raised in Initial Coin Offerings and the regulatory scheme governing cryptocurrency offerings.
Investor Guide to Cryptocurrency Offerings
The Magical Bit The Algorithm
it was originally developed by the United States National Security Agency.
Computers that were specifically designed to solve SHA256 hash problems take, on average,
about ten minutes to guess the solution to each one.
That means theyre churning through billions and billions of guesses before they get it
right. So imagine the amount of blood needed in your brain if you were brave enough to guess one.
Whoever solves the hash first gets to add the next block of transactions to the blockchain,
which then generates a new math problem that needs to be solved.
If multiple people make blocks at roughly the same time, then the network picks one
to keep building upon, which becomes the longest, and most trusted chain.
And any transactions in those alternate branches of the chain get put back into a pool to be
added onto later blocks.
These volunteers spend thousands of dollars on special computers built to solve SHA256
problems, and run their electricity bills up sky high to keep those machines running.
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How Well Do They Work As Money
One manâs trash is another manâs treasure.
As we saw in the previous chapter, practically anything can be used as money. Therefore, itâs more useful to ask if cryptocurrencies have the properties of good money, and how well do they function as money today.
In this chapter, weâll see that cryptocurrencies have excellent monetary properties, but their function as money is held back by volatility and adoption.
To decide how well cryptocurrencies can function as money, weâll take a look at the properties good money should have and see how cryptocurrencies hold up. See the previous chapter for historical context and a discussion about the properties.
Nobodyâs excluded from using cryptocurrenciesâtheyâre open to everyone by design. The drawback is that you need a device with internet connection.
A fairly small requirement given the stated purpose being digital cash, but itâs undoubtedly a drawback.
Thereâs no real technical limit to how much a cryptocurrency unit can be divided, and itâs all automatic.
Coins can be used an infinite amount of times. The only drawback is keeping your private key secure, so you donât lose your coins.
Because phones can break or be stolen, you should write down your private key as backup. Itâs a good idea to secure it from fire, theft and simply losing it.
Limited in supply
Cryptocurrencies follow predetermined emission rates, ensuring a limited supply.