How Does Cryptocurrency Work and Other Questions Answered

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Cryptocurrency is a digital medium of exchange. They are treated as a digital, tradeable asset or digital form of money, with over a thousand varieties available at present. Bitcon, Ethereum and Dogecoin are widely used.

The records of ownership are stored in a secure digital ledger. Despite their usage as a medium of exchange, they are not treated as a currency by many nations and their legalities vary or are murky.

Components and Working of Cryptocurrency

Despite their variations, many different cryptocurrencies share the same components and workings. They are summarized below:

1. Blockchain: 

blockchain consists of a list of records termed as “blocks” that grow over time as new records are added and cryptographically secured. Similar to a linked list, each block possesses a pointer to the previous records. Due to this design, they are inherently resistant to data tampering as a block cannot be altered without doing the same for all following blocks. This will require permissions from all the other block owners, thus making any changes tedious if not outright impossible. This design makes blockchains innately secure outside of any cryptographic security measures. They are typically maintained through a peer-to-peer network, working according to a set protocol.

2. Nodes: 

In a cryptocurrency network, a node refers to a computer connected to a network, The node either relays transactions made through the network or hosts a copy of the blockchain. The node owners of a blockchain either receive some rewards from the network or act as volunteers.

3. Validation of Transactions: 

To prove the validity of transactions, cryptocurrencies use various timestamping techniques. The two primary ones are proof of work and proof of state. In proof of work, the prover proves to the verifier that a certain amount of work has been done with minimal amount of work on the verifier’s part. It was meant as a means of deterring against Denial of Service attacks, spam etc. This, along with Proof of State are the two best known consensus algorithms.

In contrast, Proof of State’s objective is to avoid Proof of Work’s computational costs. In a blockchain, to remain secure, security mechanisms must exist to prevent malicious users or groups from taking care of the validation tasks. Proof of State accomplishes this by requiring the validators to have some quantity of blockchain tokens. Without this, potential attackers cannot mount an attack. However, they suffer from a nothing-at-stake problem, which involves validator nodes trying to validate conflicting copies of the blockchain, as this can cause them to validate a block on the wrong chain, causing double-spending.

4. Cryptocurrency Wallets: 

Cryptocurrency wallets act as a means of storing the public and/or private keys used in cryptocurrency transactions. This may be in the form of a program or in the form of an actual physical device.

5. Legality of Cryptocurrency: 

Outside of its recent arrival, being decentralised means that governments don’t have the same level of control over it as their own fiat currency. As such, around 8 countries or so have banned cryptocurrency in its entirety with around twice that number possessing a high level of restrictions that acts as an implicit ban. Outside of that, in other large countries, the legislation regarding this may vary by provinces/states/districts. As such, the level of restrictions vary between countries and even certain global companies.

For instance, some of the largest social platforms like facebook, Google, twitter, etc. had temporarily banned cryptocurrency advertisements. Nationally focused platforms like Baidu and Link have done the same.

Despite being their primary selling point, the fact that cryptocurrencies are relatively unregulated has often been a source of contention. This is due to their ease for money laundering and tax evasion. Outside of this, the anonymity of cryptocurrency makes it a attractive tool for white collar and cyber crimes.

Even if legal, there are often limitations in order to ensure some degree of regulation of cryptocurrency. There are also other criticisms regarding cryptocurrency that include environmental impact, technological issues and criticisms by economic experts.

Common Misconceptions Regarding Cryptocurrency

Like any new technology or idea, cryptocurrency is often associated with misconceptions that are often based on half-truths, thus seeming quite convincing. As such, let us go over some of the most common ones that people tend to believe. These include:

1. Cryptocurrency is Illegal: 

Unless you are a citizen or resident of one of the handful of countries where cryptocurrencies are banned outright, this is one of the misconceptions. Even in countries with relatively strong restrictions, trading or owning cryptocurrencies isn’t likely to be illegal. However, please ensure that you read up on your country’s laws regarding cryptocurrency as ignorance is not a solid defence against felonies.

2. Cryptocurrency is used only for Criminal Activity: 

This is a great example of a half truth as while cryptocurrency is an attractive option for criminals, the fact is that the same is true at the smaller scale for fiat currency. While ransomware hackers and money launderers have dabbled with cryptocurrencies, so have Tesla and SpaceX in payments and even certain government officials in their salaries.

consensus algorithm In short, no. To be a fiat currency, any form of medium of exchange must be steady in value, affordable for many and easily tradeable. Cryptocurrency fulfils none of these qualities. The values tend to jump up and down, making them unsuitable as a repository, not helped by them being valued only because people are willing to trade them relative to their value to fiat currency. While nothing short of disasters would stop people from using paper money, simple mistrust of cryptocurrency can render it worthless. For the general populace, owning fractions of a single cryptocurrency might be all that is practical for them, so you can forget about buying groceries. As such, when a currency can allow purchase for space flights but not a bottle of water, it has far to go before being considered anything close to fiat currency. Due to the above two points, trade in cryptocurrencies is hardly free of risks. As such, while worthy of investments, they are unlikely to be traded, the same way one wouldn’t trade ancient manuscripts or rare paintings today in any regular manner.

3. Cryptocurrency is Very Complex: 

This isn’t untrue, as the inner mechanisms used in trading cryptocurrencies tends to be complex for the layman. However, the same can be said for the economies that rely on fiat currency. As such, since to just spend or earn money doesn’t require a PhD in economics, it doesn’t require one in computer science to use cryptocurrency, though good general knowledge regarding this goes a long way.

4. Cryptocurrency is a Get Rich Scheme: 

This was true, emphasis on the past tense. When bitcoin exploded in value, there were a lot of overnight millionaires. However, like the dot com bubble, while everyone remembers the success stories that made a few people very rich with the majority being forgotten, the crypto bubble has done likewise. As such, while you may have a nest egg with the likes of Bitcoin or Ethereum, don’t expect to own a mansion in a month or two. While you might expect to do so with the newer cryptocurrencies, hoping for a repeat of Bitcoin, the fact is that the already established cryptocurrencies cast such a large shadow that unless they come up with a breakthrough and market it well, it’s unlikely that such an event would be repeated soon with the cryptocurrency market.

5. Cryptocurrency is too Expensive: 

This isn’t quite untrue as it can be argued that many are overvalued, often resulting in the yo-yoing effect with their prices. However, this doesn’t mean that they are unaffordable, as purchases, trading and selling of fractions is an option. Other than the largest and most expensive brands, there are smaller valued options, with many countries even releasing their own, in consideration of their own fiat currency’s value.

Cryptocurrencies don’t have any value: Value is subjective, so while many would argue this for fiat currency, the same can be argued for fiat currency. It has been half a century since the US left the gold standard, thereby ensuring that all of the world’s currencies whose values were based on it were now based on trust. As such, both fiat and cryptocurrency base their value on people believing in them.

Types of Cryptocurrencies

1. Bitcoin: 

The original cryptocurrency, Bitcoin is often synonymous to cryptocurrency for many. It was created by a person or people working under the pseudonym of Satoshi Nakamoto. It introduced many of the features and workings that are standard part and parcel among cryptocurrency. This security associated with Bitcoin has resulted in its explosive growth in recent years, making many of its owners overnight millionaires.

2. Ethereum: 

The first true alternative to Bitcoin, Ethereum refers to both the name of the cryptocurrency and the blockchain network that supports it. Outside of its role as a cryptocurrency, it also enables smart contracts and decentralised applications (dApps) to run without issues such as downtime or fraud. A major selling point of this is that it can be accessed directly without the traditional barriers of state identifications. Ethereum had moved from proof of work to proof of state consensus algorithm in December 2020, to reduce the energy consumption state and improve their transaction speed. However, the primary difference between this and Bitcoin is that Bitcoin still relies on the proof of work mechanism. In Ethereum, the network participants can “stake” their ether to the network. This secures the network and processes the transactions that occur, rewarding those involved with Ether, Ethereum’s platform-specific cryptographic token. In contrast, Bitcoin’s mechanism instead receives more bitcoins for processing transactions.

3. Litecoin: 

This is essentially Bitcoin lite and has actually been referred to as the silver to the gold of Bitcoin. It uses Scrypt as a Proof of Work which can be decoded with standard commercial grade computers with the main selling point of Litecoin is that it offers a faster transaction confirmation time.

4. Dogecoin: 

This was meant as a joke. However, it seems that either people were really invested in the joke or didn’t get it because apparently the price skyrocketed. At present, this cryptocurrency that was created as a commentary about speculation in the cryptocurrency market is now accepted as payment by many different companies, including those owned by Elon Musk. At present, it outstripped the market capital valuation of Litecoin, a cryptocurrency that was actually designed as a cryptocurrency. In a similar bout of irony, a memecoin Shiba Inu that was intended as a parody of the parody was actually valued higher than Dogecoin.

5. Binance Coin: 

This is the third largest cryptocurrency at the time of writing this by market capitalization. It acts as the payment method for the fees associated with trading on the Binance exchange. It also acts as the platform where Binance’s decentralised exchange operates. It was initially an ERC-20 token, that operated on Ethereum blockchain and after its launch, it uses Proof of State’s consensus model.

6. Tether: 

This is one of the first and most popular stablecoins in existence today. These stablecoins are a group of cryptocurrency that aim to fix their market value to an external reference point such as a pre-existing currency. The objective being to reduce volatility in its pricing , thereby attracting users that might otherwise have been turned away due to the volatility in pricing of other mainstream cryptocurrencies such as Bitcoin. This has led to it becoming the third largest cryptocurrency by market capitalisation. Its value is tied to that.

The Current and Future Trends that can be expected in Cryptocurrency

Cryptocurrency is a relatively new development. So to keep up with any new developments to follow, there must be accurate, logical predictions made on the various trends that are likely to follow in the future. These include:

1. Growth of DeFi (Decentralised financial) Services: 

These services refer to those that are based on secure distributed ledgers Ethereum was built on the DeFi protocol and with the growth of Ethereum in the cryptocurrency field, so too would DeFi.

2. Growth of Stablecoins: 

Stablecoins have been discussed before in relation to Tether. The advantages of such stablecoins has been discussed before, and it can be summarised as having the advantages of both cryptocurrency and fiat currency. As such, it;s growth is a near sure prediction.

3. Growth of Regulations for Cryptocurrency: 

Having a medium of exchange with no oversight or other forms of control may have been a major selling point of cryptocurrency, but practically speaking, it’s a security nightmare from both economic and legal point of view. Many government organisations have realised the same and as such, regulations have been set up to deal with this precisely. Quite fittingly, the first regulation that is set up in many countries tends to be related to taxes.

4. Introduction and Growth of IPOs for cryptocurrency: 

IPO (Initial Public Offerings) are quite often the way many new companies explode in capital and make their foothold into their economic stage at the national or global level. As such, with cryptocurrency companies and businesses trying to gain mainstream legitimacy, it is only a matter of time until they star introducing IPOs for their services.

5. Growth of NFTs being bought with Cryptocurrency: 

NFTs (Non Fungible Tokens) are the other half of the big applications that are associated with Blockchain services. As the first half is cryptocurrency, it was only a matter of time until someone came up with the idea of using cryptocurrency to pay for NFTs. As trading between different blockchains isn’t anything new, the fact that blockchains for both cryptocurrencies and NFTs can work together isn’t anything new.

Is Cryptocurrency for you?

Having discussed the points above, one fact must be stated again in summary. Similar y how you don’t need to be an economist to own stocks, you don’t need to be a Blockchain developer to own cryptocurrency. Ignorance is no excuse however, as it must be remembered that investments, regardless of whether it is made to stocks or cryptocurrency if done poorly can beggar the investor. As such, it must be ensured that if you’re serious about investing, make sure that you’re well informed. Outside of that, your expectations must also be clear in regard to what you can get by investing in cryptocurrency. It may be a nest egg for retirement or a source of side-income, but don’t expect to strike riches out of it. Cryptocurrencies tend to explode in value if any salesman who advertises it is to be trusted. However, it must be kept in mind that there are literally over a thousand different cryptocurrencies in circulation today, so trying to strike it rich on something that literally has a 1% chance of success is foolish. Instead of trying to treat it as a magic lamp, treat it with teh seriousness of stock trading where profits are rarely large and incomes are gained through small fractions of overall value.

So, don’t go for anything that terms itself as “the next bitcoin” seeing how there already is a bitcoin. Go for something like stablecoins or something that has some backing by a regulatory body with a good reputation. In the end, what you earn may not buy you a mansion, but it will pay the rent.

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