A Brief Overview of Cryptocurrency
How cryptocurrencies work (part 1)
When you do not know what cryptocurrency actually is, it sounds like quite an abstract, intangible concept. However, cryptocurrency is simply a digital version of our regular ‘fiat’ physical currency, which operates as a store of value and aims to be used for buying and selling products and services. You may not be able to hold cryptos in your hand, but they aim to mirror the functions of the more traditional money that we currently use. However, at the moment, cryptocurrencies are still somewhat in their infancy and have not been completely accepted as a payment method. Although they are gradually being adopted by various companies, they are currently used more as an investment than anything else.
These coins are essentially ‘minted’ like regular coins, but instead of being created in a factory, they are made by people who work on the network looking after transactions by a process known as mining. These miners are rewarded in coins that are then placed into circulation. Blockchain and mining will be explained more in later entries, but a quick overview is useful in providing some overall context first.
It may seem complicated to define the currency clearly, but let us briefly look at how cryptocurrencies work. The ‘crypto’ element of the word means ‘secret’ or ‘hidden.’ This means that transactions conducted with cryptocurrencies are secured through coded messages, ensuring that only the two parties involved in buying or selling are privy to the information. This means that the data involved in the transactions are hidden from those outside of the transaction. The information such as the amount of currency and ownership details are then protected from ominous eyes. This is called ‘encryption’ and protects users from malicious people intervening in your transactions.
When you purchase a currency, you will need to send it to your own public address or wallet to store your funds. In order to send it from the exchange that you purchase it on to your own wallet, you will need your own private key to open your own wallet to gain access to your funds. This transaction means that you need your funds and information to be sent securely through encrypted data so that it cannot be stolen from you.
For these transactions to happen successfully, the information needs to flow easily through a network. This is where the key feature of cryptocurrencies regarding their communication system comes into play.
Decentralization is a key component necessary to understand the system that cryptocurrencies use. Although this is not unique to cryptocurrencies, as it is employed by several different financial institutions, it is a powerful feature that has contributed to its success. This is a shared network, which allows anyone who wishes to see anonymous transactions taking place. Now, this is where it gets tricky. This shared network is a database of all transactions that have ever occurred with a currency (anonymously, of course) stored in multiple places. This means that all the information on this database is extremely secure, as they are not simply stored in one place and are visible and open to scrutiny from anyone with access to the network.
The people on this network do not need to be located in the same place, and as many of them are miners, they may not even be located in the same country. As we will see later, multiple users, including miners, are the auditors that use this system and are responsible for organizing and maintaining this fast and efficient transaction database.
Public and Private Keys
These are protected with keys. Your public key is your address to your wallet and is how you can receive and store your coins. For you to gain access to your funds, you need a private key. This is coupled with your public key and is essentially proof of ownership. However, if anyone ever obtains your private key information, they will be able to interfere with your funds or even potentially steal them. This is why keeping them secure is of vital importance. Simply put, when you buy cryptocurrencies, you have an address that money is sent to, nobody else can tell it is your address, and for you to gain access to your own address, you need to store a special key to open your account, which proves your ownership.
Simply put, it’s like collecting an item from a PO box. Only you have the key to open it and get your package, but your box, although in plain view, cannot be gotten without your key. A clumsy analogy, perhaps, but it hopefully makes the concept easier to understand.
If you decide to invest, whatever you do, never lose your private key. Do not store it online or anywhere that can be hacked either. Simply write your key on several bits of paper and hide them in several locations to ensure that you can find them. Over the years, there have been many stories of investors losing their private keys and being unable to get at their funds, in a few cases now worth several million. Once your private key is gone, so too is your access to your money.
The Different Types of Cryptocurrency
Not all cryptocurrencies are the same, and many of them have different functions. These are some of the different terms that you may hear from time to time used to describe them.
A coin is a single unit of a currency. You can purchase a single coin or a percentage of one. These are the more ‘traditional’ forms of cryptocurrencies that aim to replace or co-exist with currencies such as Bitcoin.
These are coins such as Tether that are useful as tools for making purchases on certain exchanges quickly that may not directly accept fiat currencies. They are closely linked to the value of a fiat currency, such as the dollar, which is more useful than an investment. For example, you may wish to buy Ether or another currency in exchange. The exchange may not allow you to fund your account with dollars. Instead, you may purchase Tether on another exchange and transfer it into your account to buy what you wish. Alternatively, you can keep Tether in your wallet to purchase a currency at an exact price, and this can be easier to do with a crypto already at hand. This can also help investors save fees as using a stablecoin generally costs less.
It is thought by some that the future of cryptocurrencies lies with stablecoins as opposed to the others as they can co-exist successfully with fiat currencies. They are not directly a threat to them either as they rely on them for their intrinsic value, which could mean that traditional institutions may eventually support them.
A regular token is a digital currency that represents a specific use. Tokes have multiple purposes and use and are often related to specific needs, such as purchasing a certain service online. However, a token relies on a cryptocurrency to exist and have value, which is not reciprocated from crypto.
NFTs or Non-Fungible Tokens are quite an abstract concept to wrap your head around. Technically these are anything from artwork to video footage stored digitally and deemed to hold value. These are separate stores of value, usually some form of collector’s item, limited in production that can be created and stored online. Ether is a key contributor to the production of NFTs.
Altcoins are simply any other coin than Bitcoin, as it has dominated the market since the inception of cryptocurrencies. Some of the most popular ‘altcoins’ include Ether, Ripple, Tether, Bitcoin Cash, and Litecoin, which have grown in support and value over recent years.
About the author
Hailing from Dublin, Ireland, Caroline has a variety of published fiction and non-fiction, written in a wry style on all things nerdy and neurotic. Her collection of essays Fahckmylife: The Little Book of Fahck, is available on Amazon.