A cryptocurrency (or "crypto") is a form of digital money that allows individuals to convey value in a digital context. You may be wondering how this type of system is different from PayPal or the digital bank app you have on your smartphone. At first glance, they seem to serve the same use cases - paying friends, making purchases from websites - but in reality they couldn't be more different.
What makes cryptocurrency unique?Cryptocurrency is unique for many reasons. Its primary function, however, is to serve as an electronic money system not owned by any single participant. A valid cryptocurrency will be decentralized. There is no central bank or subset of users who can change rules without reaching consensus. Network participants (nodes) run software that connects them to other participants in order to share information with each other.
Centralized networks vs. decentralized.On the left, we find the structure used by institutions such as banks. Users must communicate via the central server. On the right, there is no hierarchy: the nodes are interconnected and transmit information to each other. The decentralization of cryptocurrency networks makes them highly resistant to closure or censorship. Conversely, to paralyze a centralized network, you just have to compromise the main server. If a bank's database is deleted and there are no backups, it will be very difficult to determine user balances. In cryptocurrencies, nodes keep a copy of the database. All effectively act as their own server. Individual nodes can go offline, but their peers will still be able to get information from the other nodes. Cryptocurrencies are therefore functional 24 hours a day, 365 days a year. They allow the transfer of value anywhere in the world without the intervention of intermediaries. For this reason we often refer to them as permissionless: anyone with an internet connection can transmit funds.
Why is it called cryptocurrency?The term "cryptocurrency" comes from the amalgamation of cryptography and currency, simply because cryptocurrency extensively uses cryptographic techniques to secure transactions between users.
What is public key cryptography?Public key cryptography is the foundation of cryptocurrency networks. It is what users rely on to send and receive funds. In a public key cryptographic system, there is a public key and a private key. A private key is essentially a very large number that is impossible to guess. It is often difficult to really understand how big this number is. For Bitcoin, guessing a private key is just as likely as guessing 256 heads or tails in a row. With current computers, you would not be able to decipher the sentence before the thermal death of the universe. However, as the name suggests, you need to keep your private key secret. From this key you can generate a public one. The public key can be safely distributed to anyone. It is virtually impossible to trace the private key starting from the public one. You can also create digital signatures by signing data with your private key. It is similar to signing a document in the real world. The main difference is that anyone can tell for sure if a signature is valid by comparing it to the corresponding public key. In this way, the user does not have to reveal his private key, but can still demonstrate ownership. In cryptocurrencies, you can only spend your funds if you have the corresponding private key. When you make a transaction, you are announcing to the network that you want to move your coins. This happens through a message (i.e., the transaction) that is signed and added to the cryptocurrency database (the blockchain). As we already mentioned, you need your private key to create the digital signature, and since anyone can see the database, everyone can check that the transaction is valid by verifying the signature.
Who Invented Cryptocurrency?There have been some attempts at digital money schemes over the years, but the first of the cryptocurrencies was Bitcoin, released in 2009. It was created by a person or group of people under the pseudonym Satoshi Nakamoto. To this day, his (or their) true identity remains unknown. Bitcoin has spawned a large number of successive cryptocurrencies - some with the aim of competing, others aimed at integrating functions not available in Bitcoin. Currently, many blockchains not only allow users to send and receive funds, but also to run decentralized applications using smart contracts. Ethereum is perhaps the most popular example of such a blockchain. At first glance, cryptocurrencies and tokens appear identical. Both are traded on exchanges and can be sent between blockchain addresses. Cryptocurrencies are designed solely to serve as money, whether it is a medium of exchange, a store of value, or both. Each unit is functionally fungible, meaning one coin has the same value as any other. Bitcoin and other cryptocurrencies created in the early days were designed as currencies, but newer blockchains aim to do more. Ethereum, for example, doesn't just provide coin functionality. It allows developers to execute code (smart contracts) on a distributed network, and to create tokens for a variety of decentralized applications. Tokens can be used as cryptocurrencies, but they are more flexible. You can issue millions of identical tokens, or a small number with unique properties. They can have many functions, from digital receipts representing a stake in a company to loyalty points. On a protocol that supports smart contracts, the base currency (used to pay for transactions or applications) is separate from its tokens. In Ethereum, for example, the native currency is ether (ETH), and must be used to create and transfer tokens within the Ethereum network. These tokens are implemented according to standards such as ERC-20 or ERC-721.
What is a crypto wallet?Essentially, a cryptocurrency wallet is something that holds your private keys. It can be a specially built device (a hardware wallet), an application on your PC or smartphone, or even a piece of paper. Wallets are the interface on which most users rely to interact with a cryptocurrency network. Different types will offer different types of functionality - evidently, a paper wallet cannot sign transactions or view current prices in fiat currencies. For convenience, software wallets (e.g., Trust Wallets) are considered superior for daily payments. For security, hardware wallets are virtually unbeatable in their ability to keep private keys out of prying eyes. Cryptocurrency users tend to hold funds in both types of wallets.
What is a blockchain?A blockchain is a special type of database where data can only be added (and not removed or changed). Transactions are periodically added to a blockchain within what we call blocks (consisting of transaction information and other important metadata). We call the structure a chain as the metadata of each block includes a piece of information that links it to the previous one. Specifically, they include a hash of the previous block, which you can imagine as a unique fingerprint. The probability of two sets of data producing the same output through a hash function is infinitesimally low. For this reason, if someone tries to modify an older block, its hash would be different, so the hash of the next block would also be different, and so on. It is therefore evident when a block is modified, as all the blocks that come after it should also be modified.
The hash of each block is included in the next block, forming the blockchain, or blockchain.The blockchain is downloaded in full by the network participants. Remember when we said that anyone can validate transactions and signatures with public key cryptography? When a node receives a lock, it performs a series of checks. If it finds anything invalid, the block is rejected. When a node receives a valid block, it creates its own copy, then propagates the block to other nodes. They do the same thing until the block has been distributed across the entire network. This process is also done for unconfirmed transactions - that is, transactions that have been transmitted, but not yet included in the blockchain. See also: What is Blockchain Technology? The Ultimate Guide.
How are blocks added to a blockchain? The integrity of a blockchain is compromised if it is possible to record false financial information. At the same time, there are no administrators or leaders in the distributed system that keeps the ledger - so how can we ensure that participants act honestly? Satoshi has proposed a Proof of Work system, which allows anyone to suggest a block to add to the blockchain. To propose a block, users must sacrifice computational power in order to guess a puzzle defined by the protocol. The Proof-of-Work is the most proven and effective scheme for reaching consensus among users, but it is not the only one. Alternatives such as Proof-of-Stake are being explored more and more, even if they have not reached an appropriate implementation in their true form (despite the fact that hybrid consensus mechanisms have existed for some time). See also: What is a Blockchain Consensus Algorithm?
How does crypto mining work?The process we have described above is known as mining. If the miner finds a solution, the block he built will extend the chain. As a result, he will receive a reward denominated in the blockchain's native currency. The cryptographic puzzle miners must solve involves hashing data repeatedly to produce a number that falls below a particular value. Hashing with a one-way function means that, knowing the output, it is virtually impossible to guess the input. However, knowing the input, it is very easy to check the output. In this way, each participant can verify that the miner has produced a 'correct' block, and reject the invalid ones. In this case, the miner receives no reward and has wasted resources trying to forge an invalid block. The result is an interesting game theory scheme that makes it costly for a subject to attempt to deceive, but profitable to act honestly. No malicious entity has the resources to endlessly attack a strong network. We therefore expect resourceful traders to seek a profit on their investment by participating correctly. See also: What is Cryptocurrency Mining?
Are cryptocurrencies scalable?As you have probably noticed, distributed networks are not very efficient. Unfortunately, cryptocurrencies can be safe and resistant to censorship if all nodes manage to synchronize a copy of the blockchain. The lower the requirements to keep up, the easier it will be to participate. You can understand why a blockchain that adds only a small block every ten minutes is preferable for this purpose over one that adds a huge block every five minutes. The latter will require nodes to use very powerful computers to stay synchronized, pushing the less performing ones offline. This would result in more centralization, as there are fewer peers in the network. With smaller blocks, however, we cannot achieve many transactions per second (TPS). This also means that, in busy periods, transactions can take some time to add to the blockchain. It's not practical if you want to make a quick payment, but it's the price to pay for decentralization. We call this a scalability dilemma. A scalable system can easily adapt to higher throughput with minimal disadvantages. Blockchains are not very scalable - as we have explained, simply increasing capacity with larger blocks compromises the entire purpose of the distributed network. To increase TPS in a way that doesn't harm network decentralization, off-chain scaling appears to be a good approach. This includes a wide range of solutions - centralized and decentralized - that allow transactions to be carried out without recording them on the blockchain. Learn more about some examples of off-chain scalability: Blockchain Scalability - Sidechain and Payment Channels.
Who Makes the Decisions for Cryptocurrency Software? Cryptocurrency networks are opt-in. Nobody forces you to run software you don't want to use. In a good protocol, the code will be entirely open-source so that users can be sure of the correctness and security of the system. Generally, cryptocurrencies allow anyone to participate in their development. New features or code changes are checked by a community of developers before they are approved and published. After that, users can personally check the code and decide whether to run it or not. Some updates will be backwards compatible, meaning that updated nodes will continue to communicate with older ones. Others will be incompatible - older nodes will be "kicked" from the network if they are not updated. Read Hard Fork and Soft Fork for an explanation on this topic.
Where to buy cryptocurrenciesThere are various ways to buy cryptocurrencies. The first thing you will need to do, however, is to convert your fiat currency into cryptocurrency. After that, you can decide between HODL, trade with other cryptocurrencies or lend it and earn interest. Let's take a look at the different types of cryptocurrency exchanges.
Centralized Exchanges (CEX)You may find the concept of centralized exchange a bit strange given that cryptocurrencies are often referred to as decentralized. In short, centralized exchanges are online platforms that facilitate transactions by connecting buyers and sellers.
It works like this, users deposit funds in fiat or cryptocurrencies on the exchange and trade on its internal systems. If you are familiar with how cryptocurrency wallets work, you will know that, in this case, your cryptocurrency is in the custody of the exchange. However, it should be pretty easy to withdraw your funds and store them in your own wallet if you wish. Some may prefer to keep their funds on the exchange, either because they trade regularly or for convenience. However, if the exchange is hacked, the user's funds could be at risk.
Decentralized Exchanges (DEX)Decentralized exchanges are different. When you are using a DEX, there are no custodians involved. In fact, a more accurate way to refer to this type of exchange would be non-custodial exchanges. This is what happens when you trade a DEX. Instead of depositing your funds into the exchange's wallet, you are trading directly from your wallet. When an operation is performed, the funds are transmitted directly to the blockchain using the magic of smart contracts. Since there is no entity acting as a custodian, some consider this category to be a safer choice than the CEX. Another positive aspect could be that most DEXs do not require you to provide any personal information other than the address of a blockchain wallet. At the same time, taking custody of your funds requires a certain amount of technical experience, and it means taking on all the responsibilities.
Exchange P2PA peer-to-peer (P2P) exchange is another space that connects buyers and sellers, but it is different from both CEX and DEX. In this case, the exchange itself does nothing but connect buyers and sellers, who can settle the transaction in any agreed way. Hence, the deposit and settlement method can be chosen by buyers and sellers for each individual transaction.
Is cryptocurrency legal?Very few countries impose an outright ban on the purchase, sale and possession of cryptocurrencies. In the vast majority of the world, Bitcoin and other virtual currencies are perfectly legal. Before starting, however, you should check if your jurisdiction allows it. It is important to remember that each country has a different approach to the regulation of cryptocurrency assets. Make sure you are not violating any rules regarding taxation or compliance.
Is cryptocurrency safe?There is a certain degree of risk associated with cryptocurrency. If you forget the password to log into your bank account, you can simply reset it through customer support. Instead, if you forget or lose the private keys that guarantee access to your crypto, there is no one who can help you. Using a reputable exchange may be a more forgiving option - it requires trust, but you are not at risk of losing your private keys. Public key cryptography has not yet been breached. With good security measures, your other online accounts are more likely to be hacked before your funds are stolen. Best practices include learning about common scams (social engineering, phishing, etc.), keeping your private keys offline at all times, and backing them up to keep them in a safe place.
Is cryptocurrency anonymous? Your name is not linked to your cryptocurrency addresses - these appear as random strings of numbers and letters on the blockchain. However, it is not safe to assume that this makes you anonymous. Actually, you're a pseudonym - you still have some sort of on-chain identity, it's just not what you use in real life. There are certain methods that can allow you to link IP addresses to your activities. On this front, things like dusting attacks and other analysis techniques can be used to de-anonymize you. Remember that blockchains are essentially huge public databases. If you are concerned about your privacy, you should try to make it as difficult as possible for others to link your transactions to your name. Cryptocurrencies such as Bitcoin are not private by default, but methods such as coin mixing and CoinJoins can make heuristic analysis unreliable. A small subset of cryptocurrencies (known as privacy coins) are able to obfuscate the source, destination and amount of funds in transactions, using methods such as Confidential Transactions. Their privacy is stronger by default, but they are not entirely resistant to deanonymization.
Does cryptocurrency have value?In financial systems, value is a shared belief. Just like anything valuable, value isn't inherent in the cryptocurrency itself - it's assigned by people. In other words, something has value if people believe it has value. This is true regardless of whether the valuable object is a precious metal, a piece of paper or some bits in a database. That said, some view cryptocurrencies and Bitcoin as something like a limited digital product. Thanks to the predictable issuance rate and monetary policy, some argue that in the future Bitcoin could act as a store of value, similar to gold. Given that Bitcoin has been in existence for just over a decade, it still remains to be seen whether it will stand the test of time in that regard.
Are all digital currencies cryptocurrencies?No. You may have heard of nations and central banks planning to create their own versions of a digital currency. However, they are none other than that - digital currencies. In fact, they are often collectively referred to as central bank digital currencies (CBDCs), or central bank digital currencies. They are essentially digital versions of fiat money and do not have much of the benefits of cryptocurrencies. They are issued and declared legal tender by a central government and typically do not use a distributed ledger, such as the blockchain, to maintain a record of transactions. You may have also heard of Facebook Libra, another type of digital currency. On the positive side, it is expected to be developed on an open source blockchain system. However, it wouldn't be permissionless like Bitcoin or Ethereum, so attendees would need more than just an internet connection to use it. In addition, the project and the activity carried out on it would be carried out and managed by an association made up of a few selected members. So while CBDCs and other forms of digital money make use of blockchain or cryptography, they are very different from cryptocurrencies like Bitcoin.
What is the market capitalization of a cryptocurrency?When you look at the price of a cryptocurrency, you only see part of the big picture. An equally important criterion is the number of individual units of the cryptocurrency in existence, i.e. supply. Specifically, to examine the valuation of a cryptocurrency network, you need to know how many individual units exist right now. This figure is called the outstanding supply. Different cryptocurrencies may adopt different issuance schemes, so it's important to understand how this works for each network. Market capitalization (or market cap) is the price of a single unit multiplied by the supply in circulation.
Market Capitalization = Outstanding Supply * PriceAs you can imagine, the market capitalization of a cryptocurrency network is a more accurate representation of the value within the network than the price of a single unit. A network with a cheaper coin but a higher supply in circulation might have a higher total valuation (market cap) than a network with a more expensive coin but a lower supply in circulation. In some cases, the reverse may also be true. It is important to note, however, that market capitalization does not represent how much money has entered a particular market. For example, it is a common mistake among beginners to assume that the Bitcoin market cap represents the total amount of money invested in Bitcoin. This does not make sense as the market cap depends on price and supply.
Why do I have to pay transaction fees?If you send a bitcoin to another address, you will notice that the address receives a little less than the one you sent. This is because you pay a small fee to reward miners who add your transaction to the blockchain. Many cryptocurrencies use a similar mechanism to incentivize users to protect the network. In Proof of Work systems, transaction fees are usually distributed alongside newly created coins (the block subsidy) to form the block reward. You can change the commission based on the urgency of your transaction. Rational miners will always try to earn as much as possible, so they will prioritize transactions with the highest fees. You can check the current pending transactions to get an idea of the average commission, and set yours accordingly.
I lost my key. Can I get my funds back?If you are sure that you have lost your keys, chances are you will never get them back. The big advantage of cryptocurrencies is the removal of custodians and intermediaries from managing financial transactions. The downside, however, is that the responsibility is now entirely in your hands. So you have to be very careful not to lose your private keys, as they are what assign ownership over your funds.
What is the future of cryptocurrency?How the future of cryptocurrency will look depends entirely on the person you ask this question to. Some believe that Bitcoin will come to replace gold in the digital age and revolutionize the existing financial system. Others argue that cryptocurrencies will always be a secondary system, present as a niche market. Still others believe that Ethereum will become a distributed computer, serving as the backbone of a new internet. Skeptics predict the industry will eventually collapse, while enthusiasts are happy with cryptocurrencies as niche money systems. There are many possible outcomes - it is simply too early to say for sure what will happen in a year's time. Despite this, we cannot deny the enormous growth potential.