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Cryptocurrency: An Introduction

Cryptocurrency: an introduction

While cryptocurrencies have fallen out of grace with the mainstream, they are far from dead. The hype has died down quite a lot, but that doesn’t mean they aren’t being traded anymore.  Now might even be a good time to talk about it, with no bias or hype, in the eleventh year since it’s creation.

11 years

Cryptocurrencies as they exist now, started with the release of a paper in November 2008. Authored by a person or group going by the name Satoshi Nakamoto, it has come a long way since then. Trading in bitcoin or one out of the hundreds of variants created ever since, is easier than ever.

11 years later, while having heard or read topics on bitcoin or cryptocurrencies, few really know how they work and why they’re important.
In the next paragraphs, you will get a brief look into its history, how and what you need to trade them and the pitfalls that come with trading on a cryptocurrency exchange.

What is cryptocurrency?

In its basic form, a cryptocurrency, which is short for cryptographic currency, allows users to transfer money from person-to-person without an intermediary and low transaction fees.
The crypto part in the name “cryptocurrency” comes from the fact that transactions are encrypted for security. This process is known as “cryptography”. Software uses cryptography for two reasons:

  1. Protect transactions from being tampered with
  2. Protecting the identity of parties acting in a transaction

A brief history: where did cryptocurrency come from

The early days

In the early 1980’s, the American cryptographer D. Chaum wrote a paper about untraceable payments using blind signatures. Later, in 1990 Chaum and two Israeli computer scientists: A. Fiat and M. Naor created anonymous, cryptographic, online money called ecash) that used this principle. A year before publishing that paper, Chaum started the company digicash. His company allowed a secure and private means of paying online like cash in the physical world through ecash.

Rise of e-money

Despite raising enough funds to start, Digicash could never take off and the company filed for Chapter 11, i.e., bankruptcy in November 1998.

Even though ecash didn’t take off, in the same year Digicash failed, a person by the name of W. Dai created b-money. In the same period, a computer scientist, legal scholar, and cryptographer N. Szabo imagined bit gold. These alternatives never found widespread support either.

The cryptocoin scene stayed quiet until in 2008 a person or group of people going by the name S. Nakamoto published a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System”.

Exponential growth

In the next years, bitcoin grew to become the biggest cryptocurrency available on the cryptocurrency market which it started.
Following bitcoin, hundreds of other cryptocurrencies followed. These other cryptocurrencies  are what we now call altcoins.

Most of these altcoins are simple copies of bitcoin while others like Namecoin tried to decentralize DNS or use scrypt as its hash function instead of SHA-256 like Litecoin.

More notable altcoins can be found in the list further below.

The technology behind: Blockchain

First and foremost, some of you might think blockchain is Bitcoin, it’s not. Bitcoin or any other cryptocurrency is not blockchain. They are not the same. Bitcoin uses the concept of the blockchain and it is the technology behind almost all cryptocurrencies. Because it is the underlying technology, it’s important the concept is understood.

Blockchain tries to remove the trusted third party that serves as an intermediary between two parties that wish to transfer money.

In order to remove this third party, blockchain uses three concepts: Open ledger, Distribution, and synchronization.

3 principals

First principle: The open Ledger

An open ledger is a chain of transaction data (known as a “block“) which is available for everyone. For example, four people (or “nodes“) wish to transact with each other: A, B, C, D. Assume in the beginning A has 10 USD (the “genesis block“) and A wants to move 5 USD to B.

We will add this transaction to a ledger that keeps track of all the transactions done: A moves to B, 5 USD. This transaction or block will be chained to the ledger. Next, B wants to move 3 USD to C. Again, this transaction will be added to the ledger. Finally, D moves 1 USD to C. Once more, this transaction will get linked to the transaction ledger. These simple transactions and the action of adding them to a ledger is the basic idea of the open ledger. It gives that everyone can see who has money and where it was moved to.

Subsequently, if A wants to move 15 USD to C, everyone will immediately see that A cannot do this transaction. So, it will not get added to the ledger, the block won’t be part of the chain.

Using the above example, we have one centralized ledger, but we want to move away from centralization. This next step introduces the principle of distribution or decentralization.

Second principle: Distributed

A distributed open ledger is the second principle. The chain will take the centralized ledger of the example and distribute it across the network.

Each node in the network holds an exact copy of this ledger. This removes the centralized ledger and makes it distributed and thus decentralized. However, this introduces a problem. All the copies of the ledger need to be synchronized. All the nodes in the network need to have the same version to make sure that a transaction from one node to another can happen correctly.

Third principle: Synchronization

To synchronize the chain over the network the previous example can be used again. From the previously used nodes, B wants to move 5 USD to C. Before this can happen, this intended transaction gets broadcasted across the network. All the participants will see this unvalidated transaction. In other, for this transaction to get validated and executed miners are introduced.

Miners

These miners will compete amongst themselves who will be the first to take the unvalidated transaction and validate it and put it into the ledger. The first miner that does it, will get a financial reward for its effort. In case of the bitcoin implementation, it will be bitcoins.

For the miner to validate it, it needs to do two things.  First, it needs to validate that the person can send the money. This is easy because the ledger is openly available.

The second part is for the node to create a key, a hash. To find this key, the miner needs to invest computational power and time, because this search for the key is random. The miner is constantly searching till it finds the key. The first one that does it, gets the reward.

Assuming person D was able to validate the transaction. He will send the transaction to the network. All the other nodes will see that the transaction has been done. It will thus add it to its ledger. Since this transaction was done, it will search for a new transaction to execute.

The rise of altcoins

After Bitcoin surged in value, various alternatives popped up trying to replicate its success by being different. Bitcoin might have been the first, but that doesn’t mean it was perfect. It has some downsides that hinder its practical use. This was (some) altcoins try to fix or at least improve. One of these downsides is, for example, the number of bitcoins there are available. For bitcoin, the supply limit is set at ₿21,000,000.

Many cryptocurrencies have been attempting to follow bitcoin’s rise to fame, albeit with varying degree of success. At the time of writing the site, coinmarketcap has registered over 1300 altcoins [ref]https://coinmarketcap.com/all/views/all/[/ref]. This market of altcoins doesn’t seem to be slowing down. While most altcoins are merely a copy of bitcoin (with very few modifications or improvements), others are attempting to do new things with the underlying blockchain technology or try to use something different but inspired by blockchain.

Some altcoins, like Ethereum, have been using the blockchain to allow the development of decentralized applications where the data is held by every user of the blockchain instead of a single server. Others, like Monero, have put their focus on anonymity, building on the cryptography used by the bitcoin blockchain to further obscure recipient and sender wallet addresses.

A list of popular altcoins:

  • Ether (ETH): Usually referred to by its platform, Ethereum, Ether’s marketed as a “next-generation” currency allowing for “smart contract” exchanges without a middleman.
  • Litecoin (LTC): Announced in 2011, Litecoin is most similar to bitcoin but with one of the highest market caps among cryptocurrencies.
  • Dogecoin (DOGE): Founded on the “doge” meme, Dogecoin has since gained traction for targeted donations and online tipping.
  • Monero (XMR): Focused on privacy, Monero claims it’s “secure, private and untraceable” through a multilayered signature process.
  • Dash (DASH): Named for “digital cash”, Dash focuses on speed and privacy with the ability to spend it through debit cards accepted worldwide.
  • Ripple (XRP): Integrated with the Earthport blockchain, Ripple can now be used for services with select banks that include Bank of America and HSBC.
  • Tether (USDT): Introduced in 2014, this currency is “tethered” to the US dollar, offering a more stable value for traders.
  • And many more …

Before you start trading

Cryptocurrencies are not without their pitfalls and you will need to be careful when trading your digital currency to avoid losing everything you invested in it.

Research

Like with any investment that involves risk, research is needed. No guide or training will ever be able to cover everything you need to know about all cryptocurrencies. There are hundreds of coins, which makes covering all of them in article or page impossible. Each cryptocurrency has its own pros and cons which need to be investigated. Additionally, you will need to understand how exchanges and wallets work. So, before trading can start, make sure you read as many guides as you can, find reviews, and try everything out with small, disposable amounts of money.

Stay safe

There is no safety net when working with cryptocurrencies. There are no police to make a report to if your money gets stolen, there is no bank to protect your money. With the freedom to do whatever you want with your own money anonymously comes a lot of responsibility. Here are a few tips:

  • Before you send cryptocurrency to someone, always double check their wallet address.
  • Never hand over products or services before the transaction on the blockchain is verified. This might take up to ten minutes on some blockchains.
  • Always keep the computer on which your wallet is installed safe and clean from viruses and malware.
  • Never lose your wallet password. If you lose the password to your crypto wallet it’s not possible to recover any cryptocurrency you own. All of it will be lost.

Unpredictable value

Bitcoin and cryptocurrencies in general often suffer from sudden dips in value. Whenever investing in cryptocurrencies, always be aware that the value of your investment can fall just like any other investment.

Of course, these huge fluctuations can work in your favor if it goes the other way around instead. However, always be aware that the cryptocurrency market is extremely volatile and past performance are no guarantee of future performance.

What do you need to get started

Setting your first baby steps in the world of cryptocurrency trading is not difficult. With a little research, you will be ready to go in no time. So what do you need?

Choose a cryptocurrency

There are over 800 cryptocurrencies at the time of writing (October 2017). These cryptocurrencies all have their own specific set of advantages and disadvantages. Choosing the cryptocurrency that’s right for you involves some research. Luckily, we’re here to help.

Check out our altcoin page for guides on some of the most commonly traded cryptocurrencies on the market today.

Get a wallet

Now that you’ve chosen a cryptocurrency, it’s time to get yourself a wallet. A wallet is your gateway into the blockchain, a piece of software that lets you connect to the blockchain, send and receive cryptocoins, and view your balance. Several types exist and choosing the right one for your needs involves a lot of trial and error. Start by downloading your cryptocurrency’s official wallet and going from there once you have some experience.

Buy from an exchange

Next, it’s time to fill your wallet with some coins. Just like regular currencies, you’ll need an exchange to convert fiat currency (such as USD, AUD or EUR) to your chosen cryptocurrency. Make sure you choose a reliable and secure exchange.

After exchanging fiat currency to cryptocurrency, simply transfer the coins to your software wallet and you’re ready to go!

Buying and selling using cryptocurrency exchanges

There is a multitude of cryptoexchanges available to trade cryptocurrencies.

One of the more simple and clear ones is Coinbase.

It gives you the possibility to buy and hold various popular cryptocurrencies. Coinbase has a solid track record and have a large customer base. It can always go wrong so it’s best not to invest too much in one single exchange. With this info you can get started, however, you must perform your own due diligence.

Note that this information is subject to change. In case the information provided is outdated, the table will get updated. If the info has not been updated, please contact me.

Where and How can I use cryptocurrencies?

There are already thousands of smaller businesses and some larger companies that accept bitcoins. There are various uses for bitcoin and to a lesser degree the numerous altcoins available. The following ways are the more common uses for cryptocurrencies:

  • Purchase products or services

The most common use for cryptocurrencies is as an alternative to regular currencies when purchasing products or services online. Several merchants accept at least bitcoin as a means of payment. Even a couple of big name brands have given customers the facility to pay with bitcoin for several products.
Some “traditional” brick-and-mortar shops have accepted cryptocurrencies as payment. Most of these shops have QR codes printed and pinned next to their traditional cash tills, customers then scan these QR codes to execute cryptocurrency payments (again, with bitcoin).

  • Money transfers and cryptocurrency tipping

The next most common use for cryptocurrencies is as a way of transferring money and tipping. If, for example, you owe money to a friend, and both of you have an Ethereum wallet, why not transfer the money in ETH coin instead of cash? It would help the Ethereum cryptocurrency grow, might prove to be a good investment for your friend, and the transfer is instantaneous with a minimal transaction fee.
On top of that, some cryptocurrencies have built tipping platforms for themselves (e.g. Dogecoin). Users of these cryptocurrencies tip each other with coins for entertaining or informative posts on Reddit, Twitter, and other social media.

  • Get paid in cryptocurrency

If you’re a goods or services provider, It is already possible to get paid in cryptocurrency. Offering your customers a different way to pay benefits your business in different ways. It opens you up to a wider market, some people might not be comfortable purchasing your products or services using traditional payment methods, or they might live in a country that does not allow such payments. Besides serving as a payment method, these cryptocurrencies in your wallet can also serve as an investment.

  • Investment opportunities

Using cryptocurrencies to diversify is a good option, keeping in mind that the cryptocurrency market is very volatile.
Some investors have seen the opportunity to make money by buying cryptocurrencies when they’re cheap and selling them when they’ve skyrocketed in price months or years later. This is a risky exercise as the market is unpredictable, and as stated earlier, past performances do not guarantee future gains. A few investors have made exceptional gains from investing in cryptocurrencies, primarily Bitcoin, which has gone from costing around $1,000/BTC at the start of 2017 to almost $14,000/BTC at the end of 2017.
Realize this is the most volatile alternative investment method out there. If, after reading about cryptocurrencies, you do not feel comfortable trading in cryptocurrencies such as bitcoin it is possible to trade in still relatively volatile markets compared to cryptocurrencies but with normal (“fiat”) money such as the euro and dollar.

The future of crypto

Cryptocurrency has evolved dramatically over the course of just a decade. This rapid progress and decline of its popularity means that it’s impossible to predict what the future holds.
A lot of the questions that originally popped up during the rise of Bitcoin, and later hundreds of altcoins, remain unanswered. Like, is it useful or can it be made useful such as making more secure? Will cryptocurrencies keep growing or will its market cap implode?

In an article by investopedia:

Harvard University Professor of Economics and Public Policy Kenneth Rogoff suggests that the “overwhelming sentiment” among crypto advocates is that the total “market capitalisation of cryptocurrencies could explode over the next five years, rising to $5-10 [trillion].” (Barone, 2019)

Time will tell if this was just a hype or it is strong enough to grow strong roots and remain for decades to come.

Sources:

Mr. FightToFIRE
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