I remember the first time I stumbled upon the term Bitcoin in late 2017. I think many of you can relate to this. It was the talk of the town back then. It sounded fancy sure, but what exactly it is? How does it work? Does it even have any real value or just a gimmick? Should I invest my money in it, and if yes, how? So many questions left me puzzled. I spent hours to understand the fundamental concepts, and they slowly started to make sense. The first thing that amazed me is that Bitcoin is just one cryptocurrency. There are thousands of other coins, and tokens out there like Bitcoin each having its unique properties and use cases. Once you start exploring more, you will come across many other concepts like Blockchain, Mining, Staking, and many more. While these are some revolutionary technology, they are hard concepts to grasp. So, in this article, I will try to present the complex crypto concepts in an easy-to-understand way, so that you know exactly what to do. So, let’s jump in.
What is Cryptocurrency?
Cryptocurrency, often referred to as Crypto, is like any other regular currency except they are entirely digital. So, every individual crypto coin or token is made of letters and numbers at its core.
You must have seen the serial number consisting of letters and numbers printed on a physical currency note. Every currency on this planet has a unique serial number. Each cryptocurrency is just like the serial number printed on a physical bill, just without the physical bill, in digital/virtual form. While a physical currency is regulated by the central bank and the government, there is no such governing authority in the case of cryptocurrency. Just like each dollar can be split into 100 cents, cryptocurrencies can be divided into smaller units. For example, each Bitcoin can be divided into 100 million satoshis.
Cryptocurrency vs Regular Currency
While both cryptocurrency and regular government-issued currency (fiat money) can be used as a medium of exchange, they have some fundamental differences.
- Cryptocurrency can only exist in digital form while regular currency can exist in both physical and digital form.
- Fiat money is managed by a central authority like banks and the government, while Cryptocurrency exists on a blockchain with no central authority.
- Fiat money has an unlimited supply. Government can print money whenever they wish, thereby devaluing the money and raising inflation. In contrast, most cryptocurrency has a limited supply. For example, the total number of Bitcoin that can ever be created is 21 million.
- Government and banks can monitor your account, shut down accounts or block transactions with regular currency. However, in the case of cryptocurrency, you have full ownership of your wallet. So, nobody can block your transaction.
Are Central Bank Digital Currencies (CBDC) Same as Cryptocurrency?
No, The Central Bank Digital Currency (CBDC) like a digital dollar, euro, pound, or yuan is very different from a cryptocurrency. Central Bank Digital Currencies are digital versions of a country’s physical currency managed by the government and central bank. Whereas Cryptocurrency is a decentralized digital asset that exists on a blockchain without any central authority.
How Many Cryptocurrencies are Out There?
You might have heard about popular coins like Bitcoin, Dogecoin, Ethereum, and a few others. But these are just the tip of the iceberg. There are many more cryptocurrencies out there. Similar to how there are many different regular currencies e.g. Dollar, Euro, Rupee, Shilling, Yuan, etc, there are thousands of cryptocurrencies. Today, there are over 20,000 cryptocurrencies in circulation, each having its unique characteristics and use cases.
What are the Types of Cryptocurrencies?
Primarily there are 2 types of cryptocurrencies:
1. Coin
Cryptocurrency coins are the native asset of an independent crypto network. For example, blockchain networks like Bitcoin, Ethereum, and Cardano, have built their own crypto networks (Layer 1 networks) from the ground up. Native asset to such layer-1 decentralized crypto networks is called coins. Cryptocurrency coins are given to computers when they process transactions for that network (this is crypto mining). Developing a crypto network from the scratch is not an easy task, that’s why only a handful of Cryptocurrencies are actually a coin. Rest all are tokens.
Examples of coins: Bitcoin (BTC), Ethereum (ETH), Binance Coin (BNB), Cardano (ADA), Tether (USDT), Ripple (XRP), Solana (SOL) etc.
2. Tokens
Cryptocurrency tokens are native assets built on top of an already existing blockchain network. Since tokens do not require to have their own blockchain, they are easy to develop. That’s why there are thousands of crypto tokens out there.
While many tokens have great use cases, the majority of the tokens are just scams. This is primarily because crypto tokens are so easy to make.
Examples of tokens: NFTs, Polygon (MATIC), Shiba Inu (SHIB), Dogecoin (DOGE), Loopring (LRC), Uniswap (UNI), AAVE, etc.
What is a Crypto Wallet?
A crypto wallet is a hardware device (like a pen drive) or software where users can store and use cryptocurrency. It is where you can store your cryptocurrency, and send or receive them.
It is similar to how your bank account works. A cryptocurrency wallet address is like a bank account number, except, you don’t get a debit/credit card with it, just the account number. You don’t need to submit your personal information to open a crypto wallet, so your identity is not directly attached to your crypto wallet. Moreover, unlike a bank account, you have total control over your crypto wallet and are not owned by the bank authority. So, nobody can freeze your wallet or block your transactions. What it also means is that no central authority can help you regain access in case you lost access to your wallet. So, you should always keep your wallet credentials and recovery phrases carefully.
What is Decentralization?
In traditional banking, the bank and the government keep track of everyone’s account balance, and transactions. However, in the case of cryptocurrency, these details are kept across all the computers connected to the cryptocurrency network. Each computer (often referred to as a ‘Node’) will have the exact same copy of its own of all the transactions made in that network. If anyone tries to tamper with a node, all other nodes will cross-reference each other and easily identify fraud. This also makes the network secure as there is no single point of failure. This is called decentralization, and it is the polar opposite of the centralized setup of banks and government.
What is Crypto Mining?
A cryptocurrency network is made of blocks. Each block consists of a list of ordered transactions. For example, a Bitcoin block can consist of 1500 to 3000 transactions. These blocks are linked to each other using cryptography, thus forming a chain. That’s why it is called a blockchain network.
Whenever new transactions are made in the blockchain network, those transactions are grouped into a block. However, to add that new block to the existing blockchain, certain validations need to be performed. Computers in the network solve complex mathematical problems to validate the block. Once validated, that block is added to the blockchain.
People who solve these mathematical problems to validate a block of transactions are called Miners. As a reward for their hard work in keeping the network secure, miners are awarded the native cryptocurrency (e.g. BTC for Bitcoin network) of that network. This provides an incentive for new computers to join the network, process transactions, and make the network more secure and fast. This process of creating new cryptocurrencies is called crypto mining. This is how new cryptocurrency comes into circulation.
Are Cryptocurrencies Safe?
You might have heard about cryptocurrencies being used by criminals or multiple occasions of hacks. That must have let you wonder about its safety.
For all major cryptocurrencies, the decentralized network is made up of thousands of computers spread across the world. To corrupt a transaction, the attacker needs to hack more the 50% of the computers all at the same time, which is extremely difficult. It is next to impossible to hack a network like Bitcoin where millions of computers are spread across the world. However, smaller cryptocurrencies where there is a very less number of computers in the network, are susceptible to cyber-attack. Centralized crypto exchanges are also vulnerable making them a major target for hacking. Individual crypto wallets are insanely more secure than a crypto exchange, that’s why, you should always keep your crypto in your personal wallet, and only keep it in exchange when you are trading or cashing out. However, nothing beats the security of a hardware wallet. You should always use a hardware wallet whenever possible.
While it is true that in most ransom attacks, hackers demand bitcoin, it makes no sense for criminals to hold that Bitcoin because Bitcoin transactions can be easily traced. So, they often exchange it for more privacy-oriented coins like Monera, which is very difficult to trace.
Does Cryptocurrency have any Value?
What gives the money in your wallet any value? Earlier fiat money used to be backed by gold. However, those days are gone now. Government can print as much money as they want, thereby raising inflation. The only thing that backs the value of a fiat currency is the trust we have in the government.
Cryptocurrency has value because of the utility they provide. This value changes for different cryptocurrencies. Bitcoin, for example, has an economic profile similar to gold. The maximum supply of Bitcoin is capped at 21 million and thereby eliminating inflation. Only a few Bitcoins are created every day and that number reduces by half every four years. So if the demand for Bitcoin remains the same, Bitcoin’s price would double every four years. The demand for Bitcoin has been raising over the years as many people find it a safe place to keep their money to fight rising inflation.
A coin like Ethereum is extremely valuable due to its wide range of use cases. The Ethereum network can be used to develop decentralized applications for payment gateway, NFTs, Decentralized finance (DeFi), Digital identity, data storage, Security infrastructure, and many more. The Ethereum network has seen serious adoption in recent years, and more and more applications are getting developed over the Ethereum network. Their applications require Ether to pay the gas fees. Thereby raising the value of the ETH coin.
Why Cryptocurrency is so Volatile?
The price of cryptocurrencies fluctuates so much because nobody knows how much these technologies are actually worth. What they do is revolutionary. Crypto networks enable users to borrow or lend without any identity, credit score, or bank. It eliminates any middleman and allows a person to do business directly with the other person. Decentralized storage networks can store files without any censorship. And many more. This potential makes average users very emotional. So small bad news can result in a market crash and some good news can drive the price high. Since there is no market regulation when it comes to crypto, the fluctuations are way more compared to stocks.
However, if you look at the long-term graph, it is clear that cryptocurrency prices go up with time and that trend is expected to continue.
Which Cryptocurrencies should You Buy?
It depends on your timeline and risk tolerance. Cryptocurrencies tend to follow a 4-year cycle, we are currently in the bear market phase which is expected to end somewhere in the middle of 2023. In terms of risk, there are varying degrees of risk in the crypto market. The more market share a cryptocurrency has, the less risky it is. So, Market Cap is an extremely important parameter to check. Whereas the current market price parameter does not indicate its growth potential.
The coins which are at the top (like Bitcoin, Ethereum, Tether, BNB) are less volatile because a lot of money needs to be pulled out for the price to fall. If you go down the list, the volatility and risk will keep on increasing. The smaller the market cap of a coin/token, the more potential it has for growth because it needs less money to push the price up. On the flip side, less money needs to be pulled to crash their price.
So, the top 10 cryptocurrencies (by market cap) could be considered low-risk investments. Risk keeps increasing as you go down the list. Ideally, you should stay away from any cryptocurrency that is beyond the top 200 list.
If you need some suggestions in identifying promising cryptocurrency, you can check out my article Top 10 Crypto Picks for 2023.
I hope you now have a much better understanding of cryptocurrency. Please share your thoughts in the comments.
