What is a Cryptocurrency? How it Works, Risks & Tips

Cryptocurrency
India

A cryptocurrency is a type of digital, “decentralized money;” with bitcoin as the most predominant. For the most part, it is not created by the government and is regulated through private encrypted databases known as blockchains. Yea sounds pretty straightforward but when it comes to deciphering how a cryptocurrency works, it becomes way complicated. In this post, we will go through a range of topics around cryptocurrency, with reference to bitcoin and other prominent coins presently dominating the markets. Plus, we’ll also take a look at how a cryptocurrency works.

Bitcoin was the first and is now the most popular type of cryptocurrency. Other popular forms include Tether, Ethereum, and Litecoin.

And with the recent growth in the industry, individuals can now buy cryptocurrencies through mainstream investment applications. However, there are dangers which include high volatility and a lack of regulatory control. More on that later.

For now, let’s begin with the basics.

What exactly is cryptocurrency?

Like I earlier mentioned, cryptocurrency is described as “decentralized money.” This literally means that it is stored, generated, and processed independently of a central bank or government.

Cryptocurrency, unlike traditional “hard” or paper money, has no physical form. It is, in fact, a collection of data under the protection of cryptography (the science of encoding and decoding information), hence the term, “cryptocurrency.”

Simply put, when data is encoded, it is changed from one form to another; a less detectable one. It is subsequently decoded – or reverted – back to its original form by the end-user. This sophisticated process minimizes the possibility of duplicate spending and counterfeiting. It also enhances the security of using cryptocurrencies to pay for goods and services.

In some ways, bitcoin functions similarly to a secure, cloud-based filing system such as Dropbox or Google Drive.

Decentralization

By being decentralized, Bitcoin avoids interactions with third-party systems and government agencies; which frequently collect large amounts of data and have potential control over an individual’s access to funds. And because there is no association with a government or banking system, it is possible to perform transactions anonymously. Most users perceive this to be a significant benefit.

On the other hand, owing to the absence of government institutions who would be accountable for regulating the central supply, or even a record of the money or its transactions, cryptocurrencies lack one of the fundamental advantages of a real or “hard” money system.

How a Cryptocurrency Works

Cryptocurrencies keep their own records by using blockchain, an online ledger and transaction log.

Blockchains are responsible for generating digital records of transactions, certificates, or contracts which is indestructible. Crypto-experts explain that this independent transaction log is significantly more secure than paper records or institutional digital accounts, which may be prone to hacks.

In reality, the platform saves both the buyer’s and seller’s information as a “hash,” or string of letters and numbers formed by a sophisticated mathematical procedure. And because each hash is closely linked to the hash preceding it, unauthorized alterations to the ledger will become apparent as soon as a hash is changed.

Meanwhile, when a specific amount of hashes are collected, the group is converted into a “block” and linked to the other blocks on the server, thus the name “blockchain.” The blockchain is updated every ten minutes and is kept on thousands of servers around the world.

Cryptocurrencies work in a closed system. This means that there is a short supply and the creation of new units only follows a rigorous set of rules. For example, some currencies, such as bitcoin, have a software-imposed limit on the number of units that can be created. As a result of the restricted supply, each unit becomes increasingly valuable, especially as the currency gains popularity among day traders.

The Most Widely Used Cryptocurrency Examples

There are various types of cryptocurrencies. The most well-known and widely traded are:

#1. Bitcoin (BTC):

This is the first and by far the most popular cryptocurrency. Bitcoin was created by Satoshi Nakamoto, who described it as a “peer-to-peer electronic cash system. “The first use of bitcoin was in the year 2010. A user exchanged 10,000 bitcoin for two pizzas – an amount that, at current exchange rates, is now worth over $100 million. Since its inception, Bitcoin has spawned a number of Bitcoin-based products, including Bitcoin SV (BSV) and Bitcoin Cash (BCH).

#2. Ethereum (ETH):

Ethereum is a digital coin and computing platform that executes every transaction automatically. The Ethereum blockchain is the has become a popular choice across the globe. Plus, the platform is now working on Version 2.0, which will include several new ways to store transactional data.

#3. Litecoin (LTC):

Also known as the “silver to Bitcoin’s gold,” Litecoin was founded shortly after Bitcoin and is now the world’s sixth most popular cryptocurrency. One of the key advantages of the coin is its quick transactional time.

#4. Tether (USDT):

Unlike Bitcoin, Ethereum, and Litecoin, which exist purely in the virtual realm, Tether is purely based on local currencies in order to escape the volatile oscillations of the crypto market.

What is the purpose of cryptocurrency?

In its early days, cryptocurrency appeared to be a little shady, associated with criminals and money launderers. The Silk Road, a black market operation, used bitcoin as its preferred currency until it was shut down by the FBI in 2013.

Since then, cryptocurrency has gradually gained popularity – and respectability. Now you can use it for a wide range of operations, such as investing in companies, negotiating import-export contracts, and even paying utility bills.

Paypal revealed in 2020 that it would let customers to hold numerous types of cryptocurrencies on their accounts, and that it is even looking into allowing crypto to be used as a payment option on their many partner websites, such as eBay.

However, while their applications are expanding, cryptocurrencies appear to be thriving as an investment asset, trading on specialized currency markets.

How to Make a Cryptocurrency Investment

Cryptocurrency can be included in a well-balanced portfolio. In contrast to traditional stocks, bonds, and mutual funds, cryptocurrency provides the security of anonymity as well as the potential for rapid future growth. Furthermore, because it operates outside of a formal government framework, the assets are rarely subject to freezing or seizure by authorities.

Common investment programs such as Robinhood, Coinbase, and Kraken all make it simple to buy cryptocurrency. There are even entire online trading platforms and exchanges that focus mainly on crypto assets (such as Gemini, BlockFi, eToro, and Bitcoin IRA).

Furthermore, publicly traded Bitcoin trusts and funds enable individuals to invest in professionally managed portfolios that trade the currencies, providing the same diversification and low costs as traditional mutual funds and ETFs.

What are the risks with investing in cryptocurrency?

The following are some of the risks that come with investing in cryptocurrency across the globe. There are about three of them. These include;

#1. It is completely independent of the government

The fact that cryptocurrency and its marketplaces are private and void of control often generates concerns about what kind of taxes are crypto investors should pay on the asset’s gains and losses, as well as its potential for abuse. For example, the Tokyo-based Bitcoin exchange site Mt. Gox in 2014 had to deal with hackers, resulting in the loss of more than 700,000 BTC.

#2. It does not exist in the physical world

Crypto is like blinker light fluid in that it isn’t real. It isn’t a physical asset like gold or other commodities. It is not a portion of a firm like a stock or bond. Cryptocurrency is not printed or minted in the same way that conventional currencies are. As a result, it has no fundamental worth and just a trading value, making it highly speculative.

#3. It is quite volatile

Cryptocurrency prices fluctuate dramatically, sometimes dropping or rising by hundreds of dollars in a matter of hours. In 2013, bitcoin fell from $1,000 to $300 per unit; in November 2020, bitcoin fell to $3,000 before rising to a new all-time high of $65,000 in April 2021. Other currencies trade in the hundreds of thousands, but their movements can be just as erratic.

Meanwhile, innovations are already underway to govern the system’s market fluctuation and control its valuation. Tether, for example, literally “tethers” itself to local currencies, avoiding the volatility that characterizes other unsecured tokens.

The Economic Takeaway

Cryptocurrency is a new asset that will undoubtedly evolve in the years to come. Whether the future is one in which all tokens are totally based on local currencies or one in which they stay ethereal, crypto will undoubtedly form part of a savvy investor’s portfolio.

And because of its decentralized nature, bitcoin has been able to shield itself from the influence of third-party servers and government agencies, resulting in an anonymous processing system that appeals to a wide range of consumers. Its blockchain technology keeps a detailed and secure transaction log.

However, the system is far from risk-free. For others, the existing lack of government and international laws may detract from the product’s popularity. On the other hand, some may find the volatility of different coin prices to be far too risky, especially for an asset with no underlying, basic value.

The public view of cryptocurrencies has varied considerably over time, much like the asset’s price. However, it is reasonable to assume that this new sort of cash has not yet been spent.

Cryptocurrency FAQs

Cryptocurrency is legal depending on the country in question and its regulations. There are certain countries where crypto investing, trading and exchange is illegal. Some of these countries include, Turkey, India, Nigeria, Bolivia, Ecuador and so on.

Can cryptocurrency be converted to cash?

Yes, cryptocurrenies its is very possible to convert cryptos to cash. There are a ton of ways that can go down. You can take the route of using exchange platforms, or peer-to-peer method; which in a way is almost the same.

How does a cryptocurrency work?

Cryptocurrencies work by using the cryptography technology. It is the science of encoding and decoding information

There are tons of countries where cryptocurrency is legal except in a few countries like; India, Turkey, Nigeria, Bolivia and so on.

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