If you go on the internet looking for an opinion on crypto and its underlying blockchain technology, you’ll find plenty of hot takes. Some will argue that cryptocurrencies such as Bitcoin are a powerful investment vehicle and the ideal solution to wealth inequality. Others will say that crypto is the future of international trade. Still, others will contend that cryptocurrency is a Ponzi scheme that enriches a select few at the expense of the masses. What you probably won’t find is a concise explanation of what cryptocurrency is, how the blockchain works, or an unbiased review of the technology’s merits. The topic elicits such passion on all sides that it’s tough to stick to the facts. Luckily, that’s exactly what this article intends to do. Sit back, grab a drink, and learn about crypto without worrying that your sources are ultimately trying to sway your opinion.
What Is a Cryptocurrency?
A cryptocurrency can be defined as any digital asset that can be exchanged for goods or services, serving a similar role to traditional money systems like the American dollar without reliance on a particular government. The first crypto token was Bitcoin, released by a person or group using the name Satoshi Nakamoto in 2008. Nobody has ever stepped forward to take credit for Nakamoto’s work, but subsequent altcoins such as Ethereum can be traced back to specific developers.
I’ve Heard that Crypto Enthusiasts Are Into DeFi. What’s that?
DeFi is a common abbreviation for decentralized finance, or a financial system that’s controlled by market forces instead of powerful individuals or institutions. For example, the Federal Reserve can manipulate interest rates to affect the value of a dollar while the European Union can impose sanctions on Russia to devalue the Russian ruble. In contrast, crypto tokens generally have no comparable authority, meaning that supply and demand are the sole determinants of each coin’s value. Advocates argue that this is a fairer financial system than that offered by fiat currencies.
Where Does the Blockchain Come in?
The blockchain is the decentralized public ledger where crypto transactions are recorded. Information is stored on “blocks” that can be “chained” together to create unlimited storage, hence the name. Unlike bank records, information on most blockchains is public information so anyone can look at any transaction at any time. Every token has a unique blockchain that only records transactions involving that specific token, some of which offer exclusive functionality. The Ethereum blockchain is programmable for example, allowing for developers to add new altcoins to its ecosystem and the creation of smart contracts that disperse funds only once prescribed conditions are met.
Are Cryptocurrencies Safe?
Supporters of crypto often cite the public nature of the blockchain as a security feature. Since anybody can trace any token through every account it’s ever been in, hackers can’t introduce foreign tokens without getting caught. Furthermore, stolen tokens can be traced back to the culprits who took them. Volunteer miners also verify every transaction, providing an added layer of security.
How Does the Mining Process Work?
Mining boils down to something called hashing. Hashing is a mathematical process that takes input data of any size, performs an operation on it, and returns output data of a fixed size. This is how passwords work: the website performs an operation on the password you set so that whatever you choose gives you access to your account.
Cryptographic hashing is when miners search for an arbitrary piece of data called a nonce that allows all inputs (or transactions) on a block to produce an output with a fixed number of zeroes, rendering that block “solved.” There is no way to predict what the nonce will be, forcing miners to do a lot of number-crunching to trial and error the solution. In exchange, successful miners are rewarded with cryptocurrency through transaction fees or special supplies held in reserve for the purpose.
What about Privacy?
While crypto transactions are public knowledge, that doesn’t mean that your life story is on the blockchain. All transactions on the blockchain consist of three pieces of information: Output, Amount, and Input. The Output is the crypto account (sometimes called a wallet or address) receiving funds while the Amount is self-explanatory. The Input is a little strange in that it is not the account losing funds but instead the accounts that gave that individual the funds they are now transferring elsewhere. For instance, if Sheldon gave Leonard three BTC that he is now giving to Howard, Sheldon’s Bitcoin account would be the Input for the transaction between Leonard and Howard.
Why Do Crypto Prices Fluctuate So Wildly?
With no institution dictating the value of crypto, supply and demand alter its price at the whims of the market. Supply is a known quantity for most tokens, allowing investors to make an informed decision on that front. Bitcoin has a maximum supply of 21 million BTC, while an altcoin called Ripple has a planned circulation of 100,000,000,000 XRP. Since there are more XRP tokens available, an individual XRP token will never be worth as much as one Bitcoin.
Demand is more difficult to quantify, but there are a few things to look for. Well-known influencers such as Elon Musk and Mark Cuban can cause wild price swings one way or the other with a simple Tweet, while news that a large government plans to tax crypto-related income or outlaw mining tends to depress prices. Individual tokens are also affected by projects they are associated with. For example, Ethereum may see a spike in value after a developer releases a new use for its programmable blockchain. That said, some price swings cannot be traced back to any root cause.
What Should I Look for in an Investment Opportunity?
Many new crypto investors fail to take transaction fees into account when planning their investments, so make sure you know what the exchange you’re using will charge per trade. Beginner-friendly options such as Paypal and CoinBase charge a premium for the convenience they offer, so you may need to graduate to another exchange if you’re serious.
Investing in crypto can yield astronomical profits in short order, but remember that it’s just as easy to lose everything. As such, invest only what you can afford to lose. You should also avoid blindly trusting experts who may purchase a cheap token and hype it up to turn a profit at the expense of those who took their “advice.” Instead, turn to trustworthy sources of information such as CoinMarketCap for information on a token’s price history, circulating supply, and prospects.
What Advantages Can Crypto Tokens Provide?
Crypto facilitates free trade and fair competition by giving people in developing nations like Guatemala and Bangladesh access to the same reliable currency used by Americans and Europeans. The blockchain is also considered hack-proof since all blocks would need to be compromised simultaneously to ensure their constant agreement, something that cannot be said for traditional bank accounts. Many blockchains can support transactions worth less than an American penny as well, allowing for microtransactions to monetize goods and services that otherwise would need to be free.
What Are the Disadvantages of Using Crypto as an Everyday Currency?
The mining process is slow and energy-intensive, leading to high transaction fees and climate-change concerns. For example, Bitcoin miners can approve three to seven transactions per second while VISA can process 24,000 in the same amount of time. The unstable price of crypto tokens can also make it difficult for businesses to charge fair prices. An item at one BTC could be $50,000 today but $60,000 or $40,000 tomorrow. While the blockchain itself hasn’t been hacked yet, exchanges and wallets have successfully been hacked and cost crypto investors millions. Most crypto accounts lack FDIC (Federal Deposit Insurance Corporation) insurance, so hacks are typically a total loss.
Are Non-Fungible Tokens (NFTs) Cryptocurrencies?
They are not, but most take advantage of the same blockchain technology. While coins are fungible by nature (meaning that each coin carries identical value), NFTs are unique assets like digital art where only one exists. As such, every NFT is a distinct asset whereas cryptocurrencies are completely interchangeable. You can read this article from Bloomberg on NFTs.
Parting Thoughts
Cryptocurrencies and the blockchain are a deep topic, but the information above should prove sufficient to give you an idea of what they are and how they work. It’s up to you to decide what you want to do with this information.