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What is Cryptocurrency?

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  • Difficulty Level : Hard
  • Last Updated : 11 Nov, 2022
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A cryptocurrency is not a type of currency that can be used in the real world. It can be used to perform transactions only in the digital world. So in order to buy/sell using a cryptocurrency, it has to be converted from a digital form to some existing currency that is used in the real world. For example, Dollars, Rupees, etc. Cryptocurrencies don’t have a central issuing authority instead using a decentralized system to record transactions and issue new units. 

What is Cryptocurrency?

Cryptocurrency is a digital payment system that does not rely on banks to verify transactions. Cryptocurrency payments exist purely as digital entries to an online database. When cryptocurrency funds are transferred, the transactions are recorded in a public ledger. 

  • In cryptocurrency, “coins” (which are publicly agreed on records of ownership) are generated or produced by “miners”.
  • These miners are people who run programs on ASIC (Application Specific Integrated Circuit) devices made specifically to solve proof-of-work puzzles. 
  • The work behind mining coins gives them value, while the scarcity of coins and demand for them causes their value to fluctuate. 
  • Cryptocurrencies can be used for buying goods just like fiat currency.
  • Cryptocurrencies use encryption to verify and protect transactions.
  • It does not exist in physical form and is not typically issued by any central authority.
  • They use decentralized control in contrast to central bank digital currency.

Cryptocurrency Examples

Some of the best-known cryptocurrencies are:

  1. Bitcoin: Bitcoin is the most widely accepted cryptocurrency. Founded in 2009 by Satoshi Nakamoto, it is still the most commonly traded. It is a decentralized digital currency that can be transferred on a peer-to-peer bitcoin network. 
  2. Ether:  Ether is the native cryptocurrency of the Ethereum blockchain network. Each Ethereum account has an ETH balance and may send ETH to any other account. The smallest subunit of Ether is known as Wei. 
  3. Litecoin: Litecoin is a peer-to-peer cryptocurrency and in technical terms, Litecoin is nearly identical to Bitcoin. It uses scrypt in its proof-of-work algorithm. It is an adaptation of Bitcoin that is intended to make payment easier. 
  4. Stablecoins: These are the class of cryptocurrencies whose values are designed to stay stable relative to real-world assets like the U.S. Dollar.
  5. Solana: Solana is a competitor of Ethereum whose main emphasis is on speed and cost-effectiveness.

Cryptocurrency Working vs Fiat Currency Working

Let’s understand the difference between the working of a cryptocurrency and fiat currency like the U.S. Dollar while purchasing goods. 

There are two things that make cryptocurrency working and fiat currency working different: Transactions and the Consensus protocol. A block in a Blockchain has the following structure:

Cryptocurrency Working vs Fiat Currency Working

 

  

As we can see, a block contains multiple transactions at a time in the transaction’s id_list.

1. Transactions: The transactions performed in the crypto world are very different than those that of which are performed in the real world. Let’s consider that Alice wants to buy a Bicycle. 

  • Real-world: In the real world Alice can pay in any available currency. The seller will return the change if any to Alice. 
  • Crypto world: Suppose the bicycle costs 0.6 BTC and Alice has 0.7 BTC in the Bitcoin Wallet. Alice has to consider the whole amount i.e 0.7 BTC
    • Transaction 1: Transfer only 0.6 BTC from Bitcoin wallet to the seller’s wallet. Now, Alice has already exhausted 0.6 out of 0.7 BTC. The remaining 0.1 BTC has to be transferred back to Alice’s wallet. There is no change in BTC being offered by the seller to Alice.
    • Transaction 2: Alice offers 0.1 BTC back to herself. So 0.1 BTC is an unspent transaction amount in Alice’s wallet.

2. Consensus protocol: Consensus decision-making is a group decision-making process in which group members develop, and agree to support a decision in the best interest of the whole. Basically, it states that the longest valid chain in the Blockchain network should exist on every node in the Network.

How Does Cryptocurrency Works?

Cryptocurrencies are not regulated or controlled by any central authority hence cryptocurrency works outside the banking system using different types of coins. 

1. Mining: Cryptocurrencies are generated through the process called Mining. In this process, the miners are required to solve a mathematical puzzle over a specially equipped computer system to be rewarded with bitcoins in exchange.

2. Buying, selling, and storing: Users can buy cryptocurrencies from central exchanges, brokers, or individual currency owners and sell crypto to them. Cryptocurrencies can be stored in wallets.

3. Investing: Cryptocurrencies can be transferred from one digital wallet to another. Cryptocurrencies can be used for the following purposes:

  • Buying goods and services.
  • Trade-in them.
  • Exchange them for cash.

How To Buy Cryptocurrency?

There are three steps involved in buying a cryptocurrency:

1. Choosing a platform: There are two platforms available to choose from:

  • Traditional Brokers: There are online brokers who offer to buy and sell cryptocurrencies along with stocks, bonds, etc, but they offer lower trading costs and fewer crypto features.
  • Cryptocurrency exchanges: Different types of cryptocurrency exchanges are available to choose from with different cryptocurrencies, wallet storage, etc.

2. Funding your account: After choosing the platform, the next step is to fund the account. Most crypto exchanges allow users to purchase cryptocurrencies using fiat currency like U.S. Dollar, the Euro, or using Credit and Debit cards, but this varies from platform to platform. An important factor to consider here is the fees that include the potential deposit and withdrawal transaction fees plus the trading fees. 

3. Placing an order: The order can be placed via exchanges or broker’s web or mobile platform. 

  • Select the Buy option.
  • Choose the order type.
  • Enter the amount of cryptocurrencies.
  • Confirm the order.

A similar process needs to be followed for selling cryptocurrencies.

How To Store Cryptocurrency

Once the cryptocurrency is purchased, it needs to be stored safely to protect it from hackers. The usual place to store cryptocurrency is crypto wallets which can be physical devices or online software. Not all exchanges or brokers provide crypto wallet services. The cryptocurrencies can be stored in these four places:

  1. Custodial Wallet: In this approach, a third party such as a crypto exchange stores the cryptocurrency either through cold storage or hot storage, or a combination of the two. This is the most simplest and convenient method for the users as it requires less work on the user part. 
  2. Cold Wallet: These are also known as Hardware wallets. It is an offline wallet in which hardware connects to the computer and stores the cryptocurrency. The device connects to the internet at the time of sending and receiving cryptocurrency but other than that the cryptos are safely stored offline.
  3. Hot Wallet: These are the applications that store cryptocurrencies online. These are available as desktop or mobile apps.
  4. Paper Wallet: This is also known as a physical wallet. It is a printout of the public and private keys available as a string of characters or scannable QR codes. To send crypto scan the public and private keys and crypto will be received using the public keys.
 Custodial WalletCold WalletHot WalletPaper Wallet
DefinitionThird-party such as the crypto exchange store the cryptocurrency.The hardware connects to the computer and stores the cryptocurrency.Applications that store cryptocurrencies onlinePhysical storage of public and private keys.
Advantage
  • Simple and convenient method.
  • Easy to access.
  • No worry about losing your crypto wallet.
  • Highest level of security. 
  • Gives control over crypto.
  • Almost always free.
  • Easy to use.
  • Maximum security at the lowest possible cost.
DisadvantageThe security risk of leaving crypto in third-party’s possession. 
  • The process is slower compared to when storing crypto online.
  • Cost of device.
Risk of being hacked. 
  • Less user-friendly.
  • Risk of losing a wallet.

What Can You Do With Cryptocurrency

Here are some of the examples:

  • Shopping: Some luxury retailers like Rolex and Patek Philippe accept cryptocurrency as a form of payment. 
  • Insurance: Some insurance companies like Premier Shield insurance accept Bitcoin for premium payments.
  • Gift: Cryptocurrency can be a great gift for persons who want to learn and invest in new technology.
  • Travel: As crypto is not tied to a specific country, thus traveling with crypto can save a lot on money exchange fees. 

Advantages of Cryptocurrencies

The following are some of the advantages of cryptocurrencies:

  1. Private and Secure: Blockchain technology ensures user anonymity and at the same time the use of cryptography in blockchain makes the network secure for working with cryptocurrencies.
  2. Decentralized, Immutable, and Transparent: The entire blockchain network works on the principle of shared ownership where there is no single regulating authority and the data is available to all the permissioned members on the network and is tamper-proof.
  3. Inflation Hedge: Cryptocurrencies are a good means of investing in times of inflation as they are limited in supply and there is a cap on mining any type of cryptocurrency.
  4. Faster Settlement: Payments for most cryptocurrencies settle in seconds or minutes. Wire transfers at banks can cost more and often take three to five business days to settle.
  5. Easy Transactions: Crypto transactions can be done more easily, in a private manner in comparison to bank transactions. using a simple smartphone and a cryptocurrency wallet, anyone can send or receive a variety of cryptocurrencies.

Disadvantages of Cryptocurrencies

The following are some of the drawbacks of cryptocurrencies:

  1. Cybersecurity issues: Cryptocurrencies will be subject to cyber security breaches and may fall into the hands of hackers. Mitigating this will require continuous maintenance of security infrastructure.
  2. Price Volatility: Cryptocurrencies are highly volatile in terms of price as they have no underlying value and there is a supply-demand-like equation that is used to determine the price of cryptocurrencies. 
  3. Scalability: Scalability is one of the major concerns with cryptocurrencies. Digital coins and tokens adoption is increasing rapidly but owing to the sluggish nature of the blockchain makes cryptocurrencies prone to transaction delays. Cryptocurrencies cannot compete with the number of transactions that payment giants like VISA, and Mastercard processes in a day.
  4. Less awareness: Cryptocurrency is still a new concept for the people and the long-term sustainability of cryptocurrencies remains to be seen.

Future scope 

The future of most cryptocurrencies is uncertain, as it is still controversial and not authorized by many Governments, institutions, etc. However, in the near future, it may be used on a large scale and accepted more. Because every development of new technologies includes the financial market to ease the user to the bottom level. The ICO (Initial Offers of Cryptocurrency) is the fundamental part of an independent project that is still in the development phase. In this process, shares are not sold; the organization offers tokens, also known as cryptocurrency. Therefore, with time and the development of these projects, cryptocurrency can offer multiple benefits for these projects, and also for investors too. Cryptocurrency is the most independent currency in the financial world. Therefore, the fact of prohibiting its dissemination and/or use could cause a partial delay with respect to economic trends. Only the future can show us how crypto influences our lifestyle.


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