Over the past few years, interest in cryptocurrencies has surged, in part due to the massive rise in the value of Bitcoin. Despite this, few people have an in-depth understanding. This post is the first in a new series called ‘Intro to Crypto’, which will cover the basics of cryptocurrencies.
So, what exactly is a cryptocurrency? In simple terms, as the name suggests, a cryptocurrency is a currency! They are designed to be used primarily as a medium of exchange. However, unlike traditional currencies (such as GBP or USD), a cryptocurrency is purely digital – there are no notes or coins in circulation.
Features of Cryptocurrencies
There are a few features of a cryptocurrency, which differ greatly from a traditional (or ‘fiat’) currency:
- Decentralisation: While traditional currencies are controlled by central banks, cryocurrencies are controlled by a network of computer hardware, which anyone can join. This means there is no single point of control, making the system more resilient to manipulation.
- Validity: Cryptocurrencies make heavy use of cryptographic algorithms, to validate and secure activity. All transactions are validated by the computer network, preventing fraudulent transactions.
- Anonymity: No personal details are required to obtain or use a wallet, providing anonymity to the user.
- Security: Coins are stored in electronic wallets, each of which has an address. This works in a similar way to the account number and sort code of a traditional bank account. Spending the coins stored in these wallets requires a key, which only the owner of the wallet will have access to. Without this key, it is not possible take coins out of the wallet.
- Scarcity: The supply of coins is limited, increasing the value of each coin over time. New coins are released at an ever declining rate, and eventually the supply of new coins will be exhausted.
These features form the basis for the vast majority of cryptocurrencies in existence, with a few notable exceptions (which we will look at in a later series).
Cryptocurrencies are not as easy to get hold of as a traditional currency, nor are they as easy to use.
There are relatively few exchanges which sell cryptocurrencies, most of which require payment via a bank transfer, which can be off-putting for new purchasers due to the lack of protection it provides.
While there are a few companies that offer a bitcoin payment method, these are very few and far between, and even more so for other cryptocurrencies. Part of the reason for this is the volatility of a cryptocurrency’s value. It is uncommon for the more stable currencies to fluctuate more than a few percent over the course of a year.
The reason many people purchase cryptocurrencies is the belief that the value will increase in the future, allowing them to sell their coins and make a profit. This is a very risky way of making money, and it is only recommended to consider this with an in-depth understanding of how the market works.
This provides a very basic overview of the workings of a cryptocurrency. The next post will explain the basic structure of the bitcoin network.