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What is Cryptocurrency

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15.08.2023
5min.
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What Is Cryptocurrency: How Does It Work

There are already many articles on the Internet about what cryptocurrency is. In order not to produce copies, we decided to write a detailed material with answers to all the main questions, starting with what is crypto money and ending with what does cryptocurrency mean for the financial market.

After reading this article, you will already have a basic understanding of the topic and will even be able to start taking the first steps toward investing and trading. Most importantly, read the material from beginning to end. This is concentrated knowledge. There are no extra paragraphs here.

What is cryptocurrency

First things first’ let’s define cryptocurrency.

Cryptocurrency is any form of currency that exists digitally or virtually and uses cryptography. This is the Wikipedia definition.

And now what is cryptocurrency in simple words? Cryptocurrency is a decentralized virtual currency that doesn't belong to any state and is not controlled by any financial institution. The rate of cryptocurrencies is not set by banks, but by the balance of supply and demand. Their circulation and security are provided by blockchain and cryptography.

The history of cryptocurrency

The beginnings of crypto coins appeared in the 2000s during the development of online games. Gamers were ready to buy game currency from other players for real money. This is how the first marketplaces appeared on the forums. These game coins were already virtual currencies with a real market value, but they could not yet be called cryptocurrencies. An important component was missing - the blockchain.

The first real cryptocurrency, Bitcoin, appeared in 2009. It was created by a developer (or a group of developers) under the pseudonym Satoshi Nakamoto. For the first few years, most people did not believe in the technology. Moreover, people didn’t know about it. Bitcoin at that time was used only by geeks. They were the only who could understand and explain crypto. Therefore, if you blame yourself for not buying bitcoin ten years ago, you should not. It's ok to be skeptical about strange new technology.

However, those who even then saw the potential of cryptocurrencies were rewarded by fate. Already in 2013, BTC reached $1,000 for the first time.

At the same time, other coins began to develop. In 2011, Litecoin appeared. This is a cryptocurrency that was in many ways similar to Bitcoin, but is more convenient and easier to scale. At that time, it seemed that LTC could easily outshine BTC, but this has not yet happened. Bitcoin remains the number one cryptocurrency, and Litecoin even dropped out of the TOP-10.

But the real game-changer is Ethereum (ETH), developed by Vitalik Buterin in 2014. The Ethereum blockchain was the first to support smart contracts and the creation of new tokens on the same blockchain. That was a real revolution. ETH is still in number two, not far behind Bitcoin, and the Ethereum blockchain is used to support the operation of thousands of tokens.

The appearance of ETH was the harbinger of the era of altcoins. Countless new cryptocurrencies appeared in the next three years. Some had their own blockchain (for example, Binance Coin or Dash), and some used the blockchain of other cryptocurrencies (mainly Ethereum). Since then, the crypto investor has to study each coin and track its development.

By 2022, there were so many cryptocurrencies and tokens that it became physically impossible to track them all. There are now more than 20,000 of them, more than there are public companies on the stock market. Even a professional trader will name a maximum of several hundred of them.

However, there is nothing surprising in such a variety of crypto assets. The market has reached the point where any startup, app, store, or online game can afford to issue a native token — and many are actively taking advantage of this opportunity.

How does cryptocurrency work

Now it’s time to explain crypto. Usually, in this place, they start talking about the blockchain. But, you know, immediately loading you with this technical information would be inappropriate. We will definitely return to this part, but a little later.

Much more important in the work of cryptocurrency is its idea, concept. And the key idea here is decentralization. Have you thought about the fact that your money in an electronic bank account is not entirely yours? In theory, you can spend them at any time or come and collect cash, but at the same time, the bank reserves the right to freeze the account or not issue money, referring to the fact that the client doesn't have confirmation of the origin of these funds.

The same is true for stock exchanges, electronic wallets, and other centralized financial instruments. They are convenient to use, but you cannot be 100% sure that your funds are safe.

What’s crypto as a concept? The idea is to make electronic money as secure as cash. Cryptocurrencies are technically designed in such a way that they do not have a central authority that decides whether or not to make this or that transaction. How is it implemented technically?

Now we are ready to talk about blockchain. This time we will not resort to the wording from Wikipedia, but will immediately move on to a simple explanation.

Blockchain is a chain of blocks that stores complete information about the entire history of transactions. And, importantly, this information is stored by each participant in the decentralized network, that is, each participant automatically checks the veracity of the data in real-time. In such a chain, funds cannot appear out of nowhere and disappear without a trace because the entire history of transactions is interconnected. This mechanism ensures the safe movement of crypto between wallets without the intervention of regulators.

Where does crypto come from

Coins and tokens may appear as a result of:

  • Mining. What is cryptocurrency mining? This means receiving crypto as a reward for participating in transaction processing.
  • Staking (getting interest for blocking assets on staking).
  • Generation of new tokens by the issuer (a team can simply “print” new tokens if smart contracts allow this).

What can you do with cryptocurrency

In other words, what’s crypto for all of us?

  • Crypto can be like gold. If you have capital that you want to keep it long-term, then cryptocurrency can serve as one of the instruments in a diversified portfolio, along with metals or real estate.
  • Crypto can be like shares. Many see digital coins solely as an opportunity to capitalize on the volatility, and we cannot blame investors for this.
  • Crypto can be like money. After all, a cryptocurrency is a currency. It can be used to pay for goods and services. A number of large companies are already accepting such payments today.

Why do people invest in cryptocurrency

People are inspired by the idea that you can get thousands of percent of the profits over the years. After all, someone bought bitcoin for $10 and sold it for $50,000.

Such stories are rather the exception to the rule because few people have the patience to wait for such profit. Most of the investors who bought BTC at $10 sold it for $50 and, at that time, were extremely happy to multiply their investments five times.

However, facts are facts. What’s crypto, and what is cryptocurrency investment? Crypto is an opportunity to multiply your investments over a matter of years or even months. Of course, there are risks here as well. You can not only earn but also lose investments. Wise crypto investors understand this and accept the rules of the game.

What determines the price of a cryptocurrency

Those who are just starting to get acquainted with the crypto market are afraid of the volatility of the price of coins. They grow twice in a few months, then they lose tens of percent of the price per day. Why is this happening? After all, ordinary currencies do not do this. The dollar and the euro may rise or fall slightly during the year, but these are not tens or hundreds of percent.

The reason for this is the fact that cryptocurrencies are not constrained by banks, financial institutions, international agreements, and so on. When the demand for cryptocurrency grows, the market instantly reacts to it automatically. When demand falls, the price goes down just as quickly. Thus, the crypto prices are not constant, but it very accurately reflects the real state of affairs.

Also, the price of both fiat (state) currencies and cryptocurrencies depends on the issue. The more money is printed or mined, the more the value of one monetary unit is eroded. For example, new BTC and ETH are being created very slowly, while US dollars have been printed the same amount in the last two years as in 40 years before. Of course, this doesn't mean that cryptocurrencies are less prone to inflation. Each case is unique.

What’s crypto stablecoin

Not all cryptocurrencies are characterized by volatility. Some of them have a fixed price linked to real (not virtual) assets. Such coins are called stablecoins.

The price of stablecoins can be pegged to a fiat currency (such as USDT), gold (such as XAUT), or another asset. Those that are pegged to the dollar are the most commonly used. This is the most convenient way. For crypto investors, stablecoins are an instrument to take profits and move away from trading by transferring funds from volatile cryptocurrencies to stablecoins.

Advantages and disadvantages of cryptocurrency

Advantages of cryptocurrency:

  • Decentralization. The absence of centralized control is an advantage for those who value freedom and oppose market monopolization.
  • Safety. Decentralization also contributes to the fact that the blockchain is much more resistant to hacker attacks because there is no human factor in its work. Technically, crypto wallets are much more secure than bank accounts and e-wallets.
  • Anonymity. To create a wallet, you do not need to enter any personal data (not a name, not even an email). Thus, crypto allows you not to advertise your expenses and income. Although, the FRS would say this is a disadvantage.
  • Manufacturability. Smart contracts implemented on the blockchain make payments easier and more secure.

Disadvantages:

  • Volatility. Most cryptocurrencies, including bitcoin, are characterized by volatility. As long as the dollar is the dominant currency, we have to regularly check the exchange rate of cryptocurrencies against the dollar (either against the euro or against the currency of your country). This rate changes too dynamically, which makes crypto payments less convenient.
  • Vulnerability. This point doesn't contradict the point about safety in the benefits. Cryptocurrencies are much more resistant to most types of attacks, but due to technical features, they have their own vulnerabilities, for example, the 51% vulnerability, which is relevant for small, unpopular coins.
  • Non-acceptance by states. Governments, tax authorities and banks in many countries do not like cryptocurrencies for their anonymity. As long as the authorities continue to put a spanner in the works, this slows down the development of technology.
  • Non-environmental. Eco-activists also have claims against the crypto community. Mining requires a lot of electricity, and this is unnecessary CO2 emissions into the atmosphere. Some cryptocurrencies, such as Ethereum, have already solved this problem by abandoning mining in favor of staking. However, a significant part of the coins (including Bitcoin) continue to resort to this method.
  • Reputation. Decentralized coins and blockchain often cause negative associations among people who are not interested in this industry. The reason for this is a large amount of speculation and fraud around crypto. This doesn't make the technology itself bad, but it stains its reputation.

Where to buy and sell cryptocurrency

Only miners can get cryptocurrency “out of nowhere”. However, this will take time, equipment, and financial investment (so it’s not “out of nowhere” in the end anyway). An easier way to get your first crypto is to simply buy it.

There are two types of crypto trading platforms: centralized (CEX) and decentralized (DEX). Centralized exchanges are less free and safer, because of the existence of central regulation of such a platform violates the original concept of cryptocurrency. Decentralized exchanges look more attractive to advanced traders as they do not require identity verification and do not have direct access to your wallet. WhiteSwap is also a DEX platform.

How to buy and sell cryptocurrency

The disadvantage of DEX for beginner traders is that here you cannot buy a cryptocurrency for fiat money. Therefore, you buy your first crypto on a centralized exchange (for example, WhiteBIT), and then transfer funds to a personal wallet to trade on WhiteSwap.

To buy coins and tokens on a centralized exchange, you need to create an account and go through KYC (know your customer) verification by confirming your identity. This procedure takes place on most popular exchanges, as this is a requirement of the authorities of the US and a number of other countries. After verification, you can buy cryptocurrencies directly from your bank card. Then you can exchange one token for another, sell them for real money, withdraw funds back to the card, or withdraw crypto to a personal crypto wallet created outside the exchange (for example, on Metamask).

Having cryptocurrency in your wallet, you can easily trade on decentralized exchanges. You can exchange any pair of cryptocurrencies that are available on a particular DEX, if there is enough liquidity on the exchange to make this trade. Luckily, the liquidity is almost always plentiful for popular pairs (such as ETH-USDT).

Many centralized and decentralized exchanges also have their own tokens. For example, WBT on WhiteBIT or WSD on WhiteSwap. Such tokens can be stored for a long time or used for trading.

Is cryptocurrency safe

When used correctly, cryptocurrencies are safer than fiat money. The wallet itself is protected by cryptography, and no one can steal your funds from there. However, there are risks associated with the vulnerability of centralized crypto exchanges, market volatility, scam tokens, scammers, and so on. The crypto world calls for caution.

Fiat currency vs Cryptocurrency

To date, cryptocurrency remains far behind traditional money in terms of volume and prevalence. At the time of writing, the entire crypto market is approximately equal to $857 billion, while today there are more than $5.4 trillion in circulation of US dollars alone. Therefore, it’s too early to compare cryptocurrency and traditional money on an equal footing.

However, you can look at it from the other side. The crypto market in general is constantly going up. More and more countries allow the use of it for payment, more and more blockchain startups and technologies appear, and crypto investments are growing. This is a global trend. And if it persists, then soon we will be able to seriously consider cryptocurrency as an alternative to fiat money.

Cryptocurrencies appeared in 2009. By historical standards, this is quite recent. What is cryptocurrency today? This is still a very young technology. So this is just the beginning…

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