Cryptocurrencies are all the talk for the last few years. More and more people are looking to invest in one, making them the next big thing in the world of finance. But what are cryptocurrencies exactly? We have some information to get you started.
Most cryptocurrencies are decentralised networks that rely on ‘blockchain’ technology. Blockchain technology is a distributed ledger enforced by a network of computers. A stand-out feature of cryptocurrency is that it is not issued by any central authority which makes them indifferent to government interference or manipulation. However, as cryptocurrencies are becoming more and more popular, that might be changing.
How do they work?
Cryptocurrencies are digital or virtual currencies that run on cryptographic systems. They enable secure online payments without any third party interference. “Crypto” refers to several encryption algorithms and cryptographic techniques that secure these entries. Some examples include elliptical curve encryption, public-private key pairs, and hashing functions.
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Cryptocurrencies can be mined or bought from cryptocurrency exchanges. Some companies allow you to buy their products and services using cryptocurrencies in certain parts of the world. To some extent, cryptocurrencies can also be used for cross-border transfers.
What is blockchain technology?
A crucial element for the functioning of cryptocurrencies is blockchain technology. As the name suggests, a blockchain is essentially a set of connected blocks or an online ledger. Each block contains a set of transactions that have been independently verified by every single member of the network. Every new block generated has to be verified by each node before being confirmed. This makes it practically impossible to forge transaction histories. The contents of the online ledger must be accepted by the whole network of an individual node, or by the computer maintaining a copy of the ledger.
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Experts say that blockchain technology can be useful for multiple industries, and processes such as online voting and crowdfunding. Some financial institutions are also looking at blockchain technology as a way of lowering transaction costs by streamlining the payment process.
What are some of the types of cryptocurrencies?
Bitcoin is the most popular and valuable cryptocurrency. An anonymous person named Satoshi Nakamoto is said to have introduced it in 2008 via a white paper. Today, along with Bitcoin, there are thousands of cryptocurrencies in the market today.
The types vary according to their function and specification. For instance, Ripple’s XRP is used by banks to facilitate transfers across the world.
Bitcoin, though, remains the most widely circulated and traded cryptocurrency. As of November 2021, there were over 18.8 million bitcoins in circulation around the world amounting to a value of $1.2 trillion.
Following the success of Bitcoin, several other cryptocurrencies known as ‘altcoins’ have been launched. Some of these are clones of bitcoins, while others have been built from scratch. Some examples of altcoins include Solana, Litecoin and EOS.
Advantages of cryptocurrencies
Cryptocurrencies present a new form of system which do not require a need of an intermediary to oversee the transaction between two entities. Thus, cryptocurrencies get rid of the possibility of a single point of failure, such as a large bank, and therefore, prevent a cascade of crises like the financial crisis of 2008.
Since they do not require third-party intermediaries, the transactions are a lot faster compared to standard money transfers.
Cryptocurrencies are becoming a lucrative option for investment. The value of cryptocurrencies has skyrocketed in the past few years and at one point it had almost reached $1 trillion.
Cryptocurrencies are being used for cross-border money transfers. Some of them like bitcoins serve as mediators for cross border money transfers. Thus, a fiat currency of one country is converted into cryptocurrency, transferred wherever desired, and converted into the fiat currency of that country. This process makes money transfers a seamless process.
Disadvantages of cryptocurrencies
Cryptocurrencies are not exactly anonymous. They can be best described as pseudo-anonymous. They leave a digital trailer that well-equipped agencies like the Federal Bureau of Investigation (FBI) can track. It can result in government agencies tracking digital payments of ordinary citizens raising concerns around ethics and privacy.
Cryptocurrencies have already become popular with criminals for acts like money laundering for illicit purposes. They are also famous amongst hackers who use them for ransomware activities.
In theory, cryptocurrencies are meant to be decentralised. However, they are highly concentrated. For example, a study by MIT found that just 11,000 investors held about 45% of Bitcoin’s surging value.
It can be mined by anyone with a computer and a stable internet connection. However, mining crypto currencies require unimaginably large amounts of energy. The high-energy costs mean that mining cryptocurrency is done only by companies that are wealthy enough to do it, creating tremendous inequality.
Although cryptocurrencies are extremely secure, they are not foolproof. They still pose danger from hackers. Instances of wallets being hacked are not uncommon, resulting in millions of worth of cryptocurrencies being stolen.
The cryptocurrency market is highly volatile, making investments risky.
Feature Image credit – Unsplash/André François McKenzie