You most likely have heard of blockchain, proof-of-work, mining, staking, and many other cryptocurrency-related technical terms. But, if you are like many people, and don't understand any of it, keep reading this article, as I will explain the basics of cryptocurrency. Even if you don't want to invest in cryptocurrency, it is still interesting to understand why there is so much fuss and why some people are so vocal about it. In other words, why do some people believe it will change our economy, and why do some people believe it's worth nothing?
Definition
Let's start with a small definition. Cryptocurrency is digital money built on blockchain technology. The blockchain is a database shared on a computer network. This blockchain makes the cryptocurrency decentralized, which means it is not controlled by one institution but by the system itself. Cryptocurrency is currently the most famous use of blockchain technology, although there are already some other promising applications like NFTs.
Why is it important?
You might wonder why people make such a fuss about digital money when we are already using fiat money, such as US dollars or euros, and making bank transfers without any issue. The main reason for this enthusiasm is that cryptocurrencies promise to solve some of the shortcomings of fiat money:
Corruption is an unfortunate reality in most countries, as cash and some bank transfers are not easily traceable. Blockchain technology can discourage corruption because every cryptocurrency exchange can be traced, making it much more difficult to hide money where everyone can see it.
Many banks have obscure conditions and charge high fees when transferring money overseas or exchanging currencies. And those transfers can take days. Cryptocurrency transaction fees are comparatively meager when trading (especially for large transactions), and transfers are instantaneous.
People see cryptocurrencies as a great investment opportunity that will significantly increase in value over time.
These are only some of the examples of solutions provided by cryptocurrencies. However, they also pose many challenges.
Most cryptocurrencies are highly volatile. It is common to see cryptocurrencies like Bitcoin lose or gain 30% of their market value over a period of a month or less. Therefore, if you live paycheck to paycheck, you might face significant issues if you receive your salary in cryptocurrency.
Cryptocurrencies are technologies. Like any technology, they could be replaced by a better one, and investors are wary about investing everything in a technology that could be obsolete in a couple of years.
All activity around crypto is consuming huge amounts of energy, negatively impacting the environment. In 2022, it was reported that Bitcoin mining consumed more energy than Norway. Although many investors want crypto companies to use renewable energy sources, it is currently only the case for a relatively small proportion of the traffic.
At present, there are over 23,000 cryptocurrencies, which is a large panel to choose from if you are interested in investing in them. Moreover, the number of coins grows every day because technology evolves and improves. For now, let's describe some of the most famous cryptos.
Bitcoin
Bitcoin was the first cryptocurrency ever created and although technology and cryptocurrency have improved a lot since then, Bitcoin is by far the most prominent cryptocurrency in the world today, with a total market capitalization of about $520 billion. Its creator, Satoshi Nakamoto (2008) describes the invention of Bitcoin as a system for electronic transactions relying not on trust, but a peer-to-peer network using proof-of-work to record transactions.
Ethereum
If Bitcoin is considered the gold of cryptocurrency, then Ethereum is the silver. It is the second biggest cryptocurrency, with a total market capitalization of about $226 billion. Ethereum was created in 2015 by Vitalik Buterin, inspired by Bitcoin; this technology can be used for transactions and recording assets. It is also programmable, and people can build applications on its blockchain. That's a big difference between these two assets as it allows the creation and use of smart contracts to build and deploy decentralized applications on its network without a middleman. For example, you can use this technology to receive payment of royalties. As Ethereum describes itself: "While Bitcoin is only a payment network, Ethereum is more like a marketplace of financial services, games, social networks and other apps that respect your privacy and cannot censor you"
Cardano
Cardano is the first cryptocurrency to be built on a proof-of-stake blockchain platform which works fundamentally differently than the proof-of-work to record transactions on the blockchain:
Proof-of-work. This used to be the traditional way all cryptocurrencies operated. Miners must solve complex cryptographical puzzles to create a new block and write the transaction on the blockchain. Those blocks of cryptocurrencies reward miners, but the computing power necessary to mine them has drastically increased over the years.
Proof-of-stake. This is considered an improvement on the proof-of-work system. Instead of having powerful computers mining on the blockchain, staking is about putting your cryptocurrency aside, locked for a specific period, to contribute to the blockchain. Unlike proof-of-work, proof-of-stake does not reward new blocks of cryptocurrencies as mining does, but a share of the transaction fee. This operation is much more cost-effective and less energy-intensive.
This was an important innovation in the crypto sphere. Even Ethereum changed from a proof-of-work to a proof-of-stake model in 2022. This technology is considered more efficient and doesn't require active work to record transactions on the blockchain.
Conclusion
Cryptocurrency is digital money built on the blockchain that aims to solve many issues of the current fiat currency we are using every day. Many people believe that cryptocurrencies will change the way we live and our economy. It's a transformative concept with the potential to revolutionize the financial landscape through its decentralization, security, and borderless transactions. It has gained widespread popularity and showcases promising resilience and potential. Will it happen? Only time will tell.
Sources
Cryptocurrency investing for dummies by Kiana Danial (2019)
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