What is Cryptocurrency?

By Kirsteen Mackay

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Cryptocurrency is a digital currency secured by cryptography. Its unique and winning formula is the cryptographic design that makes it secure and unbreakable.

Cryptocurrency is a digital currency secured by cryptography. Its unique and winning formula is the cryptographic design that makes it secure and unbreakable.

It all started back in 2008, when Bitcoin was born – a brand-new form of currency at home in the digital realm. In the ensuing years, Bitcoin has evolved to spawn many hundreds of different forms of cryptocurrency.

This digital or virtual currency is tightly secured by cryptography, making it nigh on impossible to counterfeit, hack, or double-spend.

Some of these newer cryptocurrencies now rival Bitcoin and are worthy opponents in the cryptocurrency space. Ethereum, Cardano, Tether, XRP, Binance Coin, and Polkadot are all such cryptocurrencies.

There are many more, including joke crypto, such as Dogecoin, which has caught the imagination of the masses, realizing remarkable value in a short space of time.

In its short life, cryptocurrency has courted much controversy. Central banks are now planning their own versions of a digital currency, and governments are looking at ways to regulate it.

Who invented cryptocurrency?

Satoshi Nakamoto is the anonymous creator of Bitcoin and he is credited as the first person to implement blockchain.


Nakamoto’s identity has not yet been discovered, but some people have claimed to be him (Dr. Craig Wright). While others have been suspected (Dorian Nakamoto, Elon Musk, and several more).


In February 2009, Nakamoto posted about Bitcoin publicly. In an online forum, he explained how Bitcoin could be the answer to an open-source peer-to-peer (P2P) electronic cash system. This, he believed, could solve trust issues associated with the use of conventional currency.

However, the idea behind a digital currency is not new. The global currencies in existence today already have a major digital footprint as we shift to a cashless society. But technically, cryptocurrency is an offshoot of digital currency.

The big difference with Bitcoin, the first global cryptocurrency, is its lawless nature. No single government controls it.

Cryptography is the secret ingredient that makes Bitcoin such a compelling idea. It secures each transaction while ensuring anonymity.

However, the twist in the tale is its use of the Blockchain, a digital ledger where each transaction is recorded in a decentralized location. This means it can’t ever be erased, so there is forever a digital footprint of the transaction.

While the user’s identity should remain protected by cryptography, the blockchain record leaves a detectable forensic trail.

For instance, via the exchange that the coins are purchased from. The FBI has used this to track down criminals using Bitcoin for shady dealings.

How cryptocurrency works

There are currently two popular ways to generate cryptocurrency—Proof of Work and Proof of Stake.

Bitcoin is a Proof of Work crypto.

What is Proof of Work?

New Bitcoin is produced through the process of ‘mining’ using complex computations.

The computer mining for Bitcoin has to solve a convoluted mathematical puzzle. And the first to solve it wins the Bitcoin.

Few machines were solving the puzzles initially, so those with the more powerful computers could solve the equation quickest and win the new Bitcoins.

As the idea of mining for Bitcoin caught on, and as more and more powerful computers were invented, the race was on.

But the faster an equation is solved, the more difficult each equation becomes. This naturally slows the discovery of all the Bitcoin in circulation.

Nowadays, there are major Bitcoin mining farms concentrated in small pockets of the world. These are the entities generating the newest Bitcoin. But the previously mined Bitcoin is also still circulating and exchanging between wallets for vast sums of money.

In the beginning, Bitcoin was worth so little, individuals mining on their laptops could generate thousands of them.

It didn’t rise to be worth over a dollar until 2011. But its value has exploded since then.

During the first half of 2021, the value of Bitcoin fluctuated between $29k and close to $64k.


Bitcoin’s high monetary value comes from three main factors:

1. being first to market
2. having a cult following
3. its limited supply of 21 million coins


What is Proof of Stake?

Many copycat digital currencies also run on Proof of Work. But there are now a new group of cryptocurrencies adopting the next-generation technology, deemed Proof of Stake.

Rather than winning the race to generate new coins via sheer computing power, with Proof of Stake, the miner must put up collateral. They need skin in the game to pledge money to make money.

This is technically a fairer way to generate new coins because it levels the playing field.

In Proof of Work, the computer solving the equation gets the new Bitcoin, but in Proof of Stake, the user or entity searching for the coin must match their search with a certain number of coins.

Therefore, the more coins the miner stakes, the more mining power they have. A user can buy coins to get started, then stake those coins to generate more.

Whereas in Proof of Work, the miner needs computational power to get ahead, in Proof of Stake, they need hard cash. Both are limiting.

The reason Proof of Stake is proving the more popular choice is twofold:

  1. It doesn’t require the massive amount of energy Proof of Work takes.

  2. It’s unlikely to be attacked by a malicious force.

In Proof of Work, the largest mining entities could potentially take 51% of the hashing power and attack the network. But attempting to do this in Proof of Stake would be counterproductive because that user would have the most to lose.

Ethereum is moving to a Proof of Stake framework. Cardano, Polkadot, NEO, Algorand, Cosmos, Peercoin, Nxt, and BlackCoin all use Proof of Stake.

Types of Cryptocurrency

Today there are three main types of cryptocurrencies.

These are Bitcoin, altcoins, and tokens.

Bitcoin we’ve described above.

Altcoins are alternative cryptocurrency coins that emerged after Bitcoin. Namecoin was the first altcoin to appear. It used Bitcoin’s code and arrived in 2011.

Examples of altcoins circulating today include Cardano, Litecoin, and NEO.

Thirdly we have crypto tokens or dApps (decentralized applications).

Examples of crypto tokens include Dogecoin ($DOGE), Tether ($USDT), USD Coin ($USDC), and Uniswap (UNI).

Augur is a dApp built on the Ethereum blockchain. While Sushi, FarmHero, and Polycat Finance are dApps created using the Polygon framework. Polygon itself is built on Ethereum.

According to Statista, there were over 4,500 cryptocurrencies in February 2021.

Advantages of Cryptocurrency

Realistically, the biggest draw for investors in cryptocurrency is the chance to make large sums of money.

Autonomy

Philosophically, its biggest draw is its freedom from regulation. Cryptocurrency essentially offers owners a form of autonomy where they can self-govern over their own money than traditional fiat currencies offer. But this view is idealistic. In reality, governments have more control over users transacting in crypto than fundamentalists like to think.

Purchasing power

Cryptocurrency can be used to buy some goods and services. But this is still in the early stages and not yet a widely adopted form of currency for real-world use.

The decentralized nature of cryptocurrency and its transparency on the blockchain give users protection from payment fraud.

Fast and affordable

Cryptocurrency is highly appealing as a fairer way to transact across borders and in emerging markets where many people have no personal access to a bank account.

Cross-border transactions are settled quickly and cheaply.

For the sender, it can be as simple as sending an email, whereas sending money internationally using a bank transfer is never straightforward.

Disadvantages of Cryptocurrency

Being a first-mover crypto may provide credibility, but it gives rise to a wave of competitors that can quickly copy this success. This is precisely what’s happening with many of the original cryptocurrencies, giving rise to thousands of digital currencies.

Corruption

The lack of regulation or central control leads to corruption and criminal activity.

Countless scams are operating across the internet promoting cryptocurrency, particularly when it comes to the latest wave of token hype.

There is extreme volatility in cryptocurrency markets. This makes the potential for large losses inevitable.

Cryptocurrency also encourages black market activity.

There’s also been a steep increase in the number of ransomware attacks and hacking attempts demanding cryptocurrency in payment.

No protection

If a user has their cryptocurrency stolen, they’ll not be eligible for a refund because it’s not backed by any treasury or government guarantee.

Cryptocurrency can be stolen and is vulnerable to the security of the exchange in which it is held.

Therefore, the safest way to store cryptocurrency is in cold storage – a physical wallet or hard drive not connected to the internet. Some serious crypto enthusiasts have gone so far as to store it in a vault under a mountain in Switzerland.

Taxable events

Cryptocurrency can be converted to cash or exchanged with another cryptocurrency. But each transaction may trigger a taxable event. Therefore, crypto investors and traders must be careful not to accumulate a big tax bill due to cryptocurrency volatility.

For instance, if you buy Bitcoin for $30,000, it rises in value to $35,000, you trade it for Ethereum (for a $5k gain), then the value of Ethereum drops to $20,000 – you may still be eligible for tax on the $5k gain.

This is dependent on the transaction dates and jurisdiction, but many countries do tax crypto gains. However, any crypto losses can often be offset against gains.

Where’s the value?

  • Secret, speedy and super cheap: cryptocurrency transactions offer a level of anonymity and transactions are fast and cheap.

  • A level playing field for all: the peer-to-peer nature of transacting levels the playing field. Individuals can transact with one another anywhere in the world.

  • It’s easy to get started: a smartphone and internet connection are all that is needed to transact in crypto. This lowers the barrier to entry.

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Cryptocurrency

Author: Kirsteen Mackay

This article does not provide any financial advice and is not a recommendation to deal in any securities or product. Investments may fall in value and an investor may lose some or all of their investment. Past performance is not an indicator of future performance.

Kirsteen Mackay currently holds a position or positions in the stock(s) and/or financial instrument(s) mentioned in the above article.

Kirsteen Mackay has not been paid to produce this piece by the company or companies mentioned above.