Cryptocurrency for Dummies
Updated · Jun 03, 2022
Cryptocurrency has been a buzzword for more than a decade now. If you still don’t know what it conveys, you’re not alone. We’ve made a cryptocurrency for dummies guide, because, honestly, everyone could use one. Let’s begin!
What Is Cryptocurrency (for Dummies)?
“Cryptocurrency” is a blend of cryptography and currency.
This fintech (financial technology) solution lets you move digital assets between individual parties securely using encryption and decryption.
In short, crypto serves as an alternative to our current financial and monetary systems. It’s also changing how the internet itself works.
The crypto world consists of technologists, nonprofits, for-profit organizations, and investors that play distinct roles.
At the time of writing cryptocurrency for beginners guide, the total market capitalization was over $1.4 trillion.
“Cryptocurrency” isn’t necessarily the same as “a cryptocurrency”, however. Semantics is perhaps the biggest challenge newbies have to contend with when exploring the world of crypto.
To truly grasp the basics of cryptocurrency, realize that bitcoin is just one of the thousands of cryptos. On some occasions, a cryptocurrency may not necessarily pertain to a virtual currency either.
A cryptocurrency can mean different things. You have to be aware of every context in which people use the term to understand the crypto economy more easily.
So what are cryptocurrencies?
Cryptocurrencies Are Engineering Projects
Every cryptocurrency is a fintech project conceived to address a real-world problem.
The creation of Bitcoin was revolutionary, for it has leveraged existing technologies that were previously never used together.
To name a few, Bitcoin uses:
- peer-to-peer (P2P) network
- cryptographic hashing functions
- the Proof-of-Work (PoW) consensus mechanism.
Despite Bitcoin’s elegance, there was no guarantee that it would get this big when it was rolled out. Plus, to this day it is a work in progress
So far, the greatest achievement of the first crypto project was inspiring software engineers to improve on it. Its code is open-source, giving technologists a cheat sheet for building their own blockchains.
The crypto domain has taken on a life of its own. Thanks to Ethereum (the second-most popular crypto), it’s suddenly easy to get cryptocurrency projects off the ground through initial coin offerings (ICOs).
However, not every project is a paradigm shifter.
Due to the relative ease of cryptocurrency creation and quick access to capital, Ponzi schemes have infiltrated the cryptocurrency market. Also, some engineers have brought silly cryptos to life just because they could.
The current cryptocurrency boom has many similarities to the dot-com bubble in the ‘90s.
Back then, almost every tech stock was hot. But only those with real value survived to this day.
Many crypto projects will probably suffer the same fate as the now-defunct internet startups of the dot-com era. But the ones whose networks grows the biggest will be able to stay relevant in the long term.
Cryptocurrencies Are Protocols
Protocols are the underlying code that dictate how cryptocurrencies work. They’re sets of processes that define how entities can exchange information.
The internet uses different protocols on which sites run. Internet apps can use the same protocols.
Conversely, cryptocurrency protocols (also called blockchain protocols) are unique from one another. It’s the reason why a blockchain doesn’t operate exactly in the same way as another.
Decentralization sets the said two protocol types apart.
Cryptocurrency protocols allow just a single or a few apps to run on them. Internet protocols, on the other hand, let thousands or even millions of apps function.
Cryptocurrency protocols usher in Web 3.0 and the Internet of Value. More on this later.
The protocol is what gives cryptocurrency value. It’s a vital part of how cryptocurrencies work.
It determines a project’s tokenomics, defining the generation and distribution of crypto.
Also, protocols set the rules for achieving consensus when validating transactions and incentivizing network participants.
As long as you trust what the protocol permits, you don’t have to rely on an individual party. You can expect everyone to behave accordingly.
Cryptocurrency protocols aren’t static. They go through updates to scale and keep up with demand.
Who decides what changes to pursue or abandon depends on a crypto’s governance system. Generally, the community makes decisions through deliberation, persuasion, and volition.
No one can stop you from cloning an existing blockchain and making it your own to implement the upgrades others don’t agree with. That’s why Bitcoin Cash is available for trade independently from the original Bitcoin cryptocurrency.
Many engineers draw inspiration from open-source blockchain software. Others create entirely new cryptocurrency protocols from scratch.
Taking the path less traveled is an effective way to introduce unseen innovations. Novel protocols arise when comparable technically inadequate blockchains can’t support certain use cases.
Cryptocurrencies Are P2P Networks
What is the point of cryptocurrency?
So, our next cryptocurrency for beginners lesson is about it.
Every cryptocurrency uses a decentralized communication model where peers (also called nodes) can exchange data without a central server. In other words, global networks of computers validate and add records to blockchains.
Node operators participate in cryptocurrency networks to earn incentive. They get paid for ensuring the integrity of their chosen blockchains in the form of block rewards, transaction fees, etc.
Cryptocurrencies can use different consensus algorithms to define the network’s decision-making process. Such mechanisms are necessary to keep the blockchains updated and to ensure everybody in the network has identical records.
Ideally, any party with an ordinary computer should be able to join any crypto network. However, devices designed for everyday use are no match to the computing power of mining-optimized hardware.
Any enlightening article about cryptocurrency for dummies would admit that hardware advancement has hurt Bitcoin’s decentralization.
Mining pools (groups of independent miners who agree to work together) dominate the current Bitcoin network. They combine their resources to increase their chances of earning rewards and then split the profits they rake in accordingly.
Maybe the only downside to highly decentralized cryptocurrency networks is the threat of cryptojacking malware. The more not-so-tech-savvy individuals can actively participate in crypto networks, the more vulnerable they are to hackers.
Cryptocurrencies Are Digital Assets
Cryptos don’t have a physical form. Every digital currency is merely a programmable asset that’s nothing but data on the computer screen. That’s why it can be difficult to imagine bitcoin replacing real money.
Crypto is native to the internet. The most tangible representations of cryptocurrencies are the pieces of hardware storing the private keys to them.
Cryptocurrencies Are Blockchain Residents
Cryptocurrency and blockchain are inseparable. So when you buy cryptos, you can’t really take them with you.
So, how does cryptocurrency work if it doesn’t leave the blockchain?
It’s all about private key custody. As long as you control and secure the private keys to your crypto assets, nobody could steal your funds.
Your cryptocurrency wallets contain privacy keys to your assets and enable you to do transactions. They allow you to sign transactions, encrypting them in the process.
Private keys generate their corresponding public keys. The latter generate wallet addresses, which are what other parties need to send cryptos to you.
Crypto networks use your public keys to decrypt your encrypted transactions.
Once decrypted, network participants can verify if your private keys (without exposing them) were used to sign the transactions initiated. Then, the nodes can check whether you have sufficient funds, confirm the transactions, and permanently record them on their respective blockchains.
Cryptocurrencies Are Mediums of Exchange
Like fiat currencies, cryptocurrencies enable you to obtain goods, services, or both. How efficient one is as a medium of exchange and where you can spend it is another story.
You can use some cryptocurrencies for payment without a centralized intermediary. Bitcoin is the best example.
If you’re wondering, what's the point of bitcoin? It’s a form of electronic cash exchangeable directly between peers.
Unlike every fiat currency, bitcoin is beyond the control of any government and knows no boundaries. Its censorship resistance makes it convenient to send to or to receive from any party located in any jurisdiction. Best of all, it’s proof against confiscation.
Bitcoin is pseudo-anonymous. Your transactions in it won’t reveal your identity to the network. It’s neutral and permissionless. Anybody can use this crypto money without discrimination.
Bitcoin isn’t the most efficient medium of exchange among the cryptocurrencies of its kind, however.
On average, it takes 10 minutes to confirm a bitcoin transaction. In times of extraordinary network congestion, transactions could go unconfirmed for days or even weeks.
Many comparable cryptocurrencies are better than bitcoin in certain areas.
Bitcoin Cash is more scalable. Litecoin delivers faster transaction processing and charges cheaper fees. Monero’s XMR, Zcash’s ZEC, and Bytecoin’s BCN offer greater privacy.
Despite the top cryptocurrency’s technical downfalls, 11% of its holders use it to pay for goods and services.
The majority of bitcoin investors don’t barter this crypto for anything else, though. That’s because of its extremely limited supply.
Furthermore, some cryptos are protocol tokens. They’re the native tokens on cryptocurrency protocols.
Also, there are app coins. These cryptocurrencies are valuable only in their corresponding apps, which are built on top of protocols.
Usage tokens represent one of the two groups of app coins that function as mediums of exchange.
Likewise, utility tokens are cryptocurrencies that work similarly to digital coupons. Usually, investors can get them during ICOs. Holders can spend them to access services offered on the crypto platforms on which the utility tokens natively reside.
Is it possible to spend blockchain currencies outside of the crypto space?
Yes, it is!
On May 22, 2010, a bitcoiner made history by using a cryptocurrency to buy two Papa John’s pizzas from a private individual for 10,000 bitcoin. It’s the first time that someone used crypto money to purchase anything from the real world.
By 2021, some merchants had been accepting bitcoin and some altcoins. People in countries experiencing high inflation, however, have been gravitating more toward cryptos as mediums of exchange.
Cryptocurrencies Are Units of Account
Due to the relationship between blockchain and cryptocurrency, there’s no questioning the utility of cryptos as units of account.
Cryptos are divisible, countable, and fungible. You can use them for valuing goods and services, calculations, and recording financial transactions like payments or debts.
Cryptocurrencies Are Stores of Value
A store of value is an asset whose worth grows or stays the same no matter what happens.
So, considering the market’s infamous roller-coaster price movement, how does cryptocurrency work as a store of value?
Every asset in the world experiences price fluctuations. But the historical price performance of bitcoin has been exceptional. It can actually preserve your wealth, despite being known for its boom-bust cycles and bubbles.
Bitcoin’s 2011-2020 compound annual growth rate has been about 200%. Based on this benchmark, the king crypto has outperformed gold and the S&P 500 over any multi-year period.
Other than bitcoin, most cryptocurrencies aren’t good stores of value. The purchasing power of most altcoins is unreliable because of their small valuations. The majority of them are speculative assets at best.
The few exceptions are stablecoins. These altcoins are collateralized. They’re usually pegged to fiat currencies, other cryptos, and/or commodities.
Some stablecoins are non-collateralized. Smart contracts regulate their prices.
Cryptocurrencies Are Investment Vehicles
Cryptocurrencies are liquid assets you can hold to generate returns. Security tokens, a category of altcoins, give you a voice in the governance of the corresponding crypto projects. Some of them function like company stocks and provide dividend payouts.
You can do spot transactions to get your crypto-assets instantly. Or, you can do bitcoin trading using derivatives like options, futures, or swaps. These high-risk financial instruments can be useful for hedging against risk. They can help offset any losses if you take opposite positions on the same cryptos.
If you want to know how to invest in bitcoin and altcoins with less risk, strongly consider exchange-traded products.
Many governments classify cryptocurrencies as property. So, selling them at a profit is a taxable event under certain jurisdictions.
Cryptocurrencies can satisfy the traditional definition of financial assets, which should be subject to securities laws. But there’s still lots of legal confusion about this matter.
In 2018, some officials of the U.S. Securities and Exchange Commission (SEC) said that bitcoin and ether shouldn’t be regulated like stocks and bonds. But the same agency initiated a lawsuit against Ripple for its alleged unregistered sales of XRP tokens.
So what is cryptocurrency as an investment vehicle, officially?
For the time being, it’s unclear which cryptocurrencies the SEC categorically views as securities. The regulator could still change its position on bitcoin and ether and spread doubt.
Keep this in mind when researching how to invest in bitcoin and altcoins.
Cryptocurrencies Are Brands
Many crypto investors can’t tell the difference between value and price. That’s why the valuations of assets with little to no practical value could skyrocket.
As brands, cryptocurrencies represent different ideals.
The Bitcoin community believes that the top crypto is the best hedge against inflation. They also view it as superior to the US dollar as a reserve asset.
The Ethereum community is made up of individuals that support the decentralization of the internet and open-source collaboration.
The Dogecoin community attracts the same breed of rebels that have gotten behind GameStop.
Blockchain currencies with large followings tend to accumulate considerable capital through social proof.
They seem more newsworthy than others, so they frequently hit the headlines in cryptocurrency news sites and not only. Good or bad press, they regularly get tons of media mileage. And the more popular they get, the more obscure others become.
That’s why the bitcoin cryptocurrency copycats tend to have relatively high valuations. Many casual investors think that they’re as valuable as the original just because they have “Bitcoin” in their names.
Crypto founders understand the power of branding to attain success
The taglines “Litecoin is silver to Bitcoin’s gold” and “Cardano is the Ethereum killer” are the reason why Litecoin and Cardano are highly regarded in their niches.
It’s no wonder why Mark Zuckerberg and Co. have repackaged Facebook Libra as Facebook Diem. Keeping the Libra brand could end the crypto project for good since it roused the ire of governments years ago.
Bitcoin has endured more brand assassination attempts throughout its history. But it hasn’t gone the way of Libra.
Other than its solid fundamental qualities, the mystery surrounding its creator Satoshi Nakamoto has made Bitcoin harder to attack.
Nakamoto walked away from the project on December 10, 2010. Since then, the network has had no single prominent figurehead. The facelessness of Bitcoin makes it seem more egalitarian than most cryptocurrency networks.
The fact that nobody has been able to unmask the top crypto’s inventor reinforces the Bitcoin brand as a groundbreaker.
Also, Nakamoto’s publicly known bitcoin wallet is still dormant to this day. So, no one could accuse this legendary character of a profiteer.
How Does Cryptocurrency Work?
As discussed in this cryptocurrency for dummies guide, cryptos operate distinctively from one another. Each one of them tries to be unique and accomplish different things.
In general, the nature of crypto is decentralized and private. One uses a P2P network to maintain its distributed ledger.
Network participants can sanction transactions privately and securely. The network checks whether the sending party does have sufficient funds before approving the transfer.
A consensus mechanism keeps individual network participants honest. The majority has to agree during the data verification phase before permanently adding it to the blockchain.
This system prevents double-spending. It’s a phenomenon where an asset owner reproduces a digital currency and spends it multiple times.
In a PoW system, miners invest in expensive hardware and consume enormous amounts of electricity to participate in a cryptocurrency network. They make money through transaction fees on top of the crypto reward they receive for their work.
A cryptocurrency protocol sets the rules, although it’s not necessarily set in stone. A crypto’s governance system provides a means of upgrading the infrastructure to scale as demand increases.
Cryptocurrencies are made up of interdependent foundational technologies. If one is missing, everything could crumble. That’s why cryptocurrency and blockchain usually go together.
What Is Blockchain?
Giving that this is a guide to cryptocurrency for dummies, we won’t focus on blockchain. But to put it simply, it’s a type of decentralized distributed ledger.
Blockchains store small batches of transactions in blocks and chain them together chronologically. Hence, the term “blockchain”.
Transparency, however, isn’t always one of the basics of blockchain. Not all blockchains are public. Private ones don’t belong to the people, but to centralized entities.
Staunch crypto advocates look down on private blockchains. These ledgers can have overpowered operators that can deny access to participants and can tamper with data records.
How Can You Buy Cryptocurrency?
Basically, all you need is an internet-connected electronic device. Then, download and set up a software cryptocurrency wallet and begin depositing funds.
However, not all software wallets support the use of the US dollar and other fiat currencies. For this reason, you’ll have to buy cryptocurrencies somewhere else first.
Fortunately, there’s an abundance of ways to get your hands on cryptos these days.
The world of cryptocurrency is a bewildering place to navigate.
It’s impossible to understand how each one works at the technical level. Hopefully, our cryptocurrency for beginners guide will give you enough confidence to invest in cryptocurrency.
Well, you’re ready to continue on this path on your own.
Good luck! Our guide will always be here for you to consult.
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Romj is a veteran copywriter who used to be a Jack of all trades. Now, he's trying to be a master of one: technology. He jumps down the rabbit hole to size the latest innovations up. As a content contributor for TechJury, he hopes to help you keep up in our fast-paced world with his discoveries.
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