What are cryptocurrencies and how do they work?

09 Aug 2018

What are cryptocurrencies and how do they work?

Nowadays, cryptocurrencies have become a worldwide phenomenon that most people have heard about. Although somehow they are still unusual and are not understood by most people, banks, governments and many companies are aware of their importance.

In the near future you will have trouble finding a major bank, a large accounting firm, a prominent software company or a government that has not used cryptocurrencies or started a project using blockchain.

What Are Cryptocurrencies?

Cryptocurrency or cryptocurrency has many definitions. A cryptocurrency can be defined as a digital currency created from a computer code. A cryptocurrency can also be defined as a string of coded data to indicate a unit of currency. Cryptocurrencies are also known as digital currencies. There are many cryptocurrencies, the most popular is bitcoin. Unlike conventional currencies, cryptocurrencies are free of government regulation and manipulation. They are monitored through P2P Internet protocols.

Cryptocurrencies are created through mining, that is, by adding transaction records to the public ledger of the cryptocurrency in question. Cryptocurrency transactions occur instantly and are known throughout the network. The transactions must be confirmed to be finalized. Cryptocurrency transactions are not reversible or falsifiable when they are confirmed.

To understand cryptocurrency in depth, you need to understand its revolutionary, transactional and monetary properties.

Revolutionary Features of Cryptocurrencies

Cryptocurrencies differ from regular currencies because of their revolutionary features. As mentioned above, cryptocurrencies do not have a regulatory body, that is, a government or a central bank that can create or influence its supply or demand. Cryptocurrencies are not just entries in a database, as is the case with conventional currencies. The cryptocurrency databases cannot be changed by any person you cannot see or by any rules you do not know.

Cryptocurrencies derive their name from the fact that their consensus maintenance is ensured using strong cryptography. Unlike regular currencies, cryptocurrencies are guaranteed by mathematics and not by trust or people.

This makes cryptos favorable alternatives to regular currencies.

Transactional Features of Cryptocurrencies

Irreversibility

Transactions with cryptocurrencies are irreversible. Once a transaction is confirmed, no one can reverse it, including government agencies, creators of cryptocurrencies and miners.

Confidentiality

Cryptocurrencies are also anonymous, which means that accounts and transactions involving cryptocurrencies are not connected to any real world identity. Bitcoins are received through addresses that are simply random strings of approximately 30 characters. Although it is possible to evaluate the flow of cryptocurrency transactions, it is impossible to connect addresses with the identities of real world users. This property makes the crypto currencies have no equal with regard to confidentiality.

Speed

The cryptocurrency transactions are instantaneous; they are confirmed in minutes.

Global Reach

Cryptocurrency transactions take place in a worldwide network of computers that are indifferent to a user's physical location. You can send / receive money from anywhere.

Unmatched Security

Cryptocurrency funds are locked securely in a cryptography system that can only be accessed by the owner with a private key. The cryptocurrencies are protected by strong cryptography and numbers that are impossible to break.

No Restrictions

You are free to use your cryptocurrencies as you wish. You do not need any permission to use bitcoins. You can download the corresponding cryptocurrency software for free, install it and start receiving and sending bitcoins or any other cryptocurrency.

Monetary Features of Cryptocurrencies

Controlled Supply

Crypto currencies are attractive compared to conventional currency because their supply is controlled. The supply of cryptocurrencies like Bitcoin decreases with time. The supply is controlled using schedules written in the code. This simply means that the supply of any cryptocurrency at any time in the future can be estimated today.

No Debt

Unlike the fiduciary currency, cryptocurrencies are not created by debt. The cryptocurrencies represent themselves. Its existence is real, unlike that of fiat money.

How Do Cryptocurrencies Work?

Transactions are sent between pairs from cryptocurrency wallets by matching public codes that are related to users' private passwords (also known as cryptographic keys). Transactions carried out between peers are recorded in a public ledger of transactions known as blockchain. All users of the same cryptocurrency have access to the general ledger if they choose to download a full node wallet (instead of keeping their currencies in a wallet or a virtual wallet such as Coinbase). The amounts of the transactions are public, but the number of the account that sent the transaction is encrypted. Each transaction arrives at a digital cryptocurrency wallet. The one who owns the password of the wallet has the amount of cryptocurrency indicated in the general ledger.

When someone sends or receives cryptocurrencies by sending from one wallet to another using a set of private and public passwords, that transaction is queued to be added to the general ledger. Many transactions are added to one ledger at a time. These "blocks" of transactions are added sequentially. That's why the ledger and the technology behind it are called "blockchain." It is a "chain" of "blocks" of transactions.

History of Cryptocurrencies

The history of cryptocurrencies is not at all long. Yes, there were some digital currency systems before cryptocurrency appeared. Previous versions of digital currencies were strictly centralized, while these new forms of cryptocurrency, such as Bitcoin, are decentralized in nature.

Now, what is really interesting about crypto currencies is that they never intended to be invented as they are known today. Actually, it all started with the now famous Bitcoin and a man named Satoshi Nakamoto. Nakamoto's goal at the beginning was to create only an electronic peer-to-peer box system. For a long time, people had tried to create some kind of online digital cash system, but it had always failed due to centralization problems.

Satoshi Nakamoto knew that another attempt to build a centralized cash system online would only result in more flaws, so he decided to create a digital cash system that did not have centralized authority. And that's how Bitcoin was born. Yes, Satoshi Nakamoto invented Bitcoin, the first decentralized form of digital cash that does not have a central government or a control body. Bitcoin is intended to be owned by the entire Bitcoin community.

Nakamoto created Bitcoin in 2008 and its value exploded without question. At first it was worth a little more than a penny. However, its value grew very rapidly and in recent months it has risen to monumental levels. Recently, some downward movements have been noted, but the price of these assets is still high.

Returning to the creation of Bitcoin, the serious issue faced by Nakamoto was to stop the double spending, the fact that the owner of a currency spent the same money twice. The control over the expenditure and the amount of digital money present in the digital world were controlled by a central authority, so the previous digital currencies were always subject to centralization. Nakamoto discovered how to create a digital currency that did not require this central authority. In a decentralized digital currency system, each user or entity must agree on the balance and transaction of each account so that the entire system works.

However, Nakamoto was able to create this system of cryptocurrencies, in which a complete consensus of all parties is required, and if there is a disagreement between them, everything breaks down. All this could seem very complicated and almost impossible to execute, but Nakamoto and his invention of Bitcoin proved that another type of system is possible. Bitcoin and other cryptocurrencies demonstrate how there is no need for any type of central authority to control spending and account balances, provided there is full consensus among all parties involved.

As we said, the history of cryptocurrency is not very long, but it is certainly an interesting and eventful story. Now that cryptocurrencies such as Bitcoin have demonstrated their value and ability to operate in the real world, more and more banks, investment firms, commercial organizations and even retailers have begun to accept them as legitimate forms of currency and payment.

Most Common Cryptocurrencies

Since Nakamoto revealed his amazing innovation, dozens of decentralized cryptocurrencies have been launched. The amount of cryptocurrency available is more than 1700 and continues to grow. You can create a new cryptocurrency at any time. Some of the most popular and most valuable cryptocurrencies at the moment:

  • Bitcoin: The cryptocurrency with which it all began. Nowadays it is the most popular digital currency in the market although its legal status may vary depending on the country.
  • Ethereum: A programmable coin that uses the bases that Turing founded. It allows developers to create different distributed applications and technologies that do not work with Bitcoin.
  • Bitcoin Cash: A Bitcoin fork. Its origins are recent but its value has soared and now it is among the five main cryptocurrencies in terms of market capitalization.
  • Bitcoin Gold: Project based on Bitcoin but using other types of algorithms to be encrypted. For the rest, it follows the guidelines of the basic Bitcoin project.
  • Litecoin: A cryptocurrency that was created with the intention of being the 'digital silver' compared to the 'digital gold' of Bitcoin. It is also a Bitcoin fork, but unlike its predecessor, it can generate blocks four times faster and has a four times higher currency limit (8M).
  • Ripple: Unlike most crypto currencies, it does not use Blockchain to reach a consensus across the network for transactions. Instead, an iterative process of consensus is implemented, which makes it faster than Bitcoin, but also makes it vulnerable to hacker attacks.
  • Dash: A two-tier network. The first tier is the miners who secure the network and record the transactions, while the second one consists of master nodes that retransmit transactions and enable transaction types InstantSend and PrivateSend. The first is significantly faster than Bitcoin, while the second is completely anonymous.
  • BXP Chip Coin: The first Mexican cryptocurrency. You can use it and invest or bet with its development from this year.

What Can You Do with Cryptocurrencies?

Digital currencies can be used by businesses and commerce. It can have the following uses:

  • You can buy products

You can use cryptocurrencies for online and offline payments. You can use cryptocurrencies to pay for different goods: hotels, flights, jewelry, applications, computer parts, etc. like different online transactions.

  • You can invest

Currently, these crypto currencies are considered the most attractive investment opening available. Most people take it as an opportunity and invest without any hesitation. There are several people who claim to be millionaires through their investments in cryptocurrencies.

  • Commercial payments

You can accept cryptocurrencies as payment, such as accepting cash. You can withdraw cash. Coin ATM Radar currently lists around 1,800 ATMs in 58 countries.

The cryptocurrency market in Mexico is the largest in Latin America. Exchange, electronic and even property companies work with Bitcoin and other cryptocurrencies. Currently in the country all types of businesses already accept these payment methods, and the acquisition of these assets is possible even in convenience stores such as Seven Eleven.

How to obtain cryptocurrencies?

The most common ways of obtaining cryptocurrencies can be grouped into the following methods: Buy them with fiduciary money (current), receive them for goods or services provided, generate them through mining and lend or exchange them.

Buying

When you buy or sell cryptos, you buy the asset itself. As with any investment, you must buy and sell through an exchange platform, which requires you to create an account and store the cryptocurrency in your own wallet. You must also place the total value of the asset to open a position.

To buy and sell cryptocurrencies, you will need direct access to an exchange platform. If you are not familiar with the way they work, this implies their own learning curve: you will have to become familiar with the technology involved, as well as learn to make sense of the data.

You will also need your own account to trade on an exchange platform. These exchange accounts can turn out to be:

Slow to acquire: getting an account usually takes a few days, since you will join a queue of people waiting for manual approval.

Restrictive use: As the new owner of an account, you are probably limited to a deposit of a few hundred dollars per week.

Expensive to maintain: funds and withdrawals generally generate commissions, while some large exchanges only accept bank transfers, which may take several days.

Furthermore, without the infrastructure accumulated over years of commercial activity, these young companies can be slow to solve even direct customer service problems.

Trading

When trading CFD’s (contracts for difference), you speculate on whether the chosen market will increase or decrease in value. Prices are quoted in traditional currencies, and you never take possession of the cryptocurrency itself.

CFD bets are leveraged products that allow you to open a position with a fraction of the total value of the trade. In other words, you can get a large exposure to a financial market while only mobilizing a relatively small amount of capital. Just remember that while this can increase your profits, it can have the same effect on your losses.

In addition, because it is not necessary to deal with an exchange, you could be ready to operate in much less time.

Actually, with Libertex you could start trading in less than five minutes, with our simple online instant request and verification form. With the cryptocurrency trade, you will not directly access the underlying exchange: we expose ourselves to the market in your name. This means that you will not need to set up and manage an exchange account.

Mining

Cryptocurrency mining is the processing of transactions in the system of digital currencies. In the case of Bitcoin, its current transaction records, known as blocks, are added to the past transaction record, known as the blockchain.

How does blockchain work? When a point-to-point cryptocurrency transaction is performed, that transaction is sent to all users with "full node" purses. The specific types of users called miners then try to solve a cryptographic enigma using software, which allows them to add a "block" of transactions to the general ledger. Who solves the puzzle first will receive a few coins "freshly extracted" as a reward. Sometimes the miners gather the power of computing and share the new coins. This practice is known as "mining pool" or "mining pool". The algorithm is based on consensus. If the majority of users trying to solve the puzzle send the same transaction data, then it is confirmed that the transactions are correct.

A digital currency is defined by the digitally signed record of its transactions, beginning with its creation. The block is an encrypted hash job test, created in an intensive calculation process. Miners use software that accesses their processing capacity to solve algorithms related to transactions. In return, they receive a certain number of digital coins per block. The block chain avoids attempts to duplicate digital currencies; otherwise, the digital currency could be falsified by copying and pasting.

Originally, the digital extraction of coins was done in the CPUs of the individual computers, with more cores and a higher speed, which results in greater profitability. After that, the system came to be dominated by multi-graphics card systems, then programmable gate arrays (FPGA) and finally specific application integrated circuits (ASICs), in an attempt to find more results with less use of electrical power .

Due to this constant climbing, starting has become difficult for potential miners. This adjustable difficulty is an intentional mechanism created to avoid inflation. To avoid this problem, people often work in groups, doing "mining pool".

Bitcoin started with individuals and small mining organizations. At that time, the start-up could be enabled by a single high-end gaming system. Now, however, the largest mining organizations can spend tens of thousands on a specialized high-performance computer. In the world of malware, one of the most prevalent current threats is the stealth mining by bots, in which user systems mine digital currency without the knowledge of the owners, and the funds are channeled to the master of those bots.

The Bottomline: Pros and Cons

We have gathered all the pros and cons of the ways to obtain cryptocurrencies in the table below. Please bear in mind that all types of cryptocurrency operations carry risk.

 

Way to obtain cryptocurrenciesProsCons
Buying

You own crypto
You can use cryptos for buying products or paying for services

You need to pay the full cost
There are deposit limits
You have to pay withdrawal or transfer fees

Trading

You can use cryptos for buying products or paying for services
You don’t have no pay profit taxes
You start investing right away, without opening any additional accounts
No deposit or withdrawal fees
No deposit limits

You don’t own crypto
Easy to lose control on the investment amount

Mining

You own crypto
The only capital you need is the starting capital to buy devices

Harsh competition
The number of bitcoins to mine is limited
The majority of the bitcoins has already been mined
Electricity and hardware costs
You can spend a lot of time before you earn

 

Final considerations

The future that the science fiction writers of the last century spoke of has arrived! The digital currency, which is not owned by any state and is not controlled by anyone, is used to the maximum for non-monetary settlements and serves as an enrichment tool for thousands of enterprising and forward-thinking Internet users.

There is a significant advantage in investing in cryptocurrencies: the cryptocurrency market is still relatively young, and the most optimistic investors are projecting future prices that would make a good bet to buy any of the major cryptocurrencies.

The above information should not be taken as an investment advice. It is only for general knowledge purposes. You must do your own research before buying any cryptocurrency.

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