Cryptocurrency. It’s all over the news lately, and for good reason! If you’re like most people, you have no idea what cryptocurrency is or how it works. Don’t worry, you’re not alone. In this beginner’s guide to cryptocurrency, we will discuss everything you need to know in order to get started. We’ll cover what cryptocurrency is, how it works, and some of the risks and benefits associated with it.
What is Cryptocurrency?
Cryptocurrency is a digital or virtual currency that is secured by cryptography, which involves encryption techniques to regulate the production of currency units and verify money transactions. Cryptocurrencies are decentralised, meaning they are not subject to government or financial institution control. So, rather than sending money through a bank, or middleman (such as PayPay), who then holds your money and you effectively have to get their permission to send money to someone (a traditional centralised system), you’re sending it to the end person directly.
Bitcoin, the first and most well-known cryptocurrency, was created in 2009. Since then, thousands of other cryptocurrencies have been created.
Meaning behind ‘cryptocurrency’
The word ‘crypto’ originates from the Greek word Kryptos, which means concealed, hidden or secret. ‘Crypto’ can be placed in front of another word in its combining form to show that that thing has something secretive about it. So, if we combine that with the word currency, which is a form of money issued by governments in most countries, such as the AUD in Australia, we get ‘cryptocurrency’.
The word ‘cryptocurrency’ is derived from the fact that cryptocurrencies use cryptography to secure their transactions. Cryptography is a branch of mathematics that uses mathematical algorithms to encode and decode data.
History of cryptocurrency
Cryptocurrency is a relatively new phenomenon and there have actually been a few attempts to bring it to life over the decades. However, an anonymous person (or group of people…no one is entirely sure), called Satoshi Nakamoto, released a white paper in 2008 describing the decentralised network that Bitcoin operates on. Satoshi describes crypto as: ‘a peer-to-peer electronic cash system based on cryptographic proof instead of trust.” The Bitcoin blockchain, the network Bitcoin runs on, was launched off the back of the 2007-2008 Global Financial Crisis in 2009 as there was a lot of trust lost in the traditional finance system.
Since then, thousands of other cryptocurrencies have been created and the total cryptocurrency market is currently valued at $1.9T. Despite a common misconception that people are ‘too late to the party’, cryptocurrency is still very much in its infancy.
Characteristics of Cryptocurrencies
There are many features of cryptocurrencies. They are:
- Decentralised: Decentralisation is the most important feature for cryptocurrency. This means they operate independently with no involvement from governments or central banks. Crypto is not tied to any country unlike traditional currencies like the US dollar or AUD. The control is decentralised and based on blockchain technology.
- Digital: Cryptocurrencies are completely native to the internet. You can’t physically touch or hold them (despite these illustrations of coins you’ll see everywhere).
- Peer to peer: Allows two parties, such as you and a friend, to exchange value in a digital environment without a middle-man or central party (such as a bank) to approve the transaction.
- Available for all: Absolutely anyone in the world can use cryptocurrency, unlike centralised services where you can be blocked or have your accounts frozen.
- Cheap and efficient: As it cuts out the ‘middle man’, transactions are faster and less costly.
- Secure: Due to the decentralised nature, it’s near impossible for hackers to interrupt the blockchain.
How do Cryptocurrencies Work?
Unlike traditional payment systems that involve some sort of central authority as a third party to record and validate transactions (such as a bank or government), cryptocurrencies use a decentralised ledger system, often called a blockchain, to record transactions. Therefore, rather than putting the trust in these third parties, the trust is distributed amongst peers. Many see this as a major benefit as it puts the power back in the people.
Whenever a block of transactions are validated, it is added to all the other blocks on the blockchain. As a result, the blockchain is constantly growing as ‘completed’ blocks are added to it with a new set of recordings/transactions. Each block contains a cryptographic hash of the previous block, a timestamp, and transaction data. To read more about how transactions are validated, read here.
So, let’s say you want to send $1 million to your family over in Italy. Going through the traditional centralised system would take time and cost substantial transaction fees to get the money across. However, with cryptocurrency, you could send that in a matter of minutes to your family across the world.
The Different Types Cryptocurrency
There are thousands of different cryptocurrencies out there, all with different utility or purpose. For example Litecoin provides speedier transactions to Bitcoin, whereas Monero is much more anonymous than Bitcoin, making transactions much harder to see. Ethereum, the second largest cryptocurrency, does have similarities to Bitcoin however users can also build decentralised applications (DApps) on the blockchain (apps that aren’t run by a central authority). Click here for our ultimate guide to altcoins.
Worldwide Adoption of Cryptocurrency
Cryptocurrency is gaining mainstream adoption all over the world. People who own crypto is increasing at a phenomenal rate, with 1 in 8 people in the world expected to own crypto by 2030.
On top of this, we are seeing some of the largest businesses in the world such as Tesla, MicroStrategy and Square hold Bitcoin on their balance sheet. While it’s still early days, we believe that cryptocurrency has the potential to revolutionise how we interact with the digital world.
Oh, and did we mention that an actual country, El Salvador, made Bitcoin a legal tender in 2021?
What are the benefits of cryptocurrency?
Cryptocurrencies have the potential to revolutionise the financial system. We have already touched on this a bit, bu here are some of its main benefits:
Transaction Speed
Rather than waiting for transactions to take days to clear by a central third party, transactions can be sent to someone on the other side of the world in a matter of minutes. This can also be done 24/7.
Transaction Cost
This process can be an expensive exercise, particularly for international payments. Transactions are generally much cheaper on the blockchain, but this can change depending on demand.
Security
This is one of the most important features of blockchain technology. Due to it being a peer-to-peer network, there is less chance of it being infiltrated by hackers (e.g. a 51% attack) compared to a centralised system. This is especially the case for blockchains like Bitcoin or Ethereum.
Further to this, you need a person’s private key to access their crypto wallet, so as long as you don’t give that to anyone you shouldn’t, no one will be able to access your wallet. Be careful here though, if you lose your own private key, you won’t be able to access your wallet and will lose all the money inside it!
Privacy
As we know, all transactions are recorded on the blockchain, however it doesn’t reveal the identity of the people transacting, just their wallet address. This means there is no way of these transactions being tied to anyone.
Store of wealth
You only need to look at the graph below to see that Bitcoin has been an incredible store of wealth over the years. In fact, if you invested $5,000 into Bitcoin in 2020, you would have grown that to almost $43,000 by November 2021, a return of over 750%.
What are the risks of investing in cryptocurrency?
Cryptocurrencies are much more volatile compared to the share market and their prices can fluctuate wildly. This makes them a risky investment, but also one with the potential for high rewards. This volatility comes from the industry still being very much in its infancy.
They are also not regulated across the majority of the world, such as Australia or USA. This is because they’re yet to be considered financial products. Its peer to peer system means the users itself are monitoring it’s operations, rather than a government or central bank. So if something was to happen to the exchange where you hold your money, such as it going broke or getting hacked, you may not get any of your money back.
Lastly, whilst they aim to be secure, this doesn’t eliminate the risk of hackers who will try to gain your private key and access to your wallet. Do not give anyone your private key. To be super cautious, consider using a hardware wallet or cold storage to provide additional security.
Summary
Cryptocurrencies have the potential to revolutionise the financial system. They are borderless, decentralised, and allow for near-instantaneous transactions. Additionally, cryptocurrencies are not subject to government or financial institution control. This makes them incredibly powerful and could potentially upend the current financial system.