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What is Cryptocurrency? How Do They Work?

In-depth cryptocurrency tutorials and guides covering news about Bitcoin, Ethereum & Altcoins. Learn how to use and to create with blockchain technology.

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What is a cryptocurrency?

Cryptocurrency is a digital asset used worldwide as a store of value as well as a medium of exchange. The ownership and transactions using cryptocurrency are secured by cryptographic security and a decentralized ledger. Often referred to as digital currency or virtual currency, cryptocurrency first appeared in the form of bitcoin. Non-bitcoin currencies fall into the category of altcoins, alternatives to the dominant bitcoin. The security of cryptocurrency lies in the technology behind it, the blockchain. Miners of cryptocurrency use computing power to maintain the fidelity and safety of the ledger.

How does cryptocurrency work?

There are three central components to cryptocurrency: public ledgers, transactions, and mining. Public ledgers secure the history and ownership of all coins in a given currency. Using a decentralized platform, each cryptocurrency relies on a public record to secure the network. It’s difficult to cheat or counterfeit coins when there are multiple copies of the ledger across the world. Transactions between wallets create new parts of the ledger. A confirmation process and encryption (helped by miners) lead to the transfer of digital coin between two parties.

When did cryptocurrency begin?

The history of cryptocurrency goes back to Wei Dei and an article published back in 1998. A system of “b-money” was proposed using cryptography and anonymity to create a new type of cash. Nick Szabo later created an online currency called “bit gold” to facilitate online transactions. The creator of the first modern cryptocurrency is Satoshi Nakamoto, a person or group with an unknown identity. Many believe the father of bitcoin is a Japanese coder, but rumors continue to swirl about the real story.

Are cryptocurrency wallets safe?

There are many good and bad stories about cryptocurrency wallets, but they are generally safe if you follow a few simple guidelines. Any online service faces risks to their security and any money stored online. One of the largest crypto-exchanges at the time, Mt. Gox, suffered a hack in 2014 and went bankrupt. In most cases, online wallets are perfectly safe if you follow the backup procedures and practice good security habits. For the die-hard security experts, you can maintain your coin reserves using physical storage hardware that you control directly.

Is cryptocurrency legal?

Most countries allow transactions using cryptocurrency, but there are a few exceptions. Some regimes have restrictions on payment flows out of the country, and many countries prohibit cryptocurrency mining. Illegal or criminal activity using cryptocurrency is typically illegal, but there are many legal uses in practice around the world today. Each country has specific laws pertaining to local aspects of cryptocurrency such as banking regulations, AML/TF rules, and money transmitting licenses.

How is cryptocurrency mined?

To mine cryptocurrency, there are three key ingredients in every successful mining operation. The first is hardware – faster is better. Mining bitcoin involves calculations within a certain encryption framework to hit the difficulty target. At first, bitcoin miners would use typical CPUs that you might find inside your laptop or home computer. Then, miners turned to top-of-the-line video cards (GPUs) to take advantage of their superior parallel processing. As the difficulty target rose higher and higher, bitcoin miners moved to other chipsets such as FPGA (field programmable gate array) and finally to today’s standard, ASIC (application specific integrated circuit). The hardware may change, but it remains the most important tool for any bitcoin miner.

 

Which cryptocurrency is worth mining?

The value to the miner depends on many factors. Bitcoin is the most popular coin in the world, but it may not offer the best value. Some the eventual profit relies on market prediction, but there are online calculators to determine the best choice. The block time, block reward, difficulty target, and the value of the coin are all important to know when you make your decision. Other factors include the cost of hardware, bandwidth, software, and other inputs in a given mining operation.

How is cryptocurrency valued?

In simple terms, cryptocurrency derives its value from supply and demand. Every asset on Earth has potential buyers and sellers to make up a market. There are several factors that go into price discovery for an asset for sale. Quality, location, supply, bidding interest, delivery conditions, and a host of other information goes into a purchaser’s decision. Whether it’s a used car or a digital currency, the ultimate prediction model is supply and demand. In a global market, the price of any cryptocurrency is the average willingness to pay, determined by the collection of buyers in the given exchange.

Why is cryptocurrency rising in value?

Technology is changing the world at a rising pace, and the world of money is no exception. As new transaction vehicles appear and the world becomes ever more globalized, it’s inevitable that cryptocurrency will rise in value, trading activity, and general use. As the market for cryptocurrency expands, the demand will increase. Many cryptocurrencies such as bitcoin have theoretical limits on supply, so the only response to the demand is higher prices per coin. Some currencies will rise and fall, but the value of the cryptocurrency market is likely to grow as the model proves itself as a better form of money for the world.

When to buy cryptocurrency?

Timing any market can be a tricky endeavor. If you want to get into the cryptocurrency market, the best time is hard to determine. If you want to learn more about trading and investing, the best place to learn is the history of the stock market. Equities are the most studied and researched financial market in the world. The New York Stock Exchange is over a hundred year’s old, and you can learn a lot about timing the market from the history of success and failure on Wall St. For cryptocurrency, it’s best to buy when prices are low. Predicting when a low point appears is the real challenge.

What cryptocurrency to invest in?

Choosing the right cryptocurrency for your investment is not always easy. Many investors flock to the names with the top headlines and biggest market capitalization. Bitcoin and Ethereum are two of the most popular coins. It’s always better as an investor to trade in a market with good research and editorial coverage, an active trading community, and strong market liquidity. The smaller the market, the more you pay for transaction costs and information gathering. On the flip side, the most aggressive growth and profit potential lies in the lesser-known currencies online. It’s hard to find the right one to buy without a plan, so the first step is a set of financial goals for the investment.

Who accepts cryptocurrencies?

Many retailers accept cryptocurrency, and the list is growing by the day. Technically, any person or small business can create a wallet to accept payment online. It depends on the individual country and what is being purchased. There is an active online market for gift certificates for major retailers in local currency for sale in bitcoin. The Dark Web is infamous for its association with bitcoin for black market transactions online. In recent years, the general acceptance of bitcoin grew by leaps and bounds. Some large companies were ahead of the curve, and more are adding bitcoin payment to their stores every day. For example, Sir Richard Branson added bitcoin as an approved payment method back in 2013 for passengers on his space flight project, Virgin Galactic.

Where to Buy or Sell cryptocurrency?

Bitcoin is an online currency, so the natural place to buy bitcoin is online exchanges. Most bitcoin wallets connect to an exchange to buy and sell bitcoin. Bitstamp and Kraken are two of the most popular international exchanges, but there are local exchanges for many countries and their national currencies. A list of exchanges on the bitcoin.org site can help investors find a suitable exchange.

Can cryptocurrency be taxed?

The government is extremely powerful when it comes to taxes, and cryptocurrency is likely to face regulation and taxation eventually. Each country and territory have different powers to tax financial assets, income, transactions, and wealth. While cryptocurrency offers new challenges to the taxman, it’s unlikely that cryptocurrency will face a tax-free future. How the currency and its transactions will be taxed is unclear at the moment. Some countries consider bitcoin profits to be income, while others hope to add a sales tax to transactions using government-regulated exchanges.

Will cryptocurrency replace fiat (Cash)?

It’s difficult to predict the future of bitcoin and cryptocurrency in general. While the technology behind the currency is a proven concept with real benefits over fiat money, the ultimate fate of cryptocurrency lies in the hands of government (and the voters of the world). Financial regulation is an important tool for any ruler to suppress certain activities and promote others. Physical cash may slowly disappear, but a government-controlled fiat currency will likely survive for many years to come. Bitcoin has put the pressure on politicians and central bankers to pay attention to the limitations of cash-based currencies.

What is Blockchain?

Blockchain is a digital ledger of cryptocurrency transactions with a chronological and publicly-available record of ownership and activity. Using a decentralized ledger, the security of bitcoins or other cryptocurrencies is protected from theft and counterfeiting. The network supports the ledger using mining and the public storage of historical coin data.

How does blockchain technology work?

When someone requests a transaction, the blockchain gets to work. The transaction request goes out to the peer-to-peer network of nodes for validation. Each node is a computer on the network with available computing power to process the request. Using encryption, the node will validate and record the transaction. Once the transaction is complete, a new piece of the blockchain adds to the chain of public ledger records. The data exchanged in a transaction can be coins, contracts, records, personal information, user validation, and almost any digital asset. Blockchain technology goes far beyond bitcoin and moving money.

When did Blockchain start?

The first blockchain application beyond the theory was the introduction of bitcoin. While the concept was first described in the early 1990s, bitcoin was a real-world attempt to use a cryptographic blockchain for security. Bitcoin was an early instance of blockchain technology that persists to today. Blockchain 2.0 is an expanded role for a decentralized digital ledger beyond cryptocurrency. There are many firms around the world using the blockchain to solve business problems in nearly every industry and major economy.

Is Blockchain safe?

Blockchain is a very safe and secure way to store data and share it online. Using a decentralized ledger, blockchain technology provides a built-in backup and anti-hacking layer that is far superior to previous attempts to secure data. Blockchain itself is a very safe way to secure online transactions and digital assets, but it’s only as secure as its users. The technology relies on human interaction with passwords, backups, and input from real people. Like anything, blockchain is as good as we make it. It’s only a tool, but it’s a big step forward for secure online activity and safe transactions using the web.

Why use blockchain technology?

Databases are the center of the online world, and blockchain offers an innovative way to maintain and secure digital assets. A typical server for a website, online service, or bank was vulnerable to a single-point attack. Running an entire company off of one server in one location was an unreliable and insecure way to do business. As redundancy and real-time balancing became the norm, hackers had a harder time to locate the best point of attack. With blockchain, the data in any database is secured by the entire network of nodes. Blockchain offers a new way to think about storing and sharing data between computers. Its applications to the world of business, personal life, and government are practically endless.

Are Blockchain and Bitcoin the same?

Bitcoin is only one of many cryptocurrencies that uses blockchain technology. Blockchain is also used beyond the world of cryptocurrencies to secure and share data online. There are fintech firms using blockchain to validate online identities, facilitate secure databases, and many other applications.

How Blockchain prevents fraud?

An analogy may aid in understanding the security of the blockchain. What would be easier to counterfeit and alter: a doctor’s note or the Holy Bible? If there is only one copy available, it’s easy to produce a fake version that looks like the real thing with altered information. In the case of the Bible, there are hundreds of millions of copies floating around the world. It would be easy to check the validity of a fake Bible by comparing it to any of the copies on bookshelves around the world. The blockchain is a distributed, decentralized ledger with copies available for reference around the world. It’s almost impossible to alter or fake the blockchain record.

Why is Blockchain not hackable?

Using a decentralized and distributed model, the blockchain secures its data using multiple copies of the record. The underlying encryption involves such large calculations and computing power that it’s practically impossible to counterfeit the record of ownership. Exchanges and wallets are hackable, but the blockchain itself is nearly perfect in terms of security.

Why is Blockchain here to stay?

Decentralized systems are not new, but using the technology to secure digital assets is a powerful idea. The success of peer-to-peer networks and crowdsourcing were early indicators of the power of decentralized online platforms. Using the blockchain, investors and consumers can rely on the power of numbers to enable online transactions using bitcoin and other currencies. As new industries beyond banking adopt the blockchain, there’s no end to the practical applications of the technology to change human life.

When to use Blockchain?

Blockchain works well for any transaction of value or communication of data that demands a high level of security. Fraud and hacking are a major factor using telecom and web-based services. The blockchain can enable sharing online without relying on a central authority to manage network security. Blockchain is a scalable way to use global computing power to secure the network as it grows. Anyone who wants to share data online could develop a blockchain-based solution to secure their activity.

Which Blockchain is best?

Each type of blockchain offers different benefits depending on the intended use. Public blockchains such as Bitcoin, Ethereum, Litecoin, and other cryptocurrencies are useful for global payments and online information sharing. Federated blockchains are used by banks and other financial institutions to facilitate transactions in a guarded space. They are typically faster and rely on an exclusive set of nodes such as a small consortium of partnered banks. Private blockchains are used by individual companies or people who want to control every aspect of the blockchain without outside interference.

What Blockchain will banks use?

R3 is a federated blockchain used by several banks to facilitate fund transfers between financial institutions. It seems to be the early leader, but there are other competing technologies that may dethrone R3 as the chosen blockchain for the banking sector. As the global economy evolves and computing power increases over time, new blockchains will emerge with superior functionality to R3 and the current blockchains on offer.