Cryptocurrency

What is Cryptocurrency and How Does Crypto Works: Complete Guide

Who lives under a pineapple in the sea? Well, it is you if you have not heard about the term cryptocurrency yet. Starting with a humble seven-page Bitcoin whitepaper in 2008, cryptocurrency has taken the world by storm. However, the irony is that many people still have trouble wrapping their heads around what cryptocurrency is. Of course, words like decentralization, Blockchain technology, etc. are thrown around. But how does crypto work?

Well, you are in luck. Because that is exactly what we plan to talk about today. They often say ‘DYOR‘ or “do your own research”. Turns out that research starts with understanding the very basics behind cryptocurrency and Blockchain technology. Let’s dive in.

What is Cryptocurrency: Digital Money:

Let us do a quick exercise. Whenever the term ‘money‘ is uttered, what comes to your mind instantly? Is it the Green colour? The paper? The image of a famous personality that features on your currency? What if I told you that you feel so because you were born and evolved with this type of money floating around?

Yes. Conventionally money has taken various shapes and forms like wheat, stones, bottle crowns, gold, silver etc. And we are at the cusp of another shift. Or at least, crypto fanboys would argue so.

Cryptocurrency is the digital form of currency that is secured and maintained by a decentralized system using cryptography. It is designed in a way that it cannot be counterfeited, double-spent or manipulated. All of this, without having an intermediary.

What are the types of cryptocurrencies?

There are 1500+ different cryptocurrencies listed on Coinmarketcap. That is more than the number of different fiat currencies in the world. On the basis of Blockchain, you could divide these cryptocurrencies into token and a coin. While tokens have their own native Blockchains like Bitcoin, Ethereum, BNB, tokens run on some other Blockchain. Eg. BAT is an ERC-20 token running on Ethereum.

On the basis of function, these cryptocurrencies can be categorised as follows:

A. Wrapped Tokens:

As the name suggests, a WRAP token is something that is wrapped around an underlying asset. Think of them as ETFs in traditional finance. Any commodity/currency/stock could be wrapped to run on a Blockchain.

B. Stablecoins:

Stablecoins mimic the price of a fiat currency like USD, EUR etc. They can either do this by maintaining a physical collateral (USDT, USDC) or by using algorithms (LUNC, FRAX, DAI).

C. Utility Token:

A utility coin/token is something that powers a particular network. It is the native currency of an ecosystem. For example, BAT or basic attention token can be used to tip creators, fund ad spends within the Brave browser ecosystem. Similarly, ETH, SOL are the only coins that can be used to pay for the gas fee within these networks.

D. Governance Tokens:

Governance tokens offer voting rights to its holders within an ecosystem. For example UNI, the native token of Uniswap, a decentralized exchange, allows users to vote on proposals regarding the future of the project.

How is the value of cryptocurrency calculated?

The basics of Economics apply here as well. The value of cryptocurrency is determined by supply and demand in the short term. If demand > supply, the price rises and vice versa.

In the tangible world, the cost of production would also impact the prices as a product cannot be produced out of thin air. However, that is not true in the case of cryptocurrencies. Depending on the model, cryptocurrencies can be fixed in supply (Bitcoin) or can be produced within seconds at a click of a button through a pre-decided rule. Therefore, one must go through the token distribution and maximum supply before determining the value of a crypto.

Apart from that, the prices of cryptocurrencies also fluctuate based on their availability on multiple exchanges, competition, governance and regulations.

What can you buy with a cryptocurrency?

Given the regulatory uncertainty around cryptocurrencies, a lot of businesses refrain from accepting crypto as payments. However, in the past, a lot of brands have backed up cryptos as a mode of payment. Back in 2021, Tesla announced that they would accept BTC as a payment for the cars only to take a U-turn later. Currently, they accept Dogecoin for some merchandise.

Apart from that, there are brands that offer real estate (Bithome), sporting events (tickets to Mark Cuban’s Dallas Mavericks matches via Bitpay), Travel packages (CheapAir) using Bitcoin.

Within the crypto ecosystem, you can buy art as NFTs (Opensea), domain names (ENS) using crypto.

Is Cryptocurrency Illegal?

Is drinking coffee legal? It isn’t right? There are no laws that state that drinking coffee will put you behind the bars. Similarly, cryptocurrencies are completely legal to buy, sell and hold. There is no law that prohibits the same.

People often get confused by the legality when the government says that Cryptocurrency is not legal tender. This means that you cannot force a seller to accept cryptocurrency as a mode of payment while purchasing goods (Fiat is enforceable by law). You cannot pay your taxes in crypto.

How Does Cryptocurrency Work?

Imagine there is a 7 year old boy called timmy. Timmy wants to get a dog for his christmas. So he writes a letter to Santa Claus and asks him to bring him a dog. Then he seals that letter and asks his dad to deliver it to Santa claus. But his dad opens up the letter. And since he does NOT want a dog in the house, he changes it to a book. 

Of Course it is a bummer for Timmy on the day of christmas. 

Next year, Timmy still wants a dog. So this time he writes a letter and uploads it on the North Pole Blockchain. This Blockchain is set up by Santa Claus and all the parents and kids are a part of this Blockchain. Every time a kid uploads a letter, everyone receives a copy of it. 

Once again, Timmy‚Äôs father receives this letter and yet again tries to change the dog to a guitar. 

However, this time he is caught. Why? Because his letter is different is different than the copies of all other participants. 

So finally, Timmy gets his dog.

If you understood the above example, it is very easy to translate it to an adult version. All the parents and kids in the North Pole Blockchain are ‘nodes’. Each node has a copy of what is happening in the system and can validate it. Whenever someone tries to manipulate, they are caught instantly and hence network is secured at all times.

How is cryptocurrency encrypted?

Encryption is the process of converting data to a non-readable format which can be brought back to its original form using a key. This makes sure that the data is only accessible to authorised personnel.

Blockchains and cryptocurrencies achieve this by using asymmetric encryption. This means that the encryption key for this data is available publicly but only the authorized holder of the private decryption key can gain access to the decoded plaintext.  

Should you Invest in Cryptocurrency?

While it is subjective and a personal finance decision that you have to take for yourself, allocating a small percentage of your portfolio to risky assets like cryptocurrencies goes a long way.

While it is advised to conduct your due diligence and risk management and invest only what you can afford to lose, let’s find out some benefits of investing in cryptocurrencies.

Advantages of cryptocurrency investment:

A. Transformational Technology:

Cryptocurrency (Blockchain) is a novel technology. There is just too much happening each day. If you manage to stay up to date, the benefits are way beyond money.

B. Ownership:

As the cryptocurrencies are decentralized, there is no third party involved thus giving you complete control over the ownership. It provides you with complete freedom.

C. Hedge Against Inflation:

This is applicable to Bitcoin only. Fiat Currency loses value i.e., purchasing power is reduced due to the economic policies of Governments. Since BTC is capped in supply, it acts as an hedge

D. Secure:

Transactions are encrypted and records are immutable thus disallowing any alterations or changes to be made.

Disadvantages of cryptocurrency investment:

Not so soon. Before you YOLO your life savings, let us quickly understand a few disadvantages involved in investing in cryptocurrency.

A. Extremely Risky:

Being a novel technology, no one can predict its future for sure. Therefore, you might lose all your capital.

B. Volatile:

Only invest what you do not need in short term. Cryptocurrencies can have swings as crazy as 80% on either side in a cycle.

Conclusion:

I always say that cryptocurrency isn’t magic. But trust me, it is no less either. The world is moving towards a decentralized economy and you need to be a part of it.

Talking of magic. Have you heard of EPNS yet?

EPNS is a decentralized communication protocol for Web3! Using which any dApps, smart contracts, backends or protocols can send comm (starting with on-chain / off-chain / gasless notifs) tied to user wallet in an open, gasless, multichain and platform-agnostic fashion. The open comm layer allows any crypto wallet/frontend to tap into the network and get the comm across.

This post is sponsored by EPNS.

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Until next time..

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rgvdudeja
A techno manager by profession and a hardcore geek at heart. I love to poke my nose into tasks where other usually gave up on. My hobbies include, reading about Blockchain, Cryptocurrency and latest trends in tech industry, playing guitar and yes, memes!
http://pandatechiein.wordpress.com

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