In simple terms, a cryptocurrency is a digital currency that’s secured by cryptographic techniques[1] and works on blockchain technology. This makes it very difficult to counterfeit these currencies or even double-spend them.
Most cryptocurrencies are also typically decentralized — they don’t have any central authority controlling them.
Now that we’ve got the definition out of the way, let’s dive into the details.
Source: medium.com
Contents
How Do Cryptocurrencies Work?
As mentioned above, cryptocurrencies work on blockchains. A blockchain is essentially a tamper-proof record of all transactions done using a particular cryptocurrency. Think of it as a digital ledger.
Whenever a payment is made using a cryptocurrency, the transaction information is stored in a block (transaction record), verified, and then added to the blockchain.
These blocks are added to the blockchain such that they can’t be modified or erased, meaning blockchains can’t be tampered with.
Cryptocurrencies are so-called due to the cryptographic techniques used to safeguard these currencies.
All the information about the currency is encrypted with these techniques and only those with the right keys can decrypt the information. This ensures that only the owners with private keys can verify that they own the currency, and nobody else can.
How Do You Get Cryptocurrencies?
Cryptocurrencies are created through a process called mining. The process involves verifying transactions on a blockchain by becoming a validator[2].
For every transaction that you successfully verify, you’re rewarded with some tokens. There are two major consensus algorithms cryptos use through which you can verify transactions and get rewards. These are:
- Proof of Work: This method requires computers to solve complex cryptographic puzzles to validate a transaction. The first computer to do this gets rewarded, but it requires a lot of power due to the complexity of the algorithms. Bitcoin is the best example here.
- Proof of Stake: This involves staking your already-owned tokens in a staking pool. Based on your stake, you get chosen to validate the transactions — bigger stakes improve your chances. Solana and Binance Smart Chain use this method.
That said, mining may not be the best way to go when you’re just getting started. In this situation, the best (and easiest) way to get cryptocurrencies is to buy them via crypto exchanges[3].
[1] Cryptographic techniques: Encryption methods to secure data such that it becomes almost impossible to decrypt it unless you’ve got the key to it.
[2] Validators: Cryptocurrency users who are involved in mining. They validate blocks and get them added to the blockchain in exchange for a reward.
[3] Cryptocurrency exchanges: A platform that allows users to trade cryptocurrencies and other assets, like fiat currencies (US Dollar, Euro, etc.).
Source: cravingtech.com
Pros and Cons of Cryptocurrencies
Like fiat currencies, cryptocurrencies are, by no means, perfect. While they do offer a lot of advantages to their holders, there are a few cons to them as well. Let’s take a look at them.
Advantages of Cryptos
1. Decentralized
Most cryptocurrencies are decentralized. Unlike fiat currencies, no central banks manage these currencies. This gives crypto owners more control over their money.
Additionally, cryptocurrencies are also shielded from central bank induced inflation and instead work on the global demand for the cryptocurrency.
What’s more, you don’t have an intermediary like a bank that does the transaction for you. Instead, you directly deal with the receiver. However, centralized cryptocurrencies[1] are an exception here.
2. Transparency
The presence of a blockchain ensures transparency that the traditional banking system doesn’t provide. All the transactions are stored and visible on the blockchain, meaning anybody can view them to see who’s paying whom.
Source: cryptimi.com
3. Passive Income
Proof of Stake cryptocurrencies help their owners earn a healthy passive income through staking. The crypto owners stake their crypto tokens to validate transactions and support the blockchain. This is a popular mechanism in crypto games today.
While their coins are locked up for a fixed duration, they’re paid a reward for every transaction they validate, which works out to be a great passive income mode.
4. 24/7 Trade
While traditional exchanges have fixed trading hours, crypto exchanges operate 24/7. Coins are mined all day long and you can buy and sell crypto on exchanges at any instant too. This makes cryptocurrencies great to generate income outside working hours.
Disadvantages of Cryptos
Source: globaltimes.cn
1. High Risk
While cryptocurrencies do offer high returns for your money, the risk involved is equally high. There are numerous cryptocurrencies in the market now and their value could spike or plunge quickly. So, you could make a quick buck off them. However, a large drop could also lead to massive erosion of wealth.
Additionally, a number of cryptocurrencies are created each day and many of them cease to exist too. Investing in such speculative cryptos could lead to losses. You need to vet the crypto well before choosing to invest in it.
2. Environmental Impact
Most Proof of Work cryptocurrencies, like Bitcoin, require massive power for validating transactions. This can have a significant impact on the environment. However, Proof of Stake cryptocurrencies are more environment-friendly in that regard.
3. Regulatory Changes
Governments and central banks around the world are wary of cryptocurrencies. They haven’t fully figured out how to deal with them. As a result, cryptocurrencies are susceptible to regulatory changes and crackdowns from governments around the globe.
Source: techtimes.com
Getting Started with Crypto
Cryptocurrencies are a great mode of holding your wealth. You can rest assured that your payments will be made legitimately in a transparent manner. They’re equally useful as investment instruments that promise greater returns than traditional methods.
That said, you should thoroughly vet each cryptocurrency before buying it. Opting for the right cryptocurrency can be a great way to earn a healthy passive income and grow your investment at the same time.
[1] Centralized cryptocurrencies: These cryptocurrencies rely on a central node for handling all the transactions, much like a bank. For instance, Binance Smart Chain has only 21 validators, making it very centralized.
[2] NFTs: These are non-fungible tokens that exist on a blockchain and can’t be copied. They essentially give you the ownership of that particular digital asset.
