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What is Cryptocurrency: A Beginner’s Guide to Crypto

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What is Cryptocurrency: A Beginners Guide To Crypto

There is an incredible wealth of knowledge about cryptocurrency out there. But an easy-to-understand synthesis of all that information is hard to find. What is cryptocurrency? And what does all the terminology surrounding it mean? If you’re diving into the fast-paced world of crypto, this guide is for you. In it, we cover the fundamentals of cryptocurrency, explain the forces that influence the cryptocurrency market, provide an overview of cryptocurrency news, and delve into cryptocurrency prices. Here’s how to start investing and trading the right way, right away.

A Beginner’s Guide to Cryptocurrency

Welcome to the beginning of your next great adventure. Blockchain technology and the cryptocurrency market are already revolutionizing the world in more ways than we know. Even if you’re not planning to invest in or trade cryptocurrencies, you can still benefit from understanding the breakthrough technology behind it.

Building the Blockchain: a Story

Like all great adventures, this one begins with a story. Imagine a society that invented a new way of trading without banks or governments. There isn’t a central power making decisions for everybody else. Instead, there is one set of rules that governs how this society records the entire history of its trades. These rules apply to everyone, and everyone voluntarily agrees to them.

Following only those rules, this society has built an amazing monument it calls the “blockchain.” What is blockchain? At the same time, this monument belongs to everyone and no one. It just is. And engraved on its towering and ever-growing surface is a record of every single transaction every member of this society has ever initiated. Every trade, purchase, contract—they’re all publicly viewable on this monument at any time.

And since there’s always at least one person looking at the blockchain monument, and still others building, checking and rechecking the work put into building it, it’s virtually impossible for a dishonest member of society to change or erase the monument’s engravings without someone noticing.

The Root of Cryptocurrency Price and Value

Everyone trusts what the blockchain monument says because people are continually verifying it. If someone were to record a lie on the blockchain, the lie would be found out almost instantly and the liar outcast. And because that trust lies not with an individual or group, but in the blockchain monument itself, this technology can create value. Specifically, it generates value anytime members of this society reach an indisputable consensus about something.

In other words, the immutability of the blockchain is what makes the cryptocurrency market possible. 

Fundamentals of Cryptocurrency: from Metaphor to Money

What is Cryptocurrency: A Beginners Guide To Crypto

To the outside observer, our mythical society might seem like a democratic utopia. And indeed, many cryptocurrency news headlines have hailed the age of cryptocurrencies as the democratization of money, putting power in the hands of the people rather than in those of a bank or government. In technical jargon, we refer to this as “decentralization.”

Centralization vs. decentralization is the fundamental distinction between cryptocurrencies and fiat, meaning currencies backed by banks or governments, like the U.S. dollar.

Decentralization

Cryptocurrencies and the cryptocurrency market rely on a digital technology called the blockchain. It’s a digital version of the massive stone monument in the story above. But whereas the monument in our story resides in the town square, the digital blockchain exists virtually, distributed across a network of computers.

This type of network is called a peer-to-peer (P2P) network. It links countless computers around the world, which work together to add and verify transactions on the blockchain, like the key members of the blockchain society. Since it’s typically a record of transactions, financial or otherwise, digital blockchains are often called “distributed ledgers.” Distributed and decentralized are two ways of saying the same thing.

But like a society, not all members are able or willing to do the same amount of work. However, work still needs to get done for the benefit of the whole, and the quicker the better. So digital blockchains incentivize workers to work harder and faster and elect the hardest workers to do the toughest jobs. This work, in crypto lingo, is called “mining.”

Mining

In our blockchain society, we liken this “work” to the physical labor of building the monument and engraving transactions. In digital blockchains, “work” is equivalent to solving math problems. Without using too much technical jargon, computers add and verify information on the blockchain by solving the complex algorithms that govern it.

Solving these mathematical puzzles adds a “block,” or group of transactions, to the “chain,” meaning the preceding blocks of transactions linked together in chronological order. The computers that solve these math problems are called “nodes” on the P2P network. In exchange for the work that they do to solve these math problems, they’re awarded funds, which typically means cryptocurrency. In fact, mining is basically the only way to create cryptocurrency. But for cryptocurrencies to function as assets with market value, you need to add one more element to this equation: consensus.

Consensus

Here’s where the crypto novice usually smacks their head against a brick wall of complex concepts that most cryptocurrency news sources don’t explain. It’s easy to picture a decentralized web of computers all working together to record, validate and share information. But what makes all this function as a currency?

In short, the same thing that makes all currencies possible, including ones backed by governments: consensus. Cryptocurrency has value because people agree to invest value in it. The unvarnished, objective truth of the blockchain’s digital ledger cements this agreement. The beauty in all this is that there is no trust involved. You never have to put your faith in some unknown party to guarantee the value of any transaction or asset.

“Proof of Work” Is the Reason Cryptocurrency Carries Value

You may have come across the terms “Proof of Work” (PoW), “Proof of Stake” (PoS) or “Federated Byzantine Agreement” (FBA) in cryptocurrency news. These terms refer to different mechanisms of consensus, meaning that they solidify agreements made on the blockchain. In other words, consensus mechanisms make it possible to safely send and receive cryptocurrency to and from anyone, anywhere without you trusting or even knowing them. Pretty radical, right?

Maybe you can already answer, ‘What is Bitcoin?’ and trust it because so many other people do. You’ve seen cryptocurrency news articles projecting a market cap of hundreds of billions of dollars. People wouldn’t invest that much if they didn’t trust the system, right? But trust misses the point. With cryptocurrency, as opposed to fiat currency, consensus is “trustless” and distributed.

And that’s exactly why verification, or Proof of Work, is so important. It eliminates the need for trust, for a central government or bank to back and record a transaction.

Miners, Proof of Work and Cryptocurrency Creation

What is Cryptocurrency: A Beginners Guide To Crypto

The creation of new units of a given cryptocurrency happens while verifying transactions using that same cryptocurrency. In simple terms, completing a Proof of Work calculation creates new coins. Furthermore, this process of creating new coins, the basic units of cryptocurrencies, introduces value.

Remember: Cryptocurrencies only carry value in relation to the history of previous transactions on their blockchains. That is because nodes in the network—those with serious computation resources—have verified and reverified those transactions. Hence, blockchain’s objective truth.

Proof of Work is the calculation needed to verify a block of transactions. Solving this math problem is the only way to add a new block to the chain. But here’s the kicker: These math problems are asymmetrical. This means that solving these math puzzles is difficult, but verifying that the solution is correct is easy. After miners do the hard work, the blockchain rewards them with new units of cryptocurrency. Everyone else on the blockchain’s P2P network can verify that the math puzzle’s solution makes sense.

When you’re making trades on secure exchanges in the cryptocurrency market, most of this heavy lifting goes on in the background. But it’s important to know what’s happening so that the index of cryptocurrency prices and the constant stream of cryptocurrency news doesn’t seem like an assortment of numbers rising and falling randomly.

Verifying Cryptocurrency Transactions

Here’s what happens. Depending on a particular cryptocurrency’s rules, a “block” represents a certain bundle of transactions. It could be just one transaction or it could be twenty. A miner’s job is to verify that all the transactions in a block are legitimate. This verification requires solving a math problem set by the blockchain protocol. These problems are so complex that there’s only one way to solve it: random guesses, aka “brute force.” So miners on a network will compete to solve a problem first.

When someone solves the “Proof of Work” problem, they announce it to the network. In return for finding the solution fastest, the miner receives a reward: new cryptocurrency units like Bitcoin. Finally, the verified block takes its place as the newest addition to blockchain.

Ethereum’s Proof of Stake: A New Take on An Old Problem

Everything you just read pertains to the Bitcoin blockchain protocol specifically. Many different cryptocurrencies, including the eponymous Bitcoin, reside on that blockchain. But there’s also Bitcoin’s largest competitor: Ethereum. Ethereum also has its own cryptocurrency, called Ether (ETH). But it’s built on an entirely different blockchain protocol. When it came out in 2015, it was serious cryptocurrency news.

Why is Ethereum so important? Because it takes an extraordinary amount of energy for a Bitcoin miner to solve a Proof of Work problem. In fact, one Bitcoin transaction requires as much electricity as an average American household uses in one week. Overall, Bitcoin’s annual carbon footprint is bigger than Switzerland’s! That’s expensive, and the reward for verifying a block doesn’t necessarily make up for the cost of the electric bill. This inefficiency weighs down the price of Bitcoin and other digital currencies on its blockchain.

By contrast, Ethereum uses “Proof of Stake” to verify and add blocks. This is a greener and cheaper way to reach that all-important objective of consensus.

Proof of Stake vs. Proof of Work

Without getting too technical, here’s the difference and why it matters.

With Proof of Stake, miners don’t compete to solve a problem. Instead, Proof of Stake algorithms determines who the creator of a new verified block will be. This depends on the creator’s wealth, or “stake.” In this way, the defining factors become someone’s total number of coins and the complexity of the network, rather than how much raw computational power they have.

Another important difference between PoS and PoW is that instead of giving a miner a reward for solving a block, Proof of Stake miners receive transaction fees. Miners on a Proof of Stake system like Ethereum go by “forgers” because they ‘mint’ new coins.

One Is Cheaper, the Other Is Safer

These differences have a couple real-world implications. Above all, understanding the difference between these systems will help you make informed decisions about which cryptocurrency market fits your trading or investing philosophy. It will also help you understand cryptocurrency news about attempted hacks and attacks on the blockchain. 

First, Proof of Work networks are generally safer from hacks and attacks. This is because it’s too costly to pull one off. In other words, you’d need more money than you could steal. At the same time, security comes with exorbitant energy expenditures that aren’t sustainable. Additionally, all that computing power takes time. This means that verifying transactions and adding blocks is a slow process.

By contrast, Proof of Stake networks are less costly and more energy efficient. It takes less time to verify transactions, but security suffers. The technological and economic disincentives of a PoW system aren’t there anymore. But because a PoS system eliminates the massive overhead of PoW, becoming a forger/miner/validator is way more accessible.

Summary of Cryptocurrency Fundamentals

What is Cryptocurrency: A Beginners Guide To Crypto

Whether you’re looking to jump into the cryptocurrency market or want to better grasp cryptocurrency prices, understanding the basics of crypto is indispensable. So far, we’ve covered the underlying concepts that give us Bitcoin, Ethereum, and so many other cryptocurrencies.

Now, let’s tie all that information into a concise summary so you can impress your friends with how much you know about crypto.

Cryptocurrency Give You the Freedom to Trade Wherever and with Whomever You Want

You can transfer cryptocurrency to anyone, anywhere using a blockchain network. The network stores all the information about this transaction, including how, when and who received the transfer. All that transaction’s data becomes a block, which has a unique identifying number called a hash. The block also carries the hash of the block immediately preceding it. Meanwhile, nodes, or computers within the network, verify the block’s transaction(s) by solving the math problem that validates the hash numbers and their sequence.

Once validated, a block links to others on the blockchain. Each block connects to the block preceding via its hash numbers. If somebody messes with a hash in one block, none of the other blocks “on top” of it will match, and everyone will notice that something is amiss. In other words, once these blocks are “stacked,” you cannot rearrange or modify them without invalidating the entire blockchain.

This immutability, meaning the inability to change verified transactions, makes it possible to trade, record and validate transactions within a cryptocurrency market almost instantly, without placing trust in a third-party.

A Beginner’s Guide to the Cryptocurrency Market

What is Cryptocurrency: A Beginners Guide To Crypto

Now that you have a solid understanding of what cryptocurrencies are and how they work in a blockchain network, you’re probably itching to put that knowledge into practice. And who could blame you? Considering that blockchain will be worth $700 billion by 2021, everyone is looking for a piece of the action.

But entering the cryptocurrency market can be overwhelming, especially if you don’t have any investment experience. Making decisions based on the movement of cryptocurrency prices alone won’t bring you success. However, knowing how to navigate the cryptocurrency market will. Here’s a guide to the cryptocurrency market for novice traders.

Cryptocurrencies Are Currencies and Commodities

One of the unique things about crypto is that it serves as a means to purchase things and a commodity or investment. In the cryptocurrency market, their primary use is buying and selling goods and services. But frequently, people hold cryptocurrencies as investments, like a security. Pardon the pun, but these are two sides of the same coin.

You may have heard of “smart contracts,” a new technology making waves in cryptocurrency news. Smart contracts are another form of cryptocurrency. In essence, they are digital agreements that enforce themselves via code and PoW/PoS, instead of though courts or third-party oversight.

The Many Sides of the Cryptocurrency Market

The cryptocurrency market is all of these things. And that’s why the market has so many different currencies. Bitcoin (BTC) and Ethereum (ETH) take up the majority of the cryptocurrency market share and dominate cryptocurrency news headlines. But starting in 2017,  there has been an explosion of hundreds of “alt-coins” with niche uses. Some experts call this a “crypto-pluralism.” As opposed to one market dominated by a few key players, the cryptocurrency market can viably sustain several hundreds of alternative digital currencies. This is another way that cryptocurrency is democratic.

Still, the cryptocurrency market is largely shaped by the coins with the highest market caps. As a beginner, you should familiarize yourself with Bitcoin and Ethereum, and also Litecoin (LTC), Ripple (XRP) and Dash (DASH).

The cryptocurrency market isn’t just for trading between fiat money and digital coins. It’s also for exchanges between different cryptocurrencies. For this reason, you need to know how they relate to each other and the factors that influence the price of cryptocurrency.

What Influences Cryptocurrency Prices?

What is Cryptocurrency: A Beginners Guide To Crypto

One approach to cryptocurrency is the investment angle. Choose this angle, and you’re not alone. Many people are holding onto digital currency as assets and are waiting to see what happens. Get in early and you could win big, the logic goes. This is the purely speculative approach.

For investors, monitoring cryptocurrency prices is of the utmost importance. Understanding what factors influence cryptocurrency prices and to what extent is essential for making smart investments.

How Geopolitics Affects Cryptocurrency Prices

Part of the overwhelming appeal of crypto is its decentralization, meaning that these assets don’t rely on banks or governments. Skeptics like to play up the cryptocurrency market’s uncertainty and unpredictability, pointing to the daily onslaught of cryptocurrency news about hacks, attacks, heists, and frauds. But governments and global financial institutions can be just as unstable. Markets crash, currencies inflate, new leaders and new regimes institute major economic policy changes and corruption is widespread. All this affects global markets.

Not beholden to the whims of a particular power, cryptocurrencies are even more attractive when it seems like the geopolitical situation is about to change. This means that cryptocurrency prices tend to increase when there is political or economic uncertainty, especially in major economies. For example, when Trump announced a new round of tariffs, cryptocurrency news reported a spike in crypto prices.

Supply and Demand Shapes Cryptocurrency Prices

Econ 101, with a digital twist. When governments face money troubles, they can print new currency. And treasuries aren’t at all transparent about issuance limits. Does anyone know the maximum number of dollars that can be in circulation at any time? Is there a limit?

In cryptocurrency, those questions are easily answerable. For example, there will never be more than 21 million Bitcoin, and they’ll all have been mined by 2140. As time goes on, supply will decrease while the rate of adoption (or demand) will increase. Basically, that gap ensures that Bitcoin’s value will climb. As long as demand edges out supply, cryptocurrency prices will increase.

Regulatory Changes Crush Cryptocurrency Prices

As cryptocurrency’s adoption and market cap grows, the stakes get much higher. Correspondingly, governments have started regulating the cryptocurrency market, especially crypto to fiat transactions. But since this all of this is so new, regulation is still in its infancy.

As a new investor, you should know that current cryptocurrency prices tend to assume a favorable future regulatory environment. Conversely, the cryptocurrency market can take a big hit after regulatory announcements. Just recently, the U.S. SEC made cryptocurrency news when they rejected 9 crypto-backed ETFs, which caused Bitcoin prices to plummet.

New Technology Pumps Cryptocurrency Prices

New blockchain innovations dominate cryptocurrency news headlines. These technological developments make the cryptocurrency market more efficient, cost-effective and secure. And when that happens, cryptocurrency prices tend to rise.

After the announcement of a new technology, crypto prices usually trend downward as people anxiously anticipate its implementation. But once these innovations improve the blockchain, cryptocurrency prices tend to increase. Conversely, cryptocurrency news about a hack, whether or not it was successful, incite concern about security. This can lead to a bearish cryptocurrency market.

Cryptocurrency Prices and Initial Coin Offerings (ICOs)

Today, Initial coin offerings, or ICOs, are the biggest cryptocurrency news out there. It’s a veritable craze. Take Mozilla CEO Brendan Eich’s ICO. It raised $35 million in 30 seconds!

Like IPOs, ICOs let you invest in a company. It’s just like buying shares in a company, except it’s a cryptocurrency company and the shares are coins. On top of that, VC investment in blockchain companies continues to trend into the hundreds of millions of dollars.

But beginning investors, beware. ICOs can artificially inflate cryptocurrency prices due to the enthusiasm generated by the glut of investments. After an ICO ends, prices usually decline to a more sustainable level.

Furthermore, this enthusiasm can be deceptive. Too often, cryptocurrency news sources hype up an ICO, leading readers to make ill-advised investments, only to issue a mea culpa to the public later. How many times have you heard of a “pump and dump” ICO scheme in cryptocurrency news? This is when hackers launch a fake currency through a fraud ICO, then disappear with investors’ cash. Even offering free cryptocurrency.

As a newcomer, it’s important to be aware that these scams exist. If you see cryptocurrency prices rapidly soar to ridiculous levels, proceed with caution. This sort of ICO is generally too good to be true.

Conclusion: Keeping Up With Cryptocurrency News

What is Cryptocurrency: A Beginners Guide To Crypto

Knowledge is power. Nowhere is this truer than in the world of crypto. And obtaining credible information is only part of the picture. You also need to analyze it and make decisions accordingly. It’s a task made harder by the light-speed pace of the cryptocurrency market.

But armed with the fundamentals—a solid understanding of what cryptocurrency is and how it works—you can make sense of cryptocurrency news. Use this guide to begin your crypto adventure the right way.