Bitcoin and Cryptocurrency 101
Cryptocurrencies, also often referred to as coins, are digital currencies that are secured through one-way cryptography, the enciphering and deciphering of messages in secret code or cipher. Many of them rely on public blockchain technology—a distributed ledger of all transactions that are decentralized and unable to be changed under most circumstances as long as nobody controls more than 50% of the computing power on the network.
Unlike traditional currencies, they are not controlled by any central government or authority. In the case of some of them (Bitcoin, Monero, and Litecoin for example), the supply of new coins is controlled by a process called mining, a computationally intensive process where computers (mining nodes) compete against each other to secure the network by solving mathematical equations, collecting bitcoins as a reward if they are the first to create a new valid block, which is then broadcasted to the rest of the network and added to the blockchain.
Other coins are pre-mined, where the mining occurs before the public launch of the coin. Pre-mined coins are sometimes viewed in a negative light as they are often heavily promoted to increase demand and drive up the price, allowing developers to cash out. Since many of them have been created as open-source software, they continue to evolve as developers work to implement solutions to address problems that arise. Some of the common problems include scalability and security issues. From a market cap perspective, Bitcoin is far and away the largest. As of December 17, it accounts for $328 billion out of the total value of $598 billion across the 1,360 cryptocurrencies that coinmarketcap.com tracks.
With Bitcoin, the original developer Satoshi Nakamoto set out to create a “peer-to-peer electronic cash system”, according to the Bitcoin white paper. The white paper was written under what appears to be a pseudonym and there is much mystery around the original creator’s true identity. One of the big innovations of Bitcoin was creating a system that did not rely on trusted third parties to process electronic payments; instead, it relied on the consensus of the nodes on the network. It also created a currency where the supply could not be altered by any central bank or government. That might not seem like as big of a deal in a country like the U.S., but in places like Zimbabwe and Venezuela that have experienced hyper-inflation due to excessive money printing by corrupt governments, this is of greater concern.
Beyond Bitcoin, according to data on coinmarketcap.com, there are 27 other coins that have a market cap of $1 billion or more (as of December 17). Ether, Ripple, Litecoin, Dash, Monero, Zcash and IOTA are just a few examples.The features and purpose of different coins vary. Several were created by developers looking to solve shortcomings of certain coins or provide additional features not present in others. For example, Bitcoin isn’t fully anonymous. The ledger can be viewed by anyone and the flow of funds can be traced to and from different Bitcoin addresses, although there is no private information linking you to your Bitcoin address. Other coins have been developed to provide full anonymity.
How are Bitcoin and Cryptocurrencies Used?
There are some merchants that accept bitcoin and other cryptocurrencies directly from a user’s wallet. Even though some of them have very high prices, they are divisible into very small fractions. Bitcoin, for example, is divisible down to a “Satoshi”, which represents 0.00000001 of one bitcoin. Some companies have created ATMs where you can use U.S. dollars and other fiat currencies to buy bitcoin and sell them to get cash. There are also companies that have created debit cards where you can convert bitcoin into dollars and use just like you would any other debit card. Other cryptocurrencies have more specific uses and are used to pay for services on a certain network. For example, Ether is the digital currency used for operating smart contracts on the Ethereum network.
Remember, there’s nothing wrong with sitting on the sidelines and watching everything play out until cryptocurrencies have matured a bit more. Don’t let the fear of missing out drive you to take on too much risk and make emotional decisions with your money. In light of the unique aspects of these new currencies, it’s a good idea to do an extensive amount of research.