What is a Cryptocurrency?
A cryptocurrency is a digital currency that is secured by cryptography.
Unlike fiat currencies like the Dollar or Euro, cryptocurrencies are not issued by a central government authority. Instead they are issued on decentralized networks in a distributed ledger enforced by a disparate network of computers called blockchain technology.
Cryptographic techniques and encryption algorithms such as hashing functions and public-private key pairs secure the digital currency entries in a digital ledger to make it near impossible to access or steal the currency.
Although cryptocurrencies are designed to be currencies that can be used to make payments for goods and services, most cryptocurrencies are simply traded (like stocks) on cryptocurrency exchange platforms. Cryptocurrencies are mainly bought and sold for fiat currency.
Because cryptocurrencies are not used in most everyday purchases, their high volume of trading makes them very volatile. The value of most cryptocurrencies swings wildly from day to day.
A cryptocurrency enables secure online payments between two parties without the interference of any middleman or third-party bank or payment processor. As such it is defined as a peer-to-peer payment system.
Bitcoin (BTC)
There are many different cryptocurrencies but the biggest by popularity and trading volume is Bitcoin. It was invented by an anonymous person or entity called Satoshi Nakamoto who wrote a white paper in 2008 about Bitcoin.
The total supply of Bitcoin is capped at 21 million. When the Bitcoin supply reaches 21 million, no additional bitcoins will be issued. At that time, Bitcoin miners who currently manage the decentralized network and are issued bitcoins as compensation will be compensated in transaction fees.
As of March 2022, there are over 18,987,312.50 bitcoins in circulation with a total market capitalization of 784 billion U.S. dollars. About $21 billion worth of Bitcoin is traded each day.
Bitcoin uses peer-to-peer technology with no central authority or banks involved. A decentralized network operating as a collective manages Bitcoin transactions and the issuance of bitcoins.
Bitcoin is open-source, which means that its technology is public, open for all to see and for software developers to contribute to. No single individual or entity owns or controls Bitcoin.
This differs markedly from a fiat currency that is issued or controlled by the central bank of a country. For example, in the United States, the central bank, the Federal Reserve, is responsible for controlling the money supply of the U.S. dollar. The U.S. Treasury prints a certain amount of dollar bills each year as instructed by the Federal Reserve.
Altcoins
There are thousands of other types of cryptocurrency which are called Altcoins. Any cryptocurrency that is not Bitcoin is referred to as an “alternative coin” or altcoin.
Each altcoin is marketed as having its own unique features and functions. A few popular altcoins are:
1. Ethereum (ETH)
The most popular altcoin and competitor to Bitcoin is Ethereum (ETH).
Ethereum is a decentralized open-source blockchain with smart contract functionality invented in 2013 by a Russian programmer Vitalik Buterin. The cryptocurrency is called Ether.
As of March 2022, about $14 billion worth of Ether is traded each day. Ether has a total market capitalization of $349 billion.
2. Tether (USDT)
Tether is a cryptocurrency referred to as a stablecoin whose price is anchored at $1 per coin. Its value is pegged to the U.S. Dollar.
Tether acts as a medium when crypto traders convert from one cryptocurrency to another. Rather than receive U.S. dollars, traders can convert to Tether. However, Tether is not backed by actual dollars held in reserve.
As of March 2022, about $48 billion worth of Tether is traded each day. Tether has a total market capitalization of $80 billion.
3. Binance Coin (BNB)
Binance is one of the biggest cryto exchanges in the world where Bitcoin and all the major altcoins can be traded securely.
Binance issued its own cryptocurrency called Binance Coin. It was created to be a token that can be used by traders on its exchange to pay for discounted trades on the platform. But today, Binance Coin is also used to buy products where it is accepted as a medium of exchange.
As of March 2022, about $1.3 billion worth of Binance Coin is traded each day. Binance Coin has a total market capitalization of $66 billion.
4. USD Coin (USDC)
USD Coin is another stablecoin that is pegged to the U.S. dollar. Its primary difference from Tether is that it is said to be backed by fully-reserved assets held in accounts with regulated U.S. institutions.
As of March 2022, about $2.7 billion worth of USDC is traded each day. USD Coin has a total market capitalization of $53 billion.
5. XRP (formerly Ripple)
XRP was formerly known as Ripple. It was created in 2012. Its currency is XRP. It is a popular cryptocurrency technology used by banks in cross-border money transfers for multiple real-world fiat currencies.
As of March 2022, about $3.7 billion worth of XRP is traded each day. XRP has a total market capitalization of $40 billion.
6. Terra (LUNA)
Terra is a platform that helps backstop stablecoins based on real currencies such as the Dollar or Euro in order to stabilize the price of stablecoins. Its currency is Luna. Terra supports smart contracts.
As of March 2022, about $2.2 billion worth of Terra is traded each day. Terra has a total market capitalization of $34 billion.
7. Cardano (ADA)
Cardano is a cryptocurrency platform created by Charles Hoskinson, the co-founder of the Ethereum blockchain platform. Its currency is called ada. Cardano uses smart contracts for identity management.
As of March 2022, about $954 million worth of Cardano is traded each day. Cardano has a total market capitalization of $29 billion.
8. Solana (SOL)
Soalana was created in 2020. It caps its coins at 480 million coins. It is said to have a high speed of completing transactions.
As of March 2022, about $1.1 billion worth of Solana is traded each day. Solana has a total market capitalization of $28 billion.
9. Avalanche (AVAX)
Avalanche is a blockchain platform based on smart contracts. Its token is AVAX. The platform is used in building decentralized apps. It is designed to be a low-cost cryptocurrency option.
As of March 2022, about $1.4 billion worth of AVAX is traded each day. AVAX has a total market capitalization of $23 billion.
10. Binance USD (BUSD)
Binance USD is a stablecoin pegged to the U.S. dollar. It was launched in 2019. It is another altcoin issued by the cryptocurrency exchange platform Binance, in a partnership with Paxos Trust Company (Paxos), which is a New York-based financial institution and technology company specializing in blockchain.
Binance USD is regulated by the New York Department of Financial Services. It runs on the Ethereum blockchain.
As of March 2022, about $3.9 billion worth of BUSD is traded each day. BUSD has a total market capitalization of $17.8 billion.
Blockchain Technology
Most cryptocurrencies are built on a technology called blockchain technology:
– A blockchain is a set of connected blocks in a digital ledger on the Internet.
– Each block contains a set of transactions.
– Each transaction is independently verified and authenticated by each member of the network.
– Each new block generated by a transaction is verified by each node before it is confirmed.
As such, the transactions in the digital ledger must be agreed upon by the entire network of an individual node. This makes blockchain technology very secure and transparent.
Benefits of Cryptocurrency
We can see from the underlying blockchain technology upon which cryptocurrencies operate that the technology has a ton of benefits in financial infrastructure.
These are some of its benefits:
Lower Costs
Cryptocurrencies do not need centralized intermediaries such as banks and payment processors to move currency between two parties. As such, with no intermediaries that require middleman fees, the transaction costs are lower in cryptocurrency transactions than in fiat currency transactions.
There are no bank wire fees and payment processing fees as with bank transfer or online payments.
Reduced Centralized Risk
Although the risk of failure of your local bank or payment processor is small, there is always the possibility that if your bank fails, the money in its holdings are at risk. This centralized system increases the risk that millions of people can be hurt by the failure of a single bank.
The decentralized blockchain system removes this possibility of a single financial institution causing an avalanche of financial pain to a larger number of people.
Faster Transactions
In the absence of third party intermediaries involved in cryptocurrency transactions to verify or enforce the transfer of currency, the currency can move faster between two parties.
Better Security
The decentralized nature of cryptocurrency transactions that are secured by the use of encryption technology such as public keys and private keys produces a very high level of security in cryptocurrency transactions.
Capital Gains
A cryptocurrency is an asset like any other currency or financial asset or property. The fluctuation in price of a cryptocurrency provides the opportunity for traders to buy and sell that cryptocurrency for profit.
Financial institutions have also created Bitcoin-related investment products such as Bitcoin futures and Bitcoin ETFs for investors.
Capital gains in cryptocurrency trading are taxed just like profit from trading any other asset class.
Other Uses of Blockchain Technology
The simple but secure and transparent blockchain technology used in cryptocurrency transactions can be applied to other industries.
These include fiat currency transfers, supply chain management, and even online fundraising. Some financial institutions such as JPMorgan are testing the use of blockchain XRP technology in their fiat currency transactions.
Problems with Cryptocurrency
There are a number of obvious and not-so-obvious problems with cryptocurrency such as:
Currency Used for Criminal Activity
If a criminal pays for a product with fiat currencies through the traditional financial system, his transactions can be monitored and flagged, and he can be identified and brought to justice. However, if he transacts in a decentralized and anonymous cryptocurrency network, he can conduct criminal activity without being identified and caught.
As such, cryptocurrency has become the preferred currency of criminals.
Alleged Anonymity
Having mentioned the possibility of anonymity in the preceding section, it is important to note that cryptocurrency transactions are actually not entirely anonymous. Cryptocurrency transactions do leave a digital trail.
As such, any individual that wishes to use cryptocurrency for legitimate purposes but requires anonymity does not benefit from total anonymity. But his digital activity and trail will only be investigated if the transaction is deemed to be of a criminal nature.
Cryptocurrency Mining
A cryptocurrency can be obtained by buying a cryptocurrency on a cryptocurrency exchange. Or a cryptocurrency can be obtained by mining the cryptocurrency.
Decentralized cryptocurrency miners manage the cryptocurrency network. Mining is a process in which computers and specialized hardware connected to the Internet are used to confirm cryptocurrency transactions.
A cryptocurrency miner will download software that contains a history of transactions that have occurred in that specific cryptocurrency network. The miner will validate and group valid transactions into blocks and if these blocks are accepted and validated by the cryptocurrency network, the transactions are added to the public ledger on the blockchain.
However, cryptocurrency mining computers and hardware consume a considerable amount of energy. The energy costs are extremely high.
Valuable energy that could be used in other more useful activities in a community where cryptocurrencies are mined are instead consumed by cryptocurrency miners to validate cryptocurrency transactions that originate outside of that community.
The high cost to mine cryptocurrency has led to most of the crypto mining being performed by a few large well-funded mining companies that handle the majority of cryptocurrency mining in the world.
And these high energy costs have also led to cryptocurrency mining being performed in geographical regions where electrical power supply is abundantly available. A country like Iceland, which produces abundant low-cost hydro or geothermal power and has cold temperature that is ideal for cooling large computers that produce a lot of heat, has become a popular cryptocurrency mining region.
Cryptocurrency Exchanges are not 100% Secure
Cryptocurrencies are bought and sold on cryptocurrency exchanges, which act as an intermediary between a buyer and a seller of a cryptocurrency. They may also hold cryptocurrencies for their clients. Many exchanges and cryptocurrency wallets (which store the public and private keys for cryptocurrency transactions) have been hacked over the years.
The hackers have stolen hundreds of millions of dollars worth of cryptocurrency from investors.
Investment Risk
The volatile fluctuation in price of the cryptocurrency provides the opportunity for traders to buy and sell a cryptocurrency for profit, and of course, for loss.
Investing in a cryptocurrency is highly speculative and highly risky. Average investors can lose significant sums of money in a relatively short timeframe due to the high levels of volatility in the cryptocurrency trading markets.