What is cryptocurrency?

Cryptocurrency is decentralized digital money based on blockchain technology. You may be familiar with the most popular versions, Bitcoin and Ethereum, but there are over 5,000 different cryptocurrencies in circulation.

How does cryptocurrency work?

Cryptocurrency is a medium of exchange that is digital, encrypted and decentralized. Unlike the US dollar or the euro, there is no central authority that manages and maintains the value of the cryptocurrency. Instead, these functions are widely distributed among users of the cryptocurrency via the Internet.

You can use crypto to buy regular goods and services, although most people invest in cryptocurrency as much as they invest in other assets such as stocks or precious metals. While cryptocurrency is a novel and exciting asset class, buying it can be risky as you will need to do a fair amount of research to fully understand how each system works.

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Bitcoin was the first cryptocurrency, first mentioned theoretically in 2008 by Satoshi Nakamoto under the title "Bitcoin: A Peer-to-Peer Electronic Cash System". Nakamoto described the project as "an electronic payment system based on cryptographic proof rather than trust".

That cryptographic proof comes in the form of transactions that are verified and recorded on a blockchain.

What is a Blockchain?

A blockchain is an open, distributed ledger that records transactions in code. In practice, it is like a checkbook that is distributed to countless computers around the world. Transactions are recorded in "blocks" which are then linked together over a "chain" of past cryptocurrency transactions.

“Imagine a book where you spend money every day,” says Buchi Okoro, CEO and co-founder of African cryptocurrency exchange Quidax. “Each page is like a block, and the whole book, a set of pages, is a blockchain.”

With a blockchain, everyone who uses cryptocurrency has their own copy of this book to create a unified transaction record. The software logs each new transaction as it occurs, and each copy of the blockchain is updated simultaneously with new information, keeping all records identical and accurate.

To prevent fraud, each transaction is verified using one of two main verification techniques: proof of work or proof of stake.

proof of work vs proof of stake

Proof of Work and Proof of Stake are two different verification techniques used to verify transactions before they are added to a blockchain that rewards validators with more cryptocurrencies. Cryptocurrencies typically use proof of work or proof of stake to verify transactions.

proof of work

“Proof of work is a method of verifying transactions on a blockchain in which an algorithm provides a mathematical problem that a computer races to solve,” says Simon Oxenheim, social media manager at Xcoins.com.

Each participating computer, often called a "miner", solves a mathematical puzzle that helps verify a set of transactions – referred to as blocks – then convert them to a blockchain ledger. adds up. The first computer to successfully do so is rewarded with a small amount of cryptocurrency for its efforts.

This race to solve blockchain puzzles can require enormous amounts of computer power and power. In practice, this means that miners can barely break even with the crypto received to validate transactions, after considering the cost of electricity and computing resources.

proof of stake

To reduce the amount of power required to verify transactions, some cryptocurrencies use a proof of stake verification method. With Proof of Stake, the number of transactions that each person can verify is limited by the amount of cryptocurrency they “stake” or temporarily locked in a communal vault for the opportunity to participate in the process. want to do. "It's almost like bank collateral," Okoro says. Everyone betting crypto is eligible to verify the transaction, but the chances of you choosing to do so increase with the amount you face.

“Since proof of stake removes the energy-intensive equation solution, it is far more efficient than proof of work, allowing faster verification/confirmation times for transactions,” says Anton Altemente, CEO of Ossome Finance.

If a stake owner (sometimes called a validator) is chosen to validate a new set of transactions, they will be rewarded with cryptocurrency, potentially reducing the total transaction fee from the block of transactions.

In the amount of K. To discourage fraud, you forfeit a portion of what you bet if you are selected and verify an invalid transaction

The Role of Consensus in Crypto

Proof of Stake and Proof of Work both rely on consensus mechanisms to verify transactions. This means that while each uses different users to verify a transaction, each verified transaction must be verified and approved by the majority of account holders.

For example, a hacker cannot alter the blockchain ledger until they have successfully found at least 51% of the ledgers to match their fraudulent version. The amount of resources needed to do this minimizes the potential for fraud.

How can you mine cryptocurrency?

Mining is how new units of cryptocurrency are issued into the world, usually in exchange for validating transactions. While it is theoretically possible for the average person to mine cryptocurrency, it is increasingly difficult in proof of work systems such as bitcoin.

“As the bitcoin network grows, it becomes more complex, and requires more processing power,” says Spencer Montgomery, founder of Uinta Crypto Consulting. "The average consumer used to be able to do this, but now it's too expensive. There are a lot of people who have adapted their devices and technology to get better."

And remember: Proof of Work cryptocurrencies require an enormous amount of energy to mine. It is estimated that 0.21% of all the electricity in the world goes to power bitcoin farms. This is about the same amount of power as Switzerland uses in a year. It is estimated that most bitcoin miners use 60% to 80% of the earnings from mining to cover the cost of electricity.

While it is impractical for the average person to earn crypto by mining in proof of work, the way of high-powered computing requires less of a proof of stake model because validators are randomly assigned based on the amount they stake. is chosen. However, it is necessary that you already have a cryptocurrency in order to participate. (If you don't have any crypto, you have nothing to bet.)

How can you use cryptocurrency?

You can use cryptocurrency to make purchases, but it is not yet a form of payment with mainstream acceptance. A handful of online retailers, such as Overstock.com, accept bitcoin, but this is far from ideal.

Until crypto becomes more widely accepted, you can work around the current limitations by exchanging cryptocurrency for gift cards. For example, on eGifter, you can use bitcoin to buy gift cards for Dunkin' Donuts, Target, Apple, and select other retailers and restaurants. You may also be able to load cryptocurrency into a debit card to make purchases. US In the U.S., you can sign up for a BitPay card, a debit card that converts crypto assets into dollars for purchases, but there are fees involved for ordering the card and using it for ATM withdrawals, for example. for.

You can also use crypto as an alternative investment option outside of stocks and bonds. “The best-known crypto, bitcoin, is a secure, decentralized currency that has become a store of value like gold,” says David Zeiler, a cryptocurrency expert and associate editor of financial news site Money Morning. "Some people even call it 'digital gold'."

How to Use Cryptocurrency for Safe Shopping

Using crypto to shop safely depends on what you're looking to buy. If you want to spend cryptocurrency at a retailer that doesn't accept it directly, you can. You can use a cryptocurrency debit card such as Bitpay.

If you're trying to pay to an individual or retailer that accepts cryptocurrency, you'll need a cryptocurrency wallet, which is a software program that interacts with the blockchain and allows users to send and receive cryptocurrency. allows for.

To transfer money from your wallet, you can scan your recipient's QR code or manually enter their wallet address. Some services make this easier by allowing you to enter a phone number or select a contact from your phone. Keep in mind that transactions are not instantaneous as they must be validated using proof of work or proof of stake. Depending on the cryptocurrency, this can take anywhere from 10 minutes to two hours.

However, this lag time is part of what makes crypto transactions secure. "A bad actor trying to alter a transaction will not have the proper software 'key,' which means the network will reject the transaction. The network also enforces policies and double-spends," says Zeiler.

How to Invest in criptocurrency

Cryptocurrency can be purchased on peer-to-peer networks and cryptocurrency exchanges, such as Coinbase and Bitfinex. However, keep an eye on fees, as some of these exchanges charge extremely high costs on small crypto purchases. Coinbase, for example, charges a 0.5% fee of your purchase and a flat fee of $0.99 to $2.99, depending on the size of your transaction.

Recently, investment app Robinhood began offering the ability to buy several top cryptocurrencies, including bitcoin, ethereum, and dogecoin, without the fees of many major exchanges.