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Understanding Cryptocurrency

Written by prositesfinancialSep 17 • 4 minute read

As with any financial investment, you should do independent research before you buy any cryptocurrency. Cryptocurrency is a digital asset used as a medium of exchange with heavy cryptography for the security of transactions and to control the creation of additional units.

Cryptocurrencies use decentralized control, not central banking systems, which works through distributed ledger technology (blockchain) as a public database of transactions. Bitcoin is the first released open-source software and is well-known as the OG of decentralized cryptocurrency. Over the last decade over 4,000 variants of bitcoin have been created and slowly gained in popularity to now be considered a worldwide phenomenon. People who invested just a few hundred dollars about eight years ago would now be multi-millionaires if they bought bitcoin and held onto it without selling. That is a colossal return on investment!

It is important to realize that just because others have made huge gains by investing in bitcoin, that does not automatically mean that you can still buy in and expect these kinds of returns. They are of course possible, but bitcoin, like many investments, is unpredictable and risky. It could go up, and you could become a millionaire, or it could plummet, and you could lose everything you put in.

This extreme increase in value (and other fluctuations) have led to a ton of hype surrounding bitcoin and other cryptocurrencies. However, to the average person, bitcoin can seem like a perplexing puzzle of jargon, buzzwords, and technical terminology. Vocabulary terms like data mining, hash rates, and market capitalization combine with enough techno-fear of instability and uncertainty to deter many potential investors. The word “cryptocurrency” was only added to the Merriam-Webster Dictionary in March 2018, so don’t feel too out of it if the concept seems alien.

The Basic Concepts of Cryptocurrency

Cryptocurrencies are digital units of value similar in concept to physical currencies. Cryptocurrencies use cryptography to ensure the secure exchange of digital information and restrict the creation of new currency units. The integrity and balance of blockchains (the continually expanding ledger of transactions) are maintained by a peer-to-peer network of mutually distrustful individuals known as “miners” who use computers to leverage cryptographic technologies and validate transactions.

Simply speaking, (as simple as possible anyway) cryptocurrencies are digital coins which fluctuate in value and are traded, similar to stocks or other securities or commodities. Think of a computer game as an analogy. Many computer games have a distinct internal currency, and in some cases, that currency can be bought and sold with dollars in the physical world. This is often how a game company makes a profit. Cryptocurrency can be bought with dollars or sold for dollars (or other traditional currency).

As with any currency exchange rate, bitcoins and other cryptocurrencies have a value relative to other currencies. This value changes from day to day and year to year, as do other currency values.

How Cryptocurrency Works

Cryptocurrencies provide a way of owning digital currencies which fluctuate in value and can be traded, saved, or used to purchase goods and services. There are many different kinds of cryptocurrency, such as Bitcoin, Litecoin, Monero, and Ethereum. Each of these cryptocurrencies is a self-contained system which tracks and controls each unit of its own currency.

Every individual unit of cryptocurrency acts like digital information moving through a network. Some units of digital currency might be valued at as little as a penny, and others at hundreds of millions of dollars.

There are different control models for cryptocurrency. Some cryptocurrencies use a centralized control model, where a single entity controls the currency. Others use a decentralized model, where the public controls the currency. There are pros and cons to each model, but the key takeaway is that each cryptocurrency is different. If you don’t like the way one cryptocurrency works, you could choose to work with a different one.

Cryptocurrencies are currently largely unregulated and remain uncontrolled and even unaffected in many ways by national governments and economies. However, some countries, such as Russia, are beginning to accept cryptocurrencies into their economies. They may even regulate it using the central bank. It’s still unknown how the mainstream acceptance of cryptocurrencies will affect the global economy.

What Drives Cryptocurrency?

With cryptocurrencies, there is no central governing body which regulates and verifies the transactions as there is with traditional currencies. Bitcoin, for example, uses something known as “mining” where large groups of dedicated computers are tasked with complex problems to solve. When the computers successfully solve this problem, a specified value of bitcoin credits to the computer system’s account. This complex mining system serves to verify the value and integrity of transactions and prevents people from being able to write code to generate bitcoins.

Cryptocurrency fluctuates in value with changes in supply and demand. As with many other financial instruments, positive news about a cryptocurrency will tend to raise its value, while negative news adversely affects it. The wider the public’s acceptance of a cryptocurrency, the more it tends to go up in value.

This market-driven fluctuation is a big part of why bitcoin has surged so much in value in recent years, to the point where many people are concerned it could be a bubble. Many people speculatively invest in or mine bitcoin without fully understanding the math behind it or the supply and demand models that affect its value. Bitcoin, in particular, has risen greatly in value as it has become popular with retailers and accepted by a lot of mainstream websites and companies.

Should You Invest?

That answer is much like the answer to whether or not you should invest in stocks or other securities. They fluctuate in value, are incredibly complex financial instruments, and are affected by countless market factors beyond your control. It is certainly possible to make tremendous investment gains, as many have, with bitcoin and other cryptocurrencies. It is also possible to lose everything you put in, just as it is with stocks and other forms of investment.

It is important to research before investing in cryptocurrency. The key thing to realize is that if you want to invest in bitcoin or other cryptocurrencies, it would be wise to gather as much knowledge as you can on the subject and only invest after you know what you are getting into and have a reasoned and strategic approach.

If you have any tips or suggestions for people curious about cryptocurrencies, feel free to share them in the comments below!

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