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What is Cryptocurrency?
In recent years, cryptocurrency has become a very popular topic in the financial industry. It is hard to read the news and not see something about cryptocurrency being reported. Whether it is bitcoin mining or Tesla’s recent decision to no longer accept bitcoin in payment for Teslas, cryptocurrency has become big news as well as big business. Efforts by central banks to rein in the use of cryptocurrency are often a hot topic as well. But what exactly is a cryptocurrency, and why should it matter to you? Let’s take a close look at cryptocurrency, so you have a better understanding of this major financial innovation.
The name “cryptocurrency” is derived from the encryption methods that these currencies are based on. At first, many people, governments, and businesses didn’t take cryptocurrency seriously at all, but now there are many major companies and institutional investors coming aboard to work with cryptocurrency in one way or another.
Cryptocurrency is essentially a digital currency that has the ability to be exchanged for products or services online. These currencies are secured by cryptography which makes it almost impossible to use cryptocurrencies in a fraudulent way. Many of these cryptocurrencies work on their own blockchain technology which is essentially a ledger that that is enforced by a team of computers.
The most admirable thing about cryptocurrencies would be the fact that most of them work in an entirely decentralized manner. This ensures that there can be no government regulation on a cryptocurrency because these are worldwide assets that do not hold any affiliation to countries; they simply work off of their blockchain technology.
Cryptocurrency has grown to become very popular among investors since these financial instruments can be a very lucrative investment if gone about in the correct fashion. The entire cryptocurrency market is incredibly volatile at the present time, which gives investors the opportunity to take small amounts of money and produce impressive returns.
How Does Cryptocurrency Work?
Cryptocurrency works in a similar fashion to other fiat currencies around the world. The main difference is that there is no physical coin when it comes to cryptocurrencies, as they are all backed by blockchain technology. Outside of computers, cryptocurrency does not exist. This basically stemmed from the idea that 100 years ago money was entirely cash and check. Now, even the U.S. Dollar is mostly just numbers on a screen. Cryptocurrency works in exactly that manner, to put it in the simplest terms, cryptocurrency is actually really similar to using things like PayPal, Venmo, and other online banking systems.
The thing that has made many people flock to cryptocurrency is the fact that there is little to no government regulation of these new financial instruments. This has certainly brought some uncertainty to the world of crypto since many people believe that it is an unsafe bet. There have also been instances in which cryptocurrency was used for illegal reasons but the innovation that cryptocurrency has offered seems to outweigh the risk of criminals or anyone else using it illegally.
To get into the actual use of cryptocurrency, there are many different places you can store cryptocurrency; accounts or other mechanisms used to store an owner’s crypto are called wallets. The most common cryptocurrency wallets are Coinbase and Gemini, which are both apps that you can use to buy, sell, and hold cryptocurrency.
Let’s say that your friend pays for dinner and you are sending him half of the bill in crypto. You’d take the amount of crypto you need to give him and send it to the address of his crypto wallet. That transaction is then encrypted on the blockchain and will stay there forever. These transactions are also in the public domain, but your identity will be hidden by an anonymous code.
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What is Blockchain?
It has been mentioned a couple of times in this article, but let’s dive into what blockchain actually is, since it is so critical to the world of cryptocurrency. So, if cryptocurrency is the equivalent to other currencies, then blockchain would be considered analogous in many ways to banks. There is, of course, much more that goes into blockchain but that is the simplest analogy.
Just like a bank records all of the data and transactions from its users, blockchain does the same. The main difference is that these cryptocurrency transactions that are recorded don’t go back into a centralized banking system. Instead, that transaction is sent out to all users on that blockchain, and those blocks will authorize the transaction.
Decentralization and Centralization
For almost the entirety of our lives, we have become accustomed to centralized banks. For the most part, no one thought that it would be possible to have a sort of decentralized currency. As mentioned above, decentralization in cryptocurrency is the process of transferring the control of a digital asset to several blocks as opposed to just one single block. This gives more power to the holders of that crypto because there is not one bank at the center of this currency that is controlling what is going on with it.
The thing that makes this good for everyday people is that there is no one that has the power to go in and change the encryption or date within the blockchain. It is basically proving that people are capable of sending money to one another without the need for a third-party bank or organization.
The innovation of decentralization was actually meant to increase security levels which is contrary to what many think when they hear about cryptocurrency. However, if there is a database breach in a centralized system, everyone that is under that system would be affected. It is much easier to hack one system than it would be to hack an entire blockchain system. This is because the power is spread out evenly among multiple points that hold verify every transaction in unison.
The Future of Cryptocurrency
A lot has happened in the digital asset world since Bitcoin was created in 2009. It is often overlooked that there were crypto-like experiments that dated back to the 1990s. Bitcoin just happens to be the first one that came to see success. With that being said, there have been thousands of cryptocurrencies created since Bitcoin came out and many of them offer some extremely innovative technology that has the ability to change banking forever.
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There are more and more cryptocurrency trading apps on the market than ever before. Some crypto banking apps, like Celsius and BlockFi, offer savings wallets with interest rates that are immensely higher than any centralized bank is currently offering. You can buy into these savings wallets with stable coins like USDC to reduce the risk of investing. Celsius is the most popular crypto savings wallet and can give you up to 12% APY depending on what assets you hold in the wallet, which towers over the average $0.04% APY that most U.S. banks offer. So, this is an innovation that could really benefit everyday people if they use this tool properly.
These apps are even taking it a step further and offering crypto-backed loans in which you use the crypto that you already have in your wallet as collateral. At the time of this writing, Celsius offers loans starting at just 1% APY and are in direct correlation to the current portfolio balance that you have. This makes it so that you aren’t able to borrow more than you can afford.
Those are just a couple of the many innovations that people are seeing with cryptocurrency. There has been a growing number of cryptocurrency apps that have debit cards that you can use your crypto to purchase items in real-time in whatever currency you want. Coinbase is one of the apps that created a debit card. With no fees and the ability to get 4% cashback in a cryptocurrency of your choice, this is certainly an innovation that will likely stay for years to come.
Security and Privacy
On the back end, there are many innovations in regard to security and privacy with cryptocurrency. This has been noted as one of the biggest areas of innovation with these financial instruments. As mentioned above, there is a serious focus on security in blockchain technology. This is certainly something that can see a mass of innovation in years to come. Using cryptocurrency to ensure and validate supply chains for food, minerals and medicine may become a routine occurrence in the days ahead.
As the years go on, it is likely that many of the current cryptocurrencies will die out, this is very similar to the internet boom, many of those original companies faded away. The overall innovation of the cryptocurrency and blockchain world appears to be just getting started. There is likely still going to be immense growth and innovation over the course of the next few decades and many people are going to see some great benefits throughout the course of this period. This isn’t to say that you should spend your life savings on a cryptocurrency investment, but there is certainly something to be paying attention to here.
Different Kinds of Cryptocurrencies
At the time of this writing, there are over 4,000 cryptocurrencies, so naturally, there are many that aren’t going to be successful. The most well-known cryptocurrency is Bitcoin and the 2015 technology named Ethereum is growing into that number two spot. These are two cryptos that are essentially paving the way for the future of blockchain technology, they may continue to innovate and grow, or they may open up space for some of the third-generation coins to pass them. Either way, these coins have shown that what was once deemed impossible is certainly possible. It is very exciting to see what some of the new coins will come up with in regard to the road that was set out by Bitcoin.
Going through every one of the 4,000+ would be excessive for the scope of an article, so let’s take a walk through some of the most popular cryptocurrencies today.
Bitcoin is the father of all cryptocurrencies, created in 2009 by Satoshi Nakamoto. The goal of Bitcoin was to create transactions without the need for any middlemen, meaning that there is no need for any form of a centralized bank when using Bitcoin for transactions. There is a lot that Bitcoin can be used for, and stores are starting to adapt so that they can accept it at the cash register. The main hype that has come from Bitcoin would be from the investor’s side. Bitcoin has produced some unheard-of gains over the course of the last decade. This is now bringing attention to institutional investors who were originally very skeptical about Bitcoin and the entire Cryptocurrency market.
Ethereum is known as a second-generation cryptocurrency, meaning that it came in with the first wave of new coins created after Bitcoin. This coin was created by the founder of Ethereum Network, Vitalik Buterin. The intention of Ethereum is essentially to be a medium of exchange or a store of value. Basically meaning that Ethereum is a computing network that is entirely decentralized. There are many similarities between Bitcoin and Ethereum, but Ethereum actually takes things a step further. There is the added attribute in Ethereum as it sits as a host to run applications, smart contracts, and other forms of transactions. Ethereum is so brilliant because it took the road that Bitcoin paved and then provoked even more innovation in order to create the network. Ethereum has seen some immense growth over the course of the last year and is starting to get some more attention among investors.
XRP is a cryptocurrency that focuses more on the financial side of things. Created by Ripple Labs, XRP is a means of payment processing in a cross-border environment that is entirely decentralized. This cryptocurrency is also a second-generation coin that took some of the things about Bitcoin that could be better and put it into their network. The main difference between XRP and Bitcoin is that XRP settles payments much faster than Bitcoin does. A Bitcoin transaction can take up to a half-hour to settle while XRP does it almost instantly. This makes XRP a more viable option for international transactions. Though, they have been in an ongoing lawsuit with the SEC since December of 2020. Despite this lawsuit, Ripple Labs has still been innovating and the XRP coin is up over 100% in 2021.
Cardano is a third-generation cryptocurrency network, coming after Ethereum. This is a proof-of-stake platform that is similar to Ethereum. This ADA coin was founded by Charles Hoskinson, who was also a co-founder of Ethereum. This coin works as an alternative to Ethereum, they do have many of the same characteristics, but Hopkinson thought that he could bring in this new cryptocurrency to solve some of the issues that he sees with Ethereum. One of the most notable goals of Cardano is to provide banking to those who are still currently unbanked. Having a goal like this could make Cardano a very successful long-term project.
Stablecoins are a fairly new class of cryptocurrency. They work in entirely different ways than cryptos as Ethereum and XRP do. They are reserve assets that offer a form of price stability. They can be backed by something like the U.S. dollar or a commodity like gold. This takes the massive volatility that is seen by Bitcoin and levels it out to refrain from wild swings in the market. People can store some of their money in Stablecoins on a platform like Celsius or BlockFi in order to gain that high APY while not worrying about their overall asset value drop with the market. Buying into a stable coin is not something that is going to give you the crazy returns that some cryptocurrencies see, so this is more of a saving mechanism than an investment.
Experiments With Cryptocurrency
There is a current experiment that is going on with Cryptocurrency and Facebook. Since there has been a growing number of transactions on the Facebook Marketplace, and with Facebook Ads, Facebook tried to release the Facebook Libra coin but due to regulatory issues, it still has not been released. There have been claims made that this coin can surface within the next year, hopefully by the end of 2021. This will be a stable coin that will be backed by FIAT currencies and will be centralized with Facebook headquarters. Overall, this is an experimental coin that will make payment processing easier for cross-border payments on the Facebook platform.
Pros and Cons of Cryptocurrencies
There are some upsides and downsides when it comes to cryptocurrency. These are things that will hopefully work themselves out as more generations of cryptocurrencies come into play. Here are some of the most notable pros and cons in the cryptocurrency world.
- 24 Hour Accessibility: Unlike the stock market, the crypto market never closes. This means that your assets are accessible at any given moment. Some traders stay up all night to purchase a dip in the market.
- Growing Acceptance: As the cryptocurrency market is growing to be more well known, there is a level of trust that has been sustained. This is making it so companies are starting to accept crypto payments.
- Limited Supply: Many cryptocurrencies have a finite amount in circulation. For instance, there were only 21 million Bitcoin created. As that number in circulation starts to diminish the basic laws of supply and demand suggest that the price will increase.
- Security: With blockchain technology, there is virtually no chance of any fraudulent activity happening within the blockchain. This is not to say that cryptocurrency can’t be used illegally, but it does suggest that there are no fake Bitcoins on the blockchain.
- Potential For Returns: Investors are always looking for as big of a return as they can get. Cryptocurrencies are providing investment opportunities like never before. It opens up the opportunity for financial freedom for everyday people.
- Environmental Concerns: cryptocurrency mining mechanisms have been proven to be bad for the environment. The crypto mining process is often powered by older generation power plants that release carbon emissions into the atmosphere. This is the reason why Elon Musk claims to have stopped allowing Bitcoin payments for Tesla.
- Extreme Volatility ad Risk: With that huge potential for returns comes the potential of losing massive amounts of money. Cryptocurrency investing is not for people with a low-risk tolerance, these are assets that can drop 40% in the blink of an eye if not gone about in the right fashion.
- Difficult To Understand: Understanding cryptocurrency requires a lot of research. This is not something that can be learned in a day. Not understanding cryptocurrency and the crypto market can have you losing a lot of your money that you put in.
- Illegal Use: Since cryptocurrencies work in an entirely decentralized fashion, it opens up the opportunity for people to misuse the technology. There was a major court case on the Silk Road website back in 2013 that landed Charlie Shrem in prison for life. This has turned people away from cryptocurrency, but in reality, people use the U.S. dollar for illegal activities every day.
These are some of the most notable pros and cons of cryptocurrency as a whole. Hopefully, in the future, some of those cons are worked out with new innovations and technologies. Overall, the cryptocurrency market has shown huge amounts of innovation that don’t look like they are going to phase away in the coming years.
Cryptocurrency is an increasingly relevant financial topic these days. Major companies, institutional investors, and everyday people are getting into the cryptocurrency game with hopes that they can invest in the next Bitcoin, or power new transactions using these financial instruments. There are now thousands of cryptocurrencies in the world and many of them are showing massive signs of innovation. People are going to benefit from the cryptocurrency revolution even if they aren’t invested in the market. Banks and shopping will change hopefully for the better and select investors may create nice levels of wealth if they can play the markets right.
It is also very important to note that cryptocurrency investing is certainly not for everyone. While many people became millionaires off of Bitcoin and Ethereum, there were also many people who bought at the wrong time and sold at an even worse time. Many people buy into the hype when all-time highs are being reached and then sell when they see their first market correction. This means that they lost massive amounts of money. If you are looking to break into cryptocurrency investing, then you need to be prepared for a bumpy ride. You must assess your risk tolerance; if you do not have a high-risk tolerance then you may want to go into index funds or bonds.
Overall, the cryptocurrency revolution is a significant innovation of technology with the introduction of blockchain networks. It is going to be very exciting to see what happens in the cryptocurrency world over the course of the next few decades. It is highly likely that there will continue to be loads of innovation and new technologies to come.
Enjoy our article: What is cryptocurrency?
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