What are Cryptocurrencies and How Do They Work?

Although cryptocurrencies have swiftly gained popularity over the past couple of years, many still are unaware of how they work and what advantages come with using them.

Updated: 14 Dec, 21 by Antoniy Yushkevych 13 Min

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News that is always drawing attention in our fast-paced world is cryptocurrency. They seem to break new records every day in the crypto market, but this hype around cryptocurrencies is not new because it has been around for more than a decade. Bitcoin, the very first cryptocurrency, recently touched an all-time high of $60,000, and its market capitalization has reached well beyond a trillion dollars. The popularity of this type of banking system or some would like to call it peer-to-peer transaction technology, increased because of its solid infrastructure and technological support. This article will break down different aspects of cryptocurrency, such as its background, applications, technology, and explore the future possibilities for digital currencies like Bitcoin or Ethereum. 

When we hear someone talk about cryptocurrency, we feel that it is very complicated, and it is hard to grasp the concept behind it. Well, that is not the case with cryptocurrency. Cryptocurrency is very similar to cash or physical money that is used to buy goods and desired services. Still, the catch here is that- it is all online and adopts a decentralized system run on highly sophisticated technologies. Cryptocurrencies act as a medium to exchange the value of goods and services digitally, so there is no need to have a prominent presence of authority like it is in banks and other financial institutions. 

Now you know that cryptocurrency is a decentralized system, it is time to understand some integral concepts that run behind it. 

Public Ledgers

This is very similar to what banks give to their account holders, consisting of transaction details and total balance amount. The only difference to cryptocurrency would be the encryption of public ledgers. Every crypto user can see other holders, but they maintain a level of anonymity for their record keeping. When a transaction is successful between two users, the ledger automatically adjusts its value by decreasing the sender's total amount and increasing the same for the receiver. 

Crypto Mining

The mining of cryptocurrencies is now regarded as one of the most challenging daily tasks. The reason lies in solving a complex computational problem that is more or less on the same level as a mathematical puzzle. As there are only a limited number of crypto coins, these problems' complexity level increases week after week. It follows something called- "Adaptive Scaling", and the entire financial system needs to maintain a controlled pace of mining digital coins. 

If crypto miners worldwide can generate more coins in a short period, then the system will level up the difficulty of the problem. For example, Bitcoin allows only one transaction block to be created every ten minutes. If we calculate the number of coins for two weeks, it will be 2016 Bitcoins. If the blocks are generated before or after 14 days, the system alters its algorithm. 

Cryptographic Hash

It is an important and essential topic for breaking down different optics behind cryptocurrency. A cryptographic hash is crucial for cryptocurrency to be effective because it validates the coins and increases their value. When there are many pending transactions in the system, they are accumulated in a block. When one solves the computational problem associated with a pending transaction, they can be the next in the transaction chain and earn significant compensation. 

When we revisit the year 1983, we will witness an American Cryptographic system called eCash which was later developed into an advanced economic transaction system called DigiCash. In the initial years, it gained a lot of traction and usage, but it slowly lost its main purpose of using a digital currency that prevents double-spending. With cash and physical coins, it is impossible to spend the same value on two different things. Still, with digital currency, there is a possibility, and it was violated with DigiCash. Even though it followed the same decentralized system, it could not prevent double-spending by the users. Present-day cryptocurrencies do not face this sort of problem because they have the backing of an extremely advanced technology called Blockchain. 

The creator of the first cryptocurrency is Satoshi Nakamoto, and to this day, we have no clue of his true identity. He came up with this idea of Bitcoin during the 08' economic crisis. The intention behind this selfless creation was to give people a new way of payment that can be made between any two parties all across the world. An idea originated from a mailing list discussion set its course in 2009, and people started to mine these coins just as a hobby. 

No one was trading these coins because Bitcoin still wasn't trusted by international institutions like they do today. When someone swapped 10,000 Bitcoins for two pizzas, it is pretty obvious that no one knew what their true value is at that moment in time. If they had hung onto those coins, they would be valued at close to $100 million.

In the last decade, Bitcoin gained an insane amount of popularity, leading to increased rival cryptocurrencies. Cryptocurrencies like Litecoin or Namecoin were some notable names at that time, and these collective groups of coins apart from Bitcoin are called altcoins. In 2013, the price of Bitcoin reached $1000, but it crashed not long after, reaching an all-time high. People started to doubt the value of Bitcoin, and in the year 2014, it attracted more bad parties than good because the largest Bitcoin exchange, Mt.Gox, went offline, and all the owners never gained access to their Bitcoin wallets. This all changed when a new cryptocurrency called Ethereum came into the picture, allowing investors to trade their share of crypto coins. 

Even with Ethereum stealing Bitcoin's thunder, the value only increased, and it reached $10,000 in the year 2017. Crypto markets are the most volatile globally, but the people who invest with the right knowledge and technical skills can reap huge rewards down the line. That is what had happened in 2020, where the value of Bitcoin increased by almost 700 percent. 

We all know that cryptocurrency has a main appeal directed towards creating a secure online currency, but that is not entirely what is creating all this hype and popularity. The underlying technology has something unique to offer shortly, and everyone is waiting to indulge in some of the best applications created by Blockchain. Finance payments are about to be revolutionized with the help of Blockchain and its wide range of applications. 

The electronic payment system offered by cryptocurrency is faster and more reliant than the bank systems. One of the main reasons people are slowly choosing Bitcoin over cash is that digital currencies do not charge a high transaction fee. The applications that revolve around Blockchain are mind-blowing because things like voting and managing supply chains will become a lot easier with its integration. 

The hype around Bitcoin and Ethereum technology is real, but it is advised to consider its risks. Cryptocurrency made many people wealthy over the last five years, but it has also made people lose their entire capital. Headlines may be encouraging, but it is safe to say that digital currencies are still considered highly speculative assets. 

When well-known financial institutions like JPMorgan and Citigroup start diversifying their portfolios into Bitcoin and other cryptocurrencies, it is for sure that they saw something valuable in this digital economic market. That is none other than the technology itself. People believe in Blockchain for so many reasons that extend to its future, but its distributed ledger technology is taking over the world right now. Even though it is still in the early stages of a technological upgrade, many experts feel that once it is deployed and implemented on a large scale - it is game over for several large industries. People in the tech world see an out of potential in Blockchain to become mainstream in financial services. 

This type of technology can secure a user's identity that doesn't allow any third party to access their identification. Many financial journalists have stated in many accounts that "Blockchain can serve as a self-sovereign ID, and it can take over myriad ordinary documents." This technology can change the face of any company because of its flawless integration. Effective record-keeping results in better management performance, and it benefits no one but multiple parties of mutual interest. 

Buying and holding coins is very different from trading in the crypto market. The risk in trading Bitcoins and other altcoins is huge, so if you are new to cryptocurrency, you should just invest and completely forget about it. The volatility may surprise you initially, but if you are a true believer, you should hold for a couple of years at least.

Investing in the crypto market has never been easier with companies like Coinbase and Bitfinex leading the industry. The only thing to look out for before you invest is to check whether digital currencies like Bitcoin are legal in your respective country. If they are not legal to invest and trade, then you may face future problems with your holdings. 

Bitcoin is now a global phenomenon, and everyone is paying close attention to learn about this evolving technology. However, digital currency's concept comes with its fair share of concerns that can disrupt the entire crypto market. In the future, people will gain more trust in cryptocurrencies because businesses are starting new ventures with Blockchain technology.

We can already see that major corporations have started accepting payments in Bitcoin, so it will only be uphill from here onwards. Once society starts to accept Bitcoin, it will entirely change the fate of major banking companies.

With time and effort, technology will only get better, and Blockchain is still in its early development stages. We can expect new features and applications to be added with its existing smart contracts. The future also holds an extreme push for strict regulation. With institutional money entering the market, government entities will introduce major changes to the regulation and rules to regularly use crypto assets. 

Here are some advantages to using cryptocurrencies:

  • Fraud: Since cryptocurrencies are completely digital, they cannot be counterfeit or reversed arbitrarily by the sender like it is possible with credit card charge-backs.
  • Identity Theft: When giving credit card credentials to a seller, you give them access to your full credit line. The store initiates the payment and pulls the designated amount from your account. Cryptocurrencies, on the other hand, use the “push” method which allows the sender to send exactly what is desired to the recipient with no further information.
  • Immediate Settlement: Bitcoin contracts can be designed to either eliminate or add third party approvals, reference external facts or be completed at a future date or time at a fraction of the expense.
  • Access to Everyone: There are over 2 billion people with internet access who don’t have access to traditional exchange systems. These individuals are primed for the cryptocurrency market.
  • Lower Fees: In most cases, there are no transaction fees when dealing with cryptocurrencies, as the miners are compensated by the network. Nevertheless, many expect that most users will engage in a third-party service for creating and maintaining their own bitcoin wallets. These services provide the online exchange system for cryptocurrencies, and thus are likely to charge fees.

Although there are so many advantages to cryptocurrencies over fiat ones (i.e. regular money), the bottom line is: it will need years of exposure to the global system before the masses start accepting it as a tool for global commerce.

Even if the world isn’t ready to start fully accepting cryptocurrencies as payment methods, Monovm is! We accept nearly all mainstream cryptocurrencies as payment gateways for any of our services. You can click here to get a VPS with Bitcoin

Cryptocurrencies will always be led by two or three major coins like Bitcoin and Ethereum because of their potential to serve the general public in many important matters like transactions and other financial services. 

A mainstream system filled with crypto coins is possible with significant Blockchain improvements, but it still has to overcome certain challenges to negate illicit and illegal activities. Being a part of a trend in this market may sound exciting and fun, but it brings risk. Try to learn cryptocurrency concepts and understand what the future looks like for Bitcoin and Blockchain technology. 

Antoniy Yushkevych

Antoniy Yushkevych

Master of word when it comes to technology, internet and privacy. I'm also your usual guy that always aims for the best result and takes a skateboard to work. If you need me, you will find me at the office's Counter-Strike championships on Fridays or at a.yushkevych@monovm.com