What is cryptocurrency?

Cryptocurrency is not just another form of currency that is akin to what we transfer via our mobile wallets and online banking nowadays–that’s just fiat money, in digital form. 

 

Cryptocurrency is fundamentally different from this. It uses cryptography to secure transactions and control the creation of new units, enabling it to operate independently of a central bank or government. 

 

In this article, we explain how cryptocurrencies came about, the main principles behind them, how they work, and what they are used for. 

 

A brief history of cryptocurrency

 

Unlike what many may think, cryptocurrency is not a new concept that sprung from the mind of one shadowy figure/entity who goes by the pseudonym Satoshi Nakamoto. In fact, the concept of cryptocurrency was first proposed all the way back in the late 1980s by the Cypherpunks, a group of activists and cryptographers who advocated for the use of cryptography to protect individual privacy and freedom. Many of them attempted to create cryptocurrencies but failed.

 

In 2008, an anonymous individual or group known as Satoshi Nakamoto published a white paper describing a peer-to-peer electronic cash system called Bitcoin. Bitcoin was the first successful cryptocurrency, and it paved the way for the development of thousands of other cryptocurrencies, known as altcoins. 

 

What makes a cryptocurrency “successful,” technically speaking? In the words of technologist and investor Jeff Booth, it has to meet two criteria. It has to be both decentralized and secure. 

 

How is cryptocurrency created?

 

Cryptocurrencies operate on top of a blockchain, a distributed ledger that records transactions across many computers i.e. “nodes” in a network. Each block in the chain contains a number of transactions, and every time a new transaction occurs, a record of that transaction is added to every node's ledger. 

 

But how is cryptocurrency created? Bitcoin, the original crypto, is minted through a process called mining, which involves verifying transactions and adding them to the blockchain. Now this process applies only to cryptocurrencies created through the proof-of-work consensus mechanism; the process is slightly different for cryptos that are created via a proof-of-stake consensus mechanism. 

 

In other words, cryptocurrency is created through software that is secured through cryptography, while fiat currency is created through the printing of money as decreed by governments. 

 

 

How does blockchain work? A quick explainer.

 

 

Benefits of cryptocurrencies

 

At the core, the main function of cryptocurrencies is to serve as currency, or money i.e. assets that can be used as a medium of exchange, a unit of account, and a store of value. 

 

At the practical level, two of the biggest benefits cryptocurrencies offer over traditional fiat currencies and payment methods are: 

 

• Lower fees: Cryptocurrency transactions often have lower fees compared to traditional payment methods, especially for international transactions like remittances.

 

• Accessibility: Cryptocurrencies are accessible to anyone with an internet connection, making them a viable option for the unbanked and underbanked populations. 

 

 At the philosophical level, however, cryptocurrencies offer the promise of decentralization, operating independently of financial institutions, credit card companies, and governments. This makes them less susceptible to manipulation and censorship, enabling the transfer and preservation of value much more easily, especially for citizens trying to save their hard-earned money in developing nations with weaker currencies.

 

What determines the value of a cryptocurrency?

 

It can be a little counterintuitive that discrete value can be attributed to something that is completely intangible, and that’s what cryptocurrency is, at the end of the day…just a software that maintains a ledger. 

 

So why do cryptocurrencies have value? The fundamental reason is that they enable the fast and low-cost transfer of money better than our traditional fiat system. Having said that, what makes one cryptocurrency more valuable than another? Here are several key factors: 

 

• Utility and use cases: Cryptocurrencies with real-world applications and use cases tend to have higher value. The more people use a cryptocurrency, the more valuable it becomes.

 

• Scarcity: Cryptocurrencies with limited or decreasing supply, like Bitcoin, tend to have higher prices as scarcity increases demand.

 

• Adoption and popularity: Cryptocurrencies that gain mainstream adoption and popularity tend to see their prices rise. Media coverage and social media promotion can also boost demand and prices.

 

• Competition: The cryptocurrency market is highly competitive. Newer cryptocurrencies that offer improvements over existing ones can gain value at the expense of competitors.

 

To sum it up, while cryptocurrencies are not backed by governments or central banks, their value is determined by a combination of supply, demand, utility, adoption, competition and availability.

 

Why are there so many cryptocurrencies today?

 

There are several reasons why there are so many cryptocurrencies today (at last count, about 23,000 according to CoinMarketCap), mainly due to:

 

• Specialization: While Bitcoin was initially developed as a form of payment, other cryptocurrencies have been created to serve specific use cases, such as Ethereum's smart contracts and decentralized applications. This specialization has led to the creation of numerous altcoins targeting different markets and industries. 

 

• Competition: The success of Bitcoin has inspired many entrepreneurs and developers to create their own cryptocurrencies in the hopes of capturing a share of the market. This competitive environment has driven innovation and the creation of new features and use cases. 

 

• Low barriers to entry: By far the biggest reason for the tens of thousands of coins in existence today is the fact that creating a new cryptocurrency is relatively easy, as anyone can just copy the source code of any other open-sourced blockchain (like Bitcoin), tweak it, and secure a community of users. This has led to the proliferation of thousands of altcoins, many of which are obscure and essentially worthless. 

 

This is why it is essential to DYOR before investing. Not every crypto is legit, and some may even be outright scams.

 

 

What are the different types of cryptocurrencies?

 

 

In conclusion

 

Being a new and evolving technology, cryptocurrency faces several risks and challenges, including volatility, security, scalability and legitimacy. However, it represents a significant innovation in the world of finance, offering a decentralized, secure, and accessible alternative to traditional payment methods.

 

If you’re learning about cryptocurrencies, understanding how traditional monetary and banking systems work can aid your understanding of crypto’s value proposition. And if you’re looking to investing in crypto, always do your due diligence and do not invest with money you cannot afford to lose.