What is cryptocurrency and how does it work?

Cryptocurrency is a decentralized digital currency based on blockchain technology and secured by cryptography. To understand cryptocurrency, one must first understand three terminologies – blockchain, decentralization, and cryptography.

Simply put, blockchain in the context of cryptocurrency is a digital ledger with access distributed among authorized users. This ledger records transactions related to a range of assets, such as money, house or even intellectual property.

Access is shared between its users and any shared information is transparent, immediate and “immutable”. Immutable means that everything the blockchain records is there for good and cannot be changed or altered, even by an administrator.

Centralized money refers to the regular money that we use, which is regulated by authorities such as the Reserve Bank of India. The decentralization of cryptocurrency means that no similar authority can be held responsible for overseeing the rise and fall of a particular cryptocurrency. This has many advantages over centralized money.

Some of these benefits include the following:

• Currency owners do not need to “trust” a single governing entity, as everyone in the network has access to the same information that cannot be changed.
• The data remains accessible only to network users and is highly secure. Shared ownership also means that all users approve of the accuracy of the data, which means there is very little room for data mismanagement or miscommunication. Think of it as a democracy.
• Security, which is a fundamental element of a blockchain.

Cryptography is the method that secures data against unauthorized access through the use of encryption techniques. Most of blockchain’s claims, like privacy and immutability, are made possible by cryptography.

The roots of cryptocurrency technology date back to the 1980s with the invention of what is known as a “blinding algorithm”. The algorithm is about secure and immutable digital transactions. It remains fundamental to modern digital currency.

In 2008, a group of people (currently known as Satoshi Nakamoto) created the guiding principles for the first and leading cryptocurrency in the market today, Bitcoin. In 2009 Bitcoin was launched to the world. But it will take years before it is formally recognized as a means of payment by major merchants, starting with WordPress in 2012.

The underlying blockchain technology is used in banking, insurance, and other industries today. Growing at a compound annual growth rate of 12.8% since 2021, the cryptocurrency market is expected to reach $4.94 billion by 2030, driven by the need to improve the efficiency of current payment systems , the increase in global remittances and the increased need to secure data.

How does cryptocurrency work?

Cryptocurrencies are not controlled by the government or central regulatory authorities. As a concept, cryptocurrency operates outside of the banking system using different brands or types of coins – Bitcoin being the main player.

1. Mining

Cryptocurrencies (which are entirely digital) are generated by a process called “mining”. It is a complex process. Basically, miners are required to solve certain mathematical puzzles on specially equipped computer systems to be rewarded with bitcoins in exchange.

In an ideal world, it would only take 10 minutes for a person to mine a bitcoin, but in reality, the process takes around 30 days.

2. Buy, sell and store

Today, users can buy cryptocurrencies from or sell to central exchanges, brokers, and individual currency owners. Exchanges or platforms like Coinbase are the easiest ways to buy or sell cryptocurrencies.

Once purchased, cryptocurrencies can be stored in digital wallets. Digital wallets can be “hot” or “cold”. Hot means that the wallet is connected to the Internet, which facilitates transactions, but is vulnerable to theft and fraud. Cold storage, on the other hand, is more secure but makes transactions more difficult.

3. Trade or invest

Cryptocurrencies like Bitcoins can be easily transferred from one digital wallet to another, using only a smartphone. Once you own them, your choices are:

a) use them to purchase goods or services

b) trade in it

c) exchange them for money

If you use Bitcoin for purchases, the easiest way is through debit card type transactions. You can also use these debit cards to withdraw cash, like at an ATM. Converting cryptocurrency to cash is also possible using bank accounts or peer-to-peer transactions.

Types of cryptocurrencies

There are tens of thousands of cryptocurrencies available today, with the figure pegged at 10,000 in 2022. The major cryptocurrencies are:

Bitcoin is the world’s first widely accepted form of cryptocurrency. Bitcoin is so popular that there was a time when its name was synonymous with cryptocurrency. But potential investors should know that bitcoins have become very expensive. In 2021, the cost of one Bitcoin was $68,000. But the good news is that you don’t always have to buy a whole coin, you can buy smaller fractions.

Altcoin is the term used for any alternative digital currency to bitcoin. The most popular in this ecosystem is Ethereum – one of the fastest growing cryptocurrencies in the market. There are also a range of other altcoins on the market today, such as Luckyblock, Shiba Inu, and Terra.

The concept of crypto coins versus tokens can be confusing to many. At first glance, coins and tokens appear identical. However, the two have many differences

• Coins can be mined, but tokens cannot be mined.
• Coins are linked to blockchains, tokens are not.
• In terms of usefulness, they vary depending on the type of product or service they allow users to purchase.

Should you invest in cryptocurrency?

Cryptocurrency trading has many advantages, as well as a fair share of disadvantages. Here are the top three reasons that work for and against cryptocurrencies.

Advantages :

• They are private and secure: The blockchain technology that powers cryptocurrencies guarantees user anonymity. It also ensures high levels of security through cryptography, which we have already discussed.

• They are decentralized, immutable and transparent: The entire system operates on shared ownership, where data is available to all authorized members and is tamper-proof.

• They are a hedge against inflation: Cryptocurrency is a great investment in times of inflation. For example, investors often compare cryptocurrency to gold. One of the reasons behind this is that just like gold, they are in limited supply, as there is a cap on mining any type of cryptocurrency.

Disadvantages:

• They are not widely understood: This is a relatively new concept and the long-term sustainability of cryptocurrencies remains to be seen.

• They are subject to high risks: Needless to say, cryptocurrencies bring as many rewards as they do risks. Their highly volatile and speculative nature makes them prone to strong downward spirals. Investing in cryptocurrency can be risky for many reasons.

• A major deterrent could be the fact that digital currency appears to have no inherent or underlying value. There is a supply-demand type equation that is used to determine the value of cryptos like bitcoins.
• Moreover, it is easy to see how simple speculation on the Internet can lead to a substantial increase or loss in the value of these coins.
• In addition, the fact that cryptocurrencies are banned or their use is restricted in many countries is a significant risk. Their legality is questionable in countries like India.

• Scalability is a problem: This is a complex question, which has more to do with the technological side of blockchain. Simply put, the slow nature of the blockchain makes it prone to transactional delays. This tends to make crypto payments inefficient compared to modern electronic payment techniques.

Cryptocurrency in India

Until the announcement of the Union Budget 2022, the fate of cryptocurrency in India was largely undecided.

In the budget, India’s finance minister’s announcement to levy a 30% tax on gains on the transfer of virtual digital assets, which includes cryptocurrency, was initially seen as an endorsement of cryptocurrencies. This has sparked the debate over whether or not the tax on cryptocurrency indicates that the government has recognized it as a legitimate form of currency.

However, this is not true and there has also been speculation that a ban on private cryptocurrencies will follow the launch of the RBI’s own official digital currency. Something to this effect was openly stated by RBI Deputy Governor T Rabi Sankar in February 2022 when he said that India was advised to ban cryptocurrency. Whether this will turn out to be similar to the government’s cryptocurrency ban in 2018 (which was overturned by the Supreme Court of India in 2020) remains to be seen.

Conclusion

Whether cryptocurrency is the future of money or not, one thing is clear: it is not advisable for anyone to invest in it without doing enough research. Investing in cryptocurrencies is not a new phenomenon. But with the recent surge in popularity and value, coupled with declining bank deposit yields, more and more people are looking for advice on cryptocurrencies.

If you have decided to invest in cryptocurrencies, be sure to start with the major cryptocurrencies like bitcoin, as newer ones may not have enough liquidity (you may not be able to sell them when you want). The market is full of scammers. It is therefore important to use authorized platforms to buy or trade cryptos, especially in the beginning.

Investing in cryptocurrency is risky business. You should be aware that there are high chances of losing your money. If you’re not comfortable with risk, it’s best to stay away. There are many ways to profit from cryptocurrency – buy coins, trade coins, mine coins, etc. The latter requires the maximum resources, but also has the potential for higher returns, while buying or trading can be done more easily.

Cryptocurrencies are also very volatile, so it is recommended to start small and diversify your investments. Simply put, don’t put all your eggs in one basket. As a beginner, it helps if you initially rely on expert advice and gradually develop your own expertise by researching the subject. For this type of research to be successful, it is also important to develop an understanding of your country’s historical and current cryptocurrency policies. And as always, don’t invest more than you can afford to lose.