Demystifying Cryptocurrency: A Guide to the Basics
In this fast-paced digital era, cryptocurrencies have emerged as a disruptive force, challenging traditional financial systems, and revolutionizing the way we perceive money. Whether you've come across terms like Bitcoin, Ethereum, or blockchain technology in the news or among friends, the concept of cryptocurrencies has become increasingly prevalent. However, understanding the fundamentals of this topic can be a daunting task for newcomers.
Cryptocurrencies represent a shift in the way we think about money. To navigate, or perhaps even simply understand what your friends are talking about, it is crucial to grasp the basics of cryptocurrencies and the underlying technologies that power them. Below is a selection of definitions to help you gain an understanding of cryptocurrency basics.
Cryptocurrency: Cryptocurrency is a digital or virtual form of currency that uses cryptography (a method of protecting information using codes), for security and operates independently of central banks. There are thousands of cryptocurrencies, but generally, they're used to pay for services or as an investment. Cryptocurrency pricing can be very volatile making this form of investing somewhat risky.
Tokens: Individual units of cryptocurrencies can be referred to as coins or tokens, depending on how they are used. Tokens can be used to purchase goods and services, store value (like a savings account) or be used in specific online applications.
Centralized Bank: A centralized bank is a public institution that is responsible for implementing monetary policy, managing the currency of a country, or group of countries, and controlling the money supply.
Decentralization: Cryptocurrencies are decentralized, meaning they operate on a distributed ledger technology called blockchain, which is maintained by a network of computers (nodes) rather than a central authority.
Distributed Ledger: This is a platform that uses ledgers stored on separate, connected devices in a network to ensure data accuracy and security.
Blockchain: Blockchain is a decentralized and transparent ledger that records all cryptocurrency transactions across multiple computers, creating a secure and tamper-resistant record. Blockchain keeps track of who owns what in the cryptocurrency world.
Bitcoin: Bitcoin was the first cryptocurrency, created in 2009 by an anonymous group known as Satoshi Nakamoto. It paved the way for the development of thousands of other cryptocurrencies. If you were to purchase some Bitcoin at a certain price, and the demand for Bitcoin increased in the future, you would be able to sell that Bitcoin for more than you purchased it for, thereby making a profit. If that sounds like trading stocks in a company, you’re correct, however, Bitcoin is not an investment in a company, but in the value of itself as a currency. It’s also important to remember that the stock market is regulated while cryptocurrency is not.
Altcoins: Alternative cryptocurrencies, or altcoins, refer to all cryptocurrencies other than Bitcoin. Examples include Ethereum (ETH), Ripple (XRP), and Litecoin (LTC). There are currently 22,000 different types of cryptocurrencies available for purchase or trade.
Cryptocurrency Wallets: Wallets are digital tools used to store, send, and receive cryptocurrencies securely. They come in various forms, such as software wallets (mobile or desktop) or hardware wallets (physical devices).
Private and Public Keys: Cryptocurrency wallets utilize pairs of cryptographic keys. The private key is kept secret and is used to sign transactions, while the public key is shared with others to receive funds.
Mining: Mining is the process of validating and adding new transactions to the blockchain. Miners use powerful computers to solve the complex mathematical problems that are required to validate transactions of cryptocurrency in blockchain. As a reward for validating these transactions miners may receive cryptocurrency.
Cryptocurrency Exchanges: Cryptocurrency exchanges are platforms where users can buy, sell, and trade cryptocurrencies. They act as intermediaries, matching buyers and sellers and facilitating transactions.
Security: Cryptocurrency security is crucial. Users must be cautious about protecting their private keys, using reputable wallets and exchanges, and implementing additional security measures like two-factor authentication.
The Bottom Line
Cryptocurrency is a relatively risky investment and should be treated the same way as other high-risk investments you may have in your portfolio. For example, you may choose to pay down your debts, pay off your mortgage, or invest in your retirement with more low-to-moderate risk stocks and bonds before dabbling in cryptocurrency. In the meantime, with these basics understood you can follow along as cryptocurrency is discussed more and more in popular culture and finance news.
Lori Stratford is the Digital Media Manager at Navicore Solutions. She promotes the reach of Navicore's financial education to the public through social media and blog content.