Cryptocurrency 101

Before we get into the definition, it helps to take a brief glimpse into the history of how cryptocurrencies came about.

Discussions of creating a cryptocurrency date back to 1983, when cryptographer David Chaum proposed to apply cryptography to cash in order to prevent prevent double-spending, which is a common error in digital cash systems because the data representing the value of the virtual cash could potentially be duplicated or falsified.

Chaum and other cryptographers later proposed a peer-to-peer electronic cash system using cryptocurrency, but it was never launched.

Over the years, numerous computer scientists further explored and improved upon these original ideas.

In 2009, an individual or a group under the pseudonym of Satoshi Nakamoto launched bitcoin, marking the first cryptocurrency, and the beginning of an era of virtual currencies.

Today, there are over a thousand cryptocurrencies in existence according to some estimates. Bitcoin is the biggest of them and is considered the “reserve currency” of all cryptocurrencies. All other cryptocurrencies are often referred to as “altcoins” (bitcoin alternatives).

What are cryptocurrencies?

You may be wondering now: so what really are cryptocurrencies? First, lets take a look at a dictionary definition from Oxford:

“a digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a central bank.”

Here is the simplest way for you to understand it: First and foremost, cryptocurrencies are currencies, like your normal government-issued fiat money; secondly, it makes use of cryptographic techniques (solving or writing codes) to secure transactions and control the creation of additional units of the currency.

An even simpler way to understand it: A currency you can use to purchase goods and services or transfer to your friends that is not issued by any government or a central bank.

Popular cryptocurrencies

Now, let’s take a look at some of the popular cryptocurrencies in existence. Most of these cryptocurrencies have very similar characteristics with sometimes only slight variations differentiating them.

  1. Bitcoin

    Bitcoin was the first cryptocurrency created and is by far the most widely accepted and traded one out there. Today, you can buy anything from pizza to clothes with bitcoin and more and more merchants are starting to accept it. It is very easy and cheap to transfer bitcoin to others online.So how can you spend your bitcoin? It’s a virtual currency, so you won’t carry it around in your pocket. Instead, you will get a bitcoin wallet, which is essentially an online account where you can store your bitcoins.

    Transactions are done electronically, without going through any banks or governments, ensuring privacy for all users along the way. We will talk more about wallets and how you can get bitcoins later.Bitcoin currently has a market capitalization of about $63 billion. The maximum amount of bitcoin that will ever be created is limited to 21 million bitcoins, with about 16.6 million in circulation currently. This keeps inflation under control, and ensures bitcoin will remain in scarce supply.

  2. Litecoin

    Litecoin was created in October 2011 by former Google engineer Charles Lee. Litecoin is basically built on the same concept as bitcoin, with some improvements added. Firstly, litecoin has a greater capacity to handle large numbers of transactions than bitcoin, and it also facilitates transactions about four times faster than bitcoin.

    While litecoin is not as widely accepted as bitcoin, many business, including charities and some online retailers, already accepts litecoin as payment. Litecoin has a market capitalization north of $7.2 billion. The maximum supply is limited to 84 million litecoins, with a little more than 53 million currently in circulation.

  3. Ripple

    Ripple refers to both an open Internet payment system and a cryptocurrency. Again, Ripple is a different type of cryptocurrency, based on a similar concept but with a different cryptographic puzzle.Created in 2012, Ripple is aimed at addressing international money transfers with its payment system, which is designed to connect different payment systems together. The cryptocurrency is said to be the fastest and most scalable digital asset.According to Ripple’s official website, banks such as UBS and Standard Chartered are already making use of its payment platform in their operations.

    Ripple has a market capitalization of nearly 7 billion. The maximum supply is set at nearly 100 billion units, with about 38 billion units currently in circulation.

  4. Ether / Etherum

    Etherum has been a rising star in the world of blockchain as of late. It is said to be the second most valuable digital asset after bitcoin.So what made etherum, which was launched in 2015, grow so fast? First of all, if is an enormously powerful platform that offer almost endless possibilities. Etherum is not a cryptocurrency in itself, but the etherum project was initially funded by issuing a digital currency, known as ether, which was based on its platform.The etherum platform let anyone do things like creating smart contracts, setting up autonomous democratic organizations with secure voting, or launch tradable cryptocoins to fund your new start-up instead of going through the traditional process of raising money from shareholders.

    Ether’s current market capitalization is more than $27.6 billion. There is no cap on the supply, and about 94.8 million units are currently in circulation.

  5. Monero

    Monero is another cryptocurrency that was launched in 2014. As all the others, it too is an open-source, privacy-oriented cryptocurrency. Different from others, the virtual currency uses something called rising signatures, which uses a mix of user’s account keys and stealth addresses to hide the identities of senders and receivers.

    Monero also employs many other cryptographic tools to ensure users remain completely anonymous. If you make a transaction with monero, it can never be traced back to your real-world identity.Helped by its high degree of privacy, monero has risen fast and has already been embraced by several online marketplaces, including AlphaBay and Oasis.Monero currently has a market capitalization of more than $1.4 billion. It has no maximum supply set and there is a little over 15 million units in circulation.

  6. Dash

    Dash was first launched in 2014 as XCoin, before it changed its name to dash in 2015. Dash is similar to bitcoin, but offers improvements in some key areas.Dash sometimes promotes itself as the cryptocurrency that is everything bitcoin was “supposed to be.” It can be spent and transferred instantly with a very high degree of privacy. It is also designed for simple and convenient use. It’s “so easy to use your grandma would use them,” dash promoters claim.With all the benefits of cryptocurrencies, the easy-to-use features helped dash become widely accepted by both online and physical stores as a payment method for goods and services. According to dash promoters online, you will find merchants ranging from VPN service providers to aquarium supply shops accepting dash as payment.

    Dash has a current market capitalization of about $2.6 billion. Max supply is set at 18.9 million units and there are nearly 7.6 billion in circulation.

  7. Zcash

    Zcash is another cryptocurrency that was launched in 2016. Like other cryptocurrencies it is based on a decentralized blockchain, but with better privacy, while at the same time being more transparent.Zcash uses a different type of proof to secure the network, which allows the network to maintain a secure ledger of balances, while also allowing the network to obscure the identities of the parties involved in the transaction and the amount of money involved.Another thing to know about Zcash is that it’s backed by some heavyweights in cryptocurrencies, including bitcoin pioneer Roger Ver.

    Zcash has a market capitalization of more than $525 million. There is no cap on the amount of units that will be mined and there are more than 2 million units in circulation currently.

  8. Dogecoin

    Dogecoin is a cryptocurrency that was launched in 2013. Believe it or now, its initial name was actually “joke currency.” Dogecoin was built upon bitcoin but had a stated goal of getting more users than bitcoin.Dogecoin has managed to establish a huge community over the years, which has been very active online and in raising fund for charitable organizations. The dogecoin community is even planning on sending a gold coin to the surface of moon in 2019 as a symbol of the virtual currency.Given its large and active community, dogecoin is widely accepted by many online and physical stores that generally accept bitcoin.

    The digital currency has about $116.8 million in market capitalization. There is no maximum supply of dogecoins, and there are already more than 111 million units in circulation.

Security

We have now talked about a lot of about different cryptocurrencies, but there are two themes that all the different cryptocurrencies out there have in common; they are decentralized and offers high degrees of privacy.

These two themes in turn have one thing in common; security, which after all is the ultimate goal of cryptocurrencies. Only then is it a secure digital monetary system that is not only safe from hacking, but also from government controls.

With all the technologies involved in the networks, cryptocurrencies are today considered to be a safe way to transfer and store money.

However, nothing in this world is perfect, and this is true even in the world of cryptocurrencies. Over the years, there have been many security breaches at several exchanges where hackers managed to get away with millions of dollar worth of bitcoins.

Another security concern is whether cryptocurrencies are completely out of reach for government and law enforcement. There have been some cases in the US and China where investigations were launched into various activities in crypto start-ups and exchanges, where some allegedly used cryptocurrencies to pay for criminal activities.

Future Potential

When it comes to the future potential of cryptocurrencies, the possibilities are endless. In the early years, bitcoin and cryptocurrencies in general was viewed mostly as a niche technology for anarchists and libertarians excited about the possibility of a financial system outside of government control.

In recent years however, bitcoin in particular has gained a massive mainstream following. Many people will even argue that cryptocurrencies is the investment opportunity of a lifetime, that finance is getting its Internet, and that its potential to disrupt the decades-old financial infrastructure we use today cannot be overestimated.

Legality

The legality of cryptocurrencies is a complex issue because the phenomena is a global one that affects all countries. So far, only a few countries in the world have taken actions to ban the use of bitcoin and other cryptocurrencies. Some countries that have taken action to try to “get rid of the problem” include Bangladesh, Ecuador, and China, which is currently cracking down on both ICOs and cryptocurrency trading.

The vast majority of countries and regions, including the US and the EU, have kept their hands off of cryptocurrencies, but there are a whole bunch of uncertainties facing the future of cryptocurrencies. Many governments, including the US, have launched investigations into alleged criminal activities involving cryptocurrencies, and are trying to figure out how to treat this new thing within their legal systems.

Meanwhile, in China, officials have grown increasingly concerned about the alleged negative impact of cryptocurrencies on the domestic financial system and the economy as a whole. The Chinese government has been cracking down on initial coin offers, cryptocurrency exchanges and miners.

However, there are still some brightspots among all this skepticism towards new technologies. Estonia has been known in the cryptocurrency world as one of the friendliest countries. The tiny Baltic nation has shown interest in implementing blockchain technology for the country’s healthcare, banking and governance systems. Other European countries such as Demark, Sweden and Finland as well South Korea and Australia, are also considered to have a friendly attitude towards cryptocurrencies.

Taxes

The issue of taxes on cryptocurrencies is also a complex one because, like the legality issue, many countries are still figuring out how to treat it: Whether it’s a currency or another form of asset. So far there are a couple of examples we can examine.

In the US, the IRS in March 2014 issued a notice that for the first time stated its position on the taxation of virtual currencies. The notice stated “virtual currency is treated as property for US federal tax purposes…general tax principles that apply to property transactions apply to transactions using virtual currency.”

This means that the US would treat the income or gains from trading virtual currencies as a capital asset, subject to capital gains taxes.

Following the US, in December 2014, the Australian Government also issued a statement on tax treatment of cryptocurrencies in the country. The statement reads:

“Transacting with bitcoins is akin to a barter arrangement, with similar tax consequences… The Australian Taxation Office’s view is that Bitcoin is neither money nor a foreign currency, and the supply of bitcoin is not a financial supply for goods and services tax purposes. Bitcoin is, however, an asset for capital gains tax purposes.”

So that actually put “double taxes” on cryptocurrencies; sales taxes on buying and selling and capital gains tax. With strong criticism form the bitcoin community in Australia, the government there have lately signaled that it may pass a new legislation to end the “double tax” system.

Though many other countries have not yet discussed how they will treat the huge trend of cryptocurrency transactions and investments, the US and Australia cases may give you some clues into how governments will eventually treat cryptocurrencies.

What is the Blockchain?

The Blockchain is a secure, transparent, and safe information storage and transmission technology that operates without any central authority. Sometimes, by extension, ‘blockchain technology’ is presented as a shared public ledger that handles a list of records protected against forgery or modification by unauthorized entities. You can clearly state that a blockchain, therefore, is a decentralized and secure timeline of all transactions made since the distributed system was started.

As mentioned earlier, many people compare the blockchain revolution to invention of the internet. Internet transfers data packets from point A to point B, while the blockchain allows “trust” to be established between different parts of the system.

History of Blockchain

The first blockchain appeared in 2008 with bitcoin; developed by an unknown person under the pseudonym of Satoshi Nakamoto (it is also unknown whether he is a person or a group of persons). While blockchain and bitcoin have been built together, today many companies and even governments are considering the use of blockchain technology for uses other than digital money.

How does it work?

Any public blockchain will work with a programmable digital currency, also called a token. Bitcoin, along with other like ripple or dash, are examples of programmable money.

Transactions between network users are grouped into blocks. Each block is validated by the ledger keepers of the network, known as “miners”, according to techniques that depends on the type of blockchain. In the blockchain of Bitcoin, this technique is called “Proof-of-Work” and consists of solving algorithmic problems. Once the block is validated, it is time-stamped and added to the chain of blocks. The transaction is then visible to the receiver as well as the entire network. This process of validation takes some time according to the type of blockchain we are talking about. In the case of bitcoin, it will take about 10 minutes, while for ethereum it will take only about 15 seconds.

The decentralized nature of the blockchain, along with its unmatched security and transparency, allows for applications much broader than just serving as money. The use of the blockchain can be classified into three categories:

  1. Applications for the transfer of assets (monetary use, but also: securities, votes, shares, bonds, etc.)
  2. Applications of the blockchain as a register: this ensures better traceability of products and assets.
  3. Smart contracts: these are stand-alone programs that automatically execute the terms and conditions of a contract without requiring human intervention at all once started.

How Can I get Cryptocurrencies?

Before answering this question; it is important for you to note that the US Consumer Financial Protection Bureau has issued a warning saying that virtual currencies, or cryptocurrencies, carry “significant risk” to consumers.

With that out of the way, let’s see how and where you can get them. There are two possible ways of getting cryptocurrencies; one is through buying just like when you want to get shares from the stock market and the second one is through mining. Well, not physical mining, but we will explain further:

Buying

Buy Cryptocurrencies

While it is a confusing prospect for most people; since we all tend to think that we should get a physical token when paying for something, buying Cryptocurrencies is all done digitally. Just so that you can relate, let us jump to a typical purchase of stocks on the stock market. You would ideally go to a stockbroker who will buy shares for you in exchange for money and you would get the share certificate proving your ownership of X amount of shares at X value.

The same concept applies to buying cryptocurrencies, but instead of going to a stockbroker, you will need to create an account on an online platform that let’s you buy and sell cryptocurrencies. You will need to upload some documents to prove your identity (this is when you know it is safe and secure) and then you can start your purchase.

After verifying your credentials, you can add payment methods such as credit or debit cards or even wire transfers of funds. Here you need to understand that not every platform let you buy all cryptocurrencies. This is because there are new coins coming up literally every other day.

To guide you, here is a list of platforms where you can get the most common coins such as ethereum, bitcoin, and litecoin:

  • Coinbase
  • Kraken
  • Gemini

If you have bought some of the more common and well-known coins like Bitcoin or Ethereum, and want to buy some of the newer and lesser-known coins like ripple, you can transfer your Bitcoin or Etherum to platforms like Bittrex, Poloniex or Livecoin, and buy the equivalent NEO’s.

In addition to these, the major cryptocurrencies can often be traded as CFD’s from online forex and CFD brokers. With CFD trading, you get the same exposure to the value of the cryptocurrency, but without actually owning it. Instead, you are buying a “contract” that tracks the price of the actual cryptocurrency. An obvious benefit with this is that you can trade cryptocurrencies with a broker that you already know and trust, in a safe and familiar environment.

Mining

Cryptocurrency Mining

How do you make sure the blockchain is working properly and has not been tampered with? This is where the miners come in. When a transaction block is created, the miners process it. They take information from it and apply a mathematical formula to it by turning everything into something completely different. This “other thing” is much shorter and resembles a random sequence of letters and numbers, called hash, which is, in fact, an electronic signature. This hash is stored with the block at the end of the blockchain.

The hash has some very interesting features. It is simple to produce a hash from a data packet of a Bitcoin block, but it is virtually impossible to understand what data was used to constitute it just by looking at the hash. And even if it is relatively simple to produce a hash from a vast amount of data, each hash is unique. It is enough to change a character in the block, and the hash will in turn be changed completely.

Miners do not just use transactions that are in a block to generate the code. Further data is also required for this process. One of these data types is the hash of the previous block stored in the blockchain. Each new block then contains the hash of the preceding block and creates an electronic version of a “wax seal.” This hash confirms that this block, as well as all those that follow, are legitimate.

As a reward for their services, miners collect the newly created bitcoins as well as the transaction fees they confirm. Currently, this reward is 12.5 Bitcoins per block. It is halved every four years. Miners (or miner cooperatives) compete, and their incomes are proportional to the computing power deployed.

How Can I Buy Cryptocurrencies?

The very first purchase should be done via fiat, aka traditional currencies. It is because you, till then, have no crypto-asset to pay for the desired cryptocurrency. As bitcoin is the mother of all cryptocurrencies, as well as the most widely accepted cryptocurrency, you should buy bitcoin first. Then, you can use your newly acquired bitcoin to pay for any cryptocoin you may want to purchase.

Similarly, it’s possible to enter the crypto world by buying some ether (based on the etherum platform) first. In other words, you will first need to have a bitcoin/ethereum “master” account. Why? Because you can then transfer the required amount of bitcoin to the various other trading sites (read on to know more about trading sites). This transfer will take place using blockchain technology, guaranteeing you anonymity and safety.

Now that you can load your account on the trading exchanges, let’s see the two ways of buying cryptocurrencies; exchanges and P2P.

Exchanges

When you go on a trip to a foreign country, you exchange your local currency for the currency of the country you are visiting; the same applies when you want to exchange your cryptocurrency for another except that here everything happens via the internet. There are several exchange platforms, and I will tell you about the most used ones later on.

Most exchanges don’t charge you anything to register an account. The more information you provide about yourself, (address, identity card, and so on) the higher your maximum deposit will be, as well as the number of transactions allowed. Basically, they will trust you more.

In order to exchange your currency, you will need to have a balance in your account. Once your account has money, you can exchange it for any cryptocurrency that the site offers.

There is no limit or fee to keep your cryptocurrency, you can keep it all your life and decide to sell it whenever you want. In the same way that it is not compulsory to buy 1 bitcoin all round, all cryptocurrencies can be split up into fractions, so you can decide to exchange for example €200, which will get you approximately 0.06481 bitcoin. Still, it should be noted that each exchange of money on exchange platforms generates costs, although very small as compared to traditional banking fees.

P2P (Peer-to-Peer)

P2P transactions are just like meeting a person face to face to facilitate a trade, except that it happens online. After a discussion, both parties agree to trade X amount of cryptocurrencies against X amount of fiat money. Examples are PayPal transfers, cash deposits to bank accounts, wire transfers or even gift cards. As you make these transfers, your wallet will be gaining cryptocurrencies. There is no third party interference between you and the seller.

However, there are several risks involved in this model. For instance, people might send you nothing in return for your money. Or they might send you less than agreed upon. Or, send you something entirely different! One way to counter this in the future might be using a Smart Contract based on the etherum technology, but that is outside of the scope of this guide. Another way would be to visit a forum where the moderators work as escrow, for a tiny fee. This ensures that you get what you pay for.

Cryptocurrency Wallets

Wallets

Now that you have purchased the cryptocurrency, where do you store it? Here comes the concept of cryptocurrency wallets.

What is a wallet?

A cryptocurrency wallet is simply a software program that keeps a record of the balances of cryptocurrencies held by the user. Wallets also interact with different blockchains to complete the transactions, and stores the private and public keys needed to make these transactions.

Online

Online wallets utilize a cloud server to store your data, which in turn can be accessed from anywhere with the right password. While this might seem to be a perfect solution, these wallets store your private keys on cloud storage systems provided by third parties, which attracts a lot of hacker attention.

Mobile

These are almost like the banking apps you use on your smartphone. These are useful because they can be carried anywhere and can be used to pay for local bills as well. However, the functionality of these wallets is somewhat limited compared to desktop wallets for obvious reasons.

Hardware

Hardware wallets store a user’s private keys on a physical piece of hardware, instead of a software or server. As the keys are stored locally on a hardware device, this is considered a much more secure option than software-based wallets. Many of these wallets use USB or mini-USB interfaces. As a user, you can simply plug in the device, type in a PIN code, mention the amount, and the transaction take place.

Paper

This is a relatively new concept and has a very high degree of security. A paper wallet can be the printed copy of your keys but it can also mean the software which generates those keys before printing. To receive money to a paper wallet, you first need to get the money from the software wallet and then transfer it to your public address which is printed on the paper wallet. To spend from such a wallet, you must transfer the money to the software wallet by using the private keys or by scanning a QR code, which is often printed on the paper.

Trading Cryptocurrencies

Trading cryptocurrencies can be compared to trading stocks or forex for that matter. In order to make money, the same old principle about buying low and selling high, applies. However, there are a few things you should know in more detail before you start trading cryptocurrencies.

Difference between investing and trading

Investing in bitcoin (or any other cryptocurrency) is somewhat similar to trading bitcoin. However, the major differences are the mindset and the time involved. Investing is usually a long-term idea where capital gains on the invested amount is the main purpose. The investor is generally ready to wait for years to see fruits of his patience.

Trading, however, is buying the currency during a dip in price and selling it during a spike to make quick profits. The trader has no intention to hoard the coins for the long term. He just wants to take advantage of the price volatility and make a profit.

Active trading or buy-and-hold investing?

Once you have decided to move into the cryptocurrency space, you need to decide whether you want to be a trader or an investor. Are you there for the long run, to profit from the inevitable long-term success of cryptocurrencies, or are you there as an active trader, attempting to make a quick profit while keeping your risk under tight control?

Both styles can surely be successful, but it depends on your own personality and personal objectives. Some people like the speed and excitement of active trading, and are able to remain disciplined. Others, however, tend to let their emotions interfere or even cannot sleep at night as they are bleeding money. If the latter describes you, you will probably be better off by sticking to buy-and-hold investing.

Trading platforms for cryptocurrencies

Cryptocurrencies can be traded using three models:

  1. Centralized Exchanges: Just like stock exchanges, there are crypto exchanges where users can create an account and buy & sell different cryptocurrencies. These exchanges, mostly, allow for the conversion of fiat currency to cryptocurrencies and vice versa. Obviously, they have transaction charges as well.
  2. P2P Exchanges: In this model, two users can come to an agreement of buying and selling cryptocurrencies according to terms set by them. There is no centralized exchange involved, meaning you can save on transaction fees. Moreover, these transactions are faster than exchange-based transactions.
  3. CFD Brokers: Cryptocurrency brokers are companies who allow you to trade the price fluctuations of cryptocoins using leverage, in the exact same way you can trade the forex markets.

Risks of trading

Trading comes with several risks that you need to be aware of before you take up this potentially profitable activity.

  1. Buy/sell spread (higher buy rate/lower sell rate): If you buy a cryptocoin in the hopes that it is going up, and the price dips, you will be forced to sell at this lower price, meaning you will make a loss.
  2. Hacking: Cryptocurrency networks, blockchains, wallets and even the exchanges are often attacked by hackers. There have been a few instances of highly damaging hacking attempts on several cryptocurrency exchanges.
  3. Another party not honoring their contract: This is a prevalent risk in the P2P model where after you transfer the amount, you receive nothing in return. You might receive less or you might receive something entirely different. However, the risk of this can often be minimized by using escrow services against small service charges. Sometimes even moderators in forums will act as escrow for these types of exchanges.

What Affects Prices of Cryptocurrencies?

This topic would surely deserve a thorough research paper, but we will try to present the basics in this nonetheless. There are multiple factors that can affect the price of a cryptocurrency, including:

  • Limited Supply and supply/demand:

    If the coin has a limited supply or has a controlled inflation, and the demand for the coin grows higher, the price will go up according to basic economics principles.

  • Mining difficulty level:

    If a cryptocurrency is more secure, complex and difficult to mine, the price of the coin goes up. As mining difficulty increases, the supply of new coins from mining will be lower and that means higher prices.

  • Energy Usage:

    Cryptocurrency mining can be extremely power hungry. As an example, the bitcoin network of the world consumes as much power as the entire country of Mauritius does.

  • Utility & Accessibility:

    If the coin is widely accepted and versatile, it can be used for most transactions. This, by itself, increases the value of the coins. Bitcoin, for example, has very high mining difficulty level, requires massive amounts of energy, and lastly it is also the most widely accepted cryptocurrency, making it a very valuable coin.

  • Price of Bitcoin:

    The price of bitcoin can severely influence other cryptocurrencies just like the USD price influences other currencies around the world. This is because bitcoin is considered to be the backbone, or “reserve currency,” of the crypto world. So, if the bitcoin price goes up, we can expect the other coins to increase in price as well.

  • Heavyweight Investors:

    Think, if people like Vitalik Buterin, the creator of etherum, backs a new coin; wouldn’t you feel confident about the future of that coin? Thus, when big names and trusted faces make investments in a new coin or get involved with the coin, the price soars because it gives confidence to general users.

  • Media Coverage:

    Media can highlight a coin in negative or positive ways, and that can also affect the price of the coin. A positive brand image can increase the price while negative coverage does exactly the opposite.

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