Cryptocurrency: Concept, Working, Uses, and more

What is Cryptocurrency

Cryptocurrency, Crypto-Currency, or Crypto is a digital currency or digital money that is used as actual currency but a little differently. Although many of us have used the money to purchase or sell something using electronic media such as using the site of an e-tailer with the means of electronic cards such as debit/credit cards, what we use as electronic money is still our money in physical form, we just use them with electronic means over internet. But cryptocurrency is a bit different from the usage of physical money in electronic means. Literally, cryptocurrency is actually can never be converted into physical money like paper money or coins. It only exists in virtual form but people all around the world can use it anywhere, anytime.

Although we cannot see or touch cryptocurrencies, they do hold value. They don’t exist physically, like the coins but can be stored in digital wallets on smartphones or computers and can be sent to other people by their owner to buy things.

Like, there are different types of physical money like dollar, pound, euro, yen, rupees, etc, there exist different types of cryptocurrencies like Bitcoin, Dogecoin, Litecoin, Ripple, Stellar, etc. Bitcoin, being the most popular form of cryptocurrency, is believed to be the first-ever cryptocurrency, created in 2009 by the pseudonymous developer ‘Satoshi Nakamoto’.

Cryptocurrencies are now being used to purchase a lot of products and services and some people are buying big things like houses and cars. Although these are not widely used like physical currency at the moment experts believe in the future with the increase in widespread e-transactions, cryptocurrencies would become a common way to buy or sell things.

How does it work 

There are good chances that you may have used a bank card such as a debit or credit card to buy something. When we use such a card, a chain of processes takes place. When a person uses such a card, his bank details are shared with the shop and the shop then shares those details with the concerned bank.

The bank checks its records to see whether its customer has enough money in his account to pay for the item. Once it is confirmed, the bank tells the shop that the customer has enough money to buy the item and the transaction can take place. This is how an online transaction takes place in simple words.

Working Overview

But cryptocurrencies work in a very different way. Cryptocurrency is a digital payment system that does not rely on a central authority, like a bank or other third-party entity to verify a transaction, so is also called a decentralized currency. It is a peer-to-peer system that enables anyone to send or receive money, anywhere.

It uses encryption to verify the transaction, that’s why it is called cryptocurrency. Advanced coding is involved in transmitting and storing cryptocurrency data between your wallets to the public ledger. Data encryption is used to provide security and information integrity.

Blockchain

Every transaction ever made or will ever be made is recorded on a huge database, known as a blockchain. you can think of it as a massive spreadsheet, checkbook, or record. Every transaction made is represented by a block that further is added to the larger chain, so got its name as ‘blockchain’. All transactions made are kept forever in the blockchain. That blockchain does not reside as a central location but is distributed over a large network of computers, which are secured all the time using complex systems. This makes it almost impossible for anyone to penetrate the security of the blockchain and ensures all transactions are protected against any threat.

With blockchain, everyone who uses cryptocurrency has their own copy of this book to create a unified transaction record. With each new transaction, the blockchain updates itself synchronously with recent information. This way, it keeps all records accurate and identical.

Transaction Verification

To prevent fraud, each transaction is verified with one of the two processes: proof of work,  and proof of stake. Every transaction has to go through one of these two different techniques for verification. Blockchain adds a transaction into its ledger only after verification.

Proof of Work

It is a method of validation for a transaction before it can be added to the blockchain, in which a mathematical problem is provided by an algorithm, that computers race to solve.

Each computer participating, is called ‘miner’. Blockchain gives a mathematical puzzle that helps verify a group of transactions, referred to as a block. This block is further added up to the blockchain ledger. The blockchain rewards a small amount of cryptocurrency to the first computer that becomes successful in solving the puzzle.

Sometimes, the intense processing power and resources required to solve the blockchain puzzle, such a race may outweigh the reward received.

Proof of Stack

In order to reduce the amount of power necessary to check transactions, some cryptocurrencies use a method called ‘proof of stake’ for the verification process.

With Proof of Stack, a person can verify a limited number of transactions and this limit depends on the amount of cryptocurrency available. Either, he/she is willing to stake, otherwise, blockchain puts that user in the waiting pool, before they can get a chance to participate in the process.

It may sound like bank collateral. In such a scheme, however, every person who stakes is eligible for the transactions validation process but each one is kept in a runnable pool and who will be chosen, depends on how much amount he/she has staked.

Proof of Stake removes processing and resource-intensive equation solving validations, thus it is much more efficient than Proof of Work. It allows faster validations or confirmation times for transactions.

For a new group of transactions, if the blockchain chooses a stake owner or say validator  he/she will get some amount of cryptocurrency as a reward. And this amount depends on the cumulative transaction’ fees from the block of transactions. To enforce integrity and discourage fraud, if you are chosen to validate a transaction and found to verify an invalid transaction, a part of your stakes are forfeited.

How and from where to get Cryptocurrency

As there is no central authority that manages or maintains the value of cryptocurrency, there might be a question of from where and how anyone obtains cryptocurrency and at how much price.

To buy cryptocurrencies, you will need a wallet like a physical wallet which is used to keep physical money. Wallet for cryptocurrency is mostly virtual as like cryptocurrency itself.

The Wallet

A Cryptocurrency wallet is a device or physical medium or a program or service which stores the keys, private or public, to facilitate cryptocurrency transactions. Besides this fundamental role in keeping cryptocurrency, a wallet also performs some other functionalities like signing information, encryption. Signing can result in the framing of a smart contract, identification, cryptocurrency transaction, signing a document legally, etc.

The Blockchain generates a random or theoretical number and its length depends on the size of the algorithm. In turns the size of the algorithm depends on a particular cryptocurrency technology. With some processing, Blockchains converts this number in to a private key as per the algorithmic requirement of cryptocurrency. After this, a public key is generated from the private key after some more processing. Now, it has created both the keys, each key plays a different role. The private resides with the owner exclusively to access or send cryptocurrency. Only the user is the sole owner of the private key. Whereas the public key is required to be shared with a third party, in order to receive cryptocurrency.

Address for Transaction

This pair of the private key and the public key is called an address and is anonymous to anyone or blockchain itself. When you use a public key for receiving money (cryptocurrency), blockchain will only record the transaction of the public address. So practically, a blockchain ledger is a database of public keys only, i.e- public addresses record of transactions.

It is possible that two or more wallets may have the same private key in theory as keys can be generated, and could remain offline until are used for transactions in the blockchain ledger. But this possibility is extremely low since blockchain generates a long random number of high magnitude key. Duplicating or hacking a certain key is not practically possible.

Integrity of Identity

Everyone including you can view your transactions made on the blockchain, but no one can identify you by just merely seeing a transaction record. Blockchain keeps a record of transactions for public view but does not identify who make which transaction.

You can own cryptocurrency in two ways, either by buying or by mining. Mining is explained as ‘Proof of Work’ and ‘Proof of Stake’. Obtaining cryptocurrency through mining is extremely difficult as cracking algorithm puzzles requires immense time and computing resources. Practically, if you start mining now, it may take years before you could get a single coin.

You may have to spend a very large amount to buy cryptocurrencies too. ‘Bitcoin’, a very popular cryptocurrency comes with $65,000 per coin (as per November 2012 data).

Cryptocurrency Exchanges

You can buy cryptocurrencies from a crypto trading service or venue. Like share brokerages, there are cryptocurrencies exchanges, services, and brokerages. Cryptocurrency exchanges are the most convenient to buy cryptocurrency as these avails you with a lot of options like the breadth of features, more types of cryptocurrencies, etc.

There are many types of cryptocurrency exchanges. Some exchanges do not require the personal information of a user and facilitate the freedom for users to remain anonymous. Such exchanges operate anonymously and no one controls these, which means not having a single point of control.

However, most exchanges do not operate freely and these have to comply with the laws of the concerned country. Thus users have to submit identification documents. Popular exchanges in the United States are ‘Coinbase’, ‘Gemini’ ‘Kraken’, ‘Binance’, and FTX.US, etc.

After choosing an exchange and submitting all ID proofs and formalities, the exchange will ask you to select a payment option. You can pay for cryptocurrency through a bank account, debit card or credit card, etc. Cryptocurrency exchanges these days work like stock brokerage exchanges.

Is It Hot or Cold

After you have purchased your cryptocurrencies, you keep these in a wallet. Wallets come in two forms, Hot wallet, and Cold wallet.

Hot wallets are digital wallets. These wallets reside in a computer, mobile phones, tablets, etc. and these are connecting through the internet. This makes these vulnerable to security threats. Whereas Cold wallets reside in hardware or physical devices like a USB drive, thus less susceptible to security threats. We also say Cold wallets as offline wallets. Cold wallets keep the user’s ‘private key’ in that hardware. You can also print your  private key on paper that you can generate on certain websites.

Popular Coins & their Rates

There are somewhere 16,000 different cryptocurrencies that are traded publically and continue to proliferate. As per data of December 2021, the $2.3 trillion value of cryptocurrency was in circulation which a few weeks earlier peaked at $2.9 trillion.

Pros and Cons of Cryptocurrency

Pros

• Fast & Inexpensive

  One of the biggest advantages of cryptocurrency is that it is very accessible and versatile. It takes only a few minutes to send cryptocurrency money to another user. No physical transaction takes place in case of cryptocurrency and all transactions happen virtually. As no centralized entity or government controls cryptocurrency. Transferring money using cryptocurrency costs you zero or negligible amount and it is like sending an e-mail.

• Potential for high returns

  Over the last five years, bitcoin, a very popular cryptocurrency has risen at a growth rate of 131.5% year by year, whereas for the same period, US equities have only registered the growth of only 14.5%. You can sell cryptocurrencies easily and you can use it to buy regular currencies like the dollar, pounds, euro, etc

• Decentralized money

  Developer control it rather than a centralized bank. Thus, it helps this currency from monopoly and restraint. No organization can determine the flow or value of cryptocurrencies. This makes it stable and secure, unlike regular currencies.

• Security

  The Security is the prime advantage of cryptocurrency. During a transaction, the Blockchain does not disclose any confidential information to the seller. Blockchain ledger makes entries after cracking rigorous mathematical puzzles. And it very hard to decode. This makes cryptocurrencies much safer than ordinary electronic transactions. On top of it, users in the public domain use pseudonyms which can not be linked with any real information.

Cons

• Risk of loss 

  What if your hard drive containing key crashes or you lose it. Then, there is not way to recover you key or wallet. With this, you will lose all your money in a matter of minutes. You secure your coins in the wallet. It will be kept there forever as an orphaned amount. You or even the company itself can no recover those coins. Backup phase code beforehand can solve the issue but it is still susceptible to human or technological errors.

• Volatility & Uncertainty

  When Satoshi Nakamoto created Bitcoin, he sat its quantity limit to 21 million. This quantity, he never or will never increase. But with passage of time, Bitcoin became popular and supply stood stand still. This is the reason bitcoin currency is so expensive.  There is always uncertainty about the future, value, and security of bitcoin and other cryptocurrencies. Although cryptocurrencies are very secure but hackers have attacked exchanges many times in the past. They have attacked and stolen coins worth of millions of US dollars from exchanges including Bitfinex, Mt Gox, etc .These stores keep users’ wallet data to figure their user ID correctly.

• Illegal Transactions

  It is hard for the government authorities to trace down a user by his wallet address. People have used cryptocurrencies in past to procure drugs and in other illegal activities on the internet. Anyone can use cryptocurrency easily to convert illegal money into coins using an intermediary.

• No regulation, no safeguard

  The centralized bank of a country regulates, guarantees, and set price of general currency. This way, the public get some protection against volatility of the market. But no one guarantees cryptocurrency with a minimum valuation.  Although, it has its benefits but also has some drawbacks. Suppose, if someday a big group of users decides to stop using it, its valuation will fall drastically. And individuals who have a large number of coins will suffer the most. With no centralized authority, if something wrong happens, there is no one, you can lodge your complaint with.

• Limited uses

  Although a large number of companies have started to accept cryptocurrencies but there are still a very few people who are dealing in it.

Final Thoughts

Cryptocurrency is a new and innovative concept. A lot of people have started to use it, but it is still in its infancy stage. Although there are great benefits of using cryptocurrencies many see it as a risky investment. Like with any regular stock market, you need to do some research before investing in cryptocurrencies. One must also understand how crypto wallets work. For new users, It is a good idea to start with a small amount.