Crypto & Finance
What Is Cryptocurrency? A Complete Guide to Crypto and Digital Currencies and Assets
Cryptocurrency, or crypto, is a digital currency designed to work as a medium of exchange for purchasing goods and services and/or a store of value. Digital assets (Non-Fungible Tokens, NFTs) are unique valuables stored on a blockchain.
A brief introduction
Commodity money vs. Fiat money
Why do we need money?
Why currencies exist?
The Problem with Fiat Currencies
value = purchasing power
A different approach to Money
Characteristics of Sound Money
Historically: GOLD, SILVER
Present times: CRYPTOCURRENCY SHA-256, Proof-of-work based
*blockchain, SHA-256 based, proof-of-work mechanism
is Sound Money
What is cryptocurrency?
Cryptocurrency is a digital currency that doesn't rely on central banks or trusted third parties to verify transactions and create new currency units. Instead, it uses cryptography to confirm transactions on a publicly distributed ledger called a blockchain.
If the definition sounds cryptic at the moment, I encourage you to keep reading. By the end of this overview you won't need a decryption key to understand crypto.
Bitcoin - the first one
The first cryptocurrency, Bitcoin (CRYPTO: BTC), was developed in 2009 by a programmer using the pseudonym Satoshi Nakamoto. Bitcoin uses SHA-256 Algorithm for the creation and management of addresses, security, and also for transaction verification. It uses Blockchain for its distributed, decentralized ledger and transaction history in a proof-of-work consensus mechanism. If you are still with me this means it is completely secure and uncrackable (uncounterfeitable) and does not require any centralized authority to operate. Once created the blockchain is self-sustaining as long as there are computers around the world with copies of its distributed proof-of-work history ledger "blockchain" which last time I checked had over 100,000 nodes! In context, the currency can operate autonomously with only a few dozen decentralized nodes. These nodes are all over the world and anyone, even you, can simply download the blockchain and start your own copy and start keeping records and validating transactions...and if you are lucky you will receive a block reward (i.e. bitcoin for your work!)
Sitoshi Nakamoto /pseudonym/
In a 2008 white paper entitled, "A Peer-to-Peer Electronic Cash System," Nakamoto provides the first description of blockchain. Blockchain is the technology that enables cryptocurrency to work like government-issued (fiat) currencies without the involvement of any central bank or trusted third party.
Specifically, blockchain solves the "double-spending problem" associated with digital cash. Since digital information is easily copied, digital money requires a mechanism that reliably prevents a currency unit from being "duplicated" or otherwise spent more than once.
The global financial system, as a collective entity, has historically been responsible for establishing and ensuring the legitimacy of monetary transactions.
The validity of cryptocurrency is established and maintained without any involvement by the world's central banks. Instead, ledgers of cryptocurrency transactions are publicly maintained. Transactions verified by blockchain technology are immutable, meaning they cannot be changed. That prevents hackers from producing fraudulent transaction records and establishes trust among users.
That's the beauty that makes it the DIGITAL GOLD of our time! You do not have to put your trust in any single entity or centralized authority for the issuance, supply, valuation, or about counterfeit currency, the SHA-256 and proof-of-work take care of all that. Just like gold, anyone who invests time and money in getting the record, and keeping and maintaining it, can earn or "mine" Bitcoin as they have to do "work" to get it. The consensus mechanism (existing computers around the world) will validate the "proof-of-work" and that's how the value is generated and is intrinsic to the Bitcoins (reward)!
This proof-of-work not only ensures that no central authority can simply print egregious numbers of the currency thereby devaluating its worth, but also encourages more individuals and institutions to keep copies of all the records (the blockchain) thereby making the overall system robust over time.
How many cryptocurrencies are there?
There are thousands of cryptocurrencies available, and thousands more that are now defunct. According to CoinMarketCap, there were 13,669 cryptocurrencies as of late 2021. New tokens are constantly coming to market.
But how, one may ask?
The reason there are so many cryptocurrencies is that Ethereum and its fork Binance made it extremely easy to create token coins.
Ethereum's (CRYPTO: ETH) blockchain allows users to write bits of code to the blockchain, essentially letting anyone launch a new token that uses the Ethereum network. So instead of having to build the whole thing from scratch, developers can just use the pre-existing infrastructure. But that also means those coins are made out of thin air overnight just like fiat currencies and are centralized to the creator who can control the supply and manipulate the value of that particular coin. Sounds familiar?
As they are known, these sh*tcoins (in the name of cryptocurrency) do not have their own blockchain. They do not have any proof-of-work mechanism or use the SHA-256 algorithm these are the two indispensable pillars of a cryptocurrency. This has inevitably given rise to a lot of pump-and-dump schemes, and all other fiat-currency like manipulation of token coins, giving cryptocurrency and its applications a bad name.
Things to look for in a Cryptocurrency
These are some of the characteristics to look for in a cryptocurrency
How does cryptocurrencies works?
You can buy or sell cryptocurrency using a cryptocurrency exchange. Exchanges, which can hold deposits in both fiat and cryptocurrencies, credit and debit the appropriate balances of buyers and sellers in order to complete cryptocurrency transactions. You can also use cryptocurrency to buy something such as a product or service.
To make a cryptocurrency transaction, you need a wallet for that digital currency. A cryptocurrency wallet doesn't actually hold any currency; it merely provides an address for your funds on the blockchain. A cryptocurrency wallet also includes private and public keys that enable you to complete secure transactions.
Every time you buy cryptocurrency or use it to complete a purchase, you authorize the movement of a specified amount of the cryptocurrency from your wallet address to the wallet address of the seller. The cryptocurrency transaction is encrypted with your private key and pushed to the blockchain.
The cryptocurrency network's miners access your public key to confirm that your private key was used to encrypt the transaction. Once the block that includes your transaction is confirmed, the ledger is updated to show the new cryptocurrency balances for both your address and the seller's address. This entire process is conducted by computers without any human intervention.
Even though the process may look similar to a fiat transaction, there are key notable differences:
In a fiat currency money is issued by a central authority also known as the Central Bank (ie US Federal Reserve) system which can at anytime increase (INFLATION) or decrease the supply of money in existence unilaterally thus affecting your savings, purchasing power, indeed every aspect of life.
In a cryptocurrency (SHA-256, proof-of-work) crypto "money" is earned by a proof-of-work mechanism and cannot be simply generated to increase the supply. It is only generated through proof-of-work validation. After a certain point, the supply may only be decreased due to individual owners losing their private wallet keys thereby reducing the overall maximum FINITE supply. The value of your crypto will at worst stay the same when compared to fiat (constant from when you obtained it) or perhaps may increase in value over time.
Fiat currency can have as much supply as a government wants thereby reducing its value to zero due to hyperinflation. The U.S. dollar has lost 97% of its value since 1913 when the Federal Reserve took over the U.S. Banking System. $100 in 1913 is equivalent to the purchasing power of $3010 in today's dollar.
The max supply limit of cryptocurrency (built into the Genesis Block) means after the initial period toward maximum supply, the currency in circulation eventually stabilizes and can be served as a constant value utility to exchange for good and services.
Traditional Fiat utilizes data centers, and banks, with other people in charge of keeping the ledger, and the requirement of human resources makes it susceptible to bank, authority, ledger, balance sheet, and transaction manipulations.
In cryptocurrency (SHA-256, proof-of-work not token coins) there are no human interventions needed for keeping the ledger, maintaining balance, processing transactions, and so on! The blockchain is a self-contained system that does everything for the users with no possible central point of failure.
Why is it called a blockchain?
A block is a collection of transaction data on a cryptocurrency network. It basically states that Person A sent this amount of cryptocurrency to Person B, Person X received this much cryptocurrency from Person Y, and so on.
A block includes a reference to the block that immediately precedes it. The blocks create a chain, linking one to another, through references to prior blocks. To change a block in the ledger, a hacker would have to reproduce the entire chain of blocks following it since not doing so would create a chain of invalid references that would not be accepted by the cryptocurrency network.
Blocks include additional information that further enables the cryptocurrency network to verify the validity of the block. The proof-of-work method of establishing distributed consensus relies on cryptocurrency miners using high computing power to add blocks to the blockchain. The computing power solves complex puzzles such as math problems for which solutions are easily verified as being correct. The miners are typically rewarded with cryptocurrency and transaction fees.
New blocks cannot be added to the blockchain without a miner computing a valid solution to the block's puzzle. With every transaction, the blockchain grows longer, and the amount of computing power required to add a new block increases. The blockchain, by design, becomes increasingly tamper-proof; a hacker today would need computing power equivalent to the majority of the computing power on the cryptocurrency network to successfully alter transactions.
Another method of establishing distributed consensus to add to a blockchain is known as proof-of-stake. Instead of requiring vast amounts of computing power, the proof-of-stake method enables the cryptocurrency holders with the most wealth or the oldest stakes to create blocks by verifying transactions.
Stakeholders are selected semi-randomly. Additional mechanisms are in place to prevent the wealthiest individuals from creating fake transactions or otherwise exerting too much power over the blockchain.
Why is crypto so popular?
Increasing utility. New uses for cryptocurrency and blockchain technology are developing every day. From new decentralized finance (or DeFi) apps to blockchain games to non-fungible tokens (NFTs), the industry is constantly evolving. Additionally, more retailers and service providers are accepting cryptocurrency as payment.
Possible attractive investment. The value of cryptocurrency as an asset class has skyrocketed over the past five years, with many having wild roller coaster rides as of late. In that time, it has shifted from a niche topic to getting widely adopted while receiving lots of buzz in the mainstream media. Many people see it as an attractive asset class to invest in to produce outsized returns. This has happened largely because of the market speculation and many pump-and-dump schemes involving token coins, also some centralized exchanges have taken advantage of their users who trusted them with their crypto "money". This defies the core concept of cryptocurrency which is meant to be a decentralized self-contained means of transacting between individuals and businesses.
Futurism. Many people believe cryptocurrency is the future of money. Indeed, countless businesses across a wide spectrum of industries are developing ways to use blockchain technology to improve operations. Most assuredly we are still in the very early days of cryptocurrency.
Some of the biggest cryptocurrencies in terms of market capitalization and popularity include:
Bitcoin, Ethereum, Binance, Dogecoin, etc.
Bitcoin is the biggest and the only one with a true unaltered SHA-256 algorithm and proof-of-work mechanism implementation and true decentralization. Thus it has become Digital Gold, albeit it has lost some utility of day-to-day transactions due to people simply holding it for future gains. As the original cryptocurrency, it has the strongest adoption rate and a large network of miners. Those factors ensure it remains at the top of this list.
Ethereum's Ether is the second-largest cryptocurrency and consistently so. Ethereum serves as a platform for other cryptocurrencies besides Ether, and offering decentralized applications to other token creators ensures that Ether consistently retains greater value than those other tokens. Most cryptocurrencies rely on the decentralized applications provided by Ethereum.
Advantages and disadvantages of cryptocurrency
Using cryptocurrency has several big advantages over traditional finance. They are:
Speed. A cryptocurrency transaction can take as little as a few minutes to confirm. Once confirmed, the receiving party is able to spend the funds however they see fit. In traditional finance, it takes at least a day for a transfer to clear.
Lower fees. In many cases, the cost of using cryptocurrency is substantially lower than using traditional financial institutions. There's no fee for storing cryptocurrency for example, whereas many banks charge a monthly fee. The cost to send money to someone internationally is extremely low compared to traditional international remittance services.
No barriers to entry. Unlike traditional finance, there's no need to have a valid ID or go into a bank to use Bitcoin. There's no credit check. There's no know-your-customer information you need to provide. That can be extremely attractive for millions of unbanked people around the world.
Security. Cryptocurrency is much more secure than holding cash or using a debit card for transactions on the internet. A hacker would need your private key to steal the Bitcoin held in your wallet. Furthermore, cryptocurrency transactions are generally anonymous.
There are also some disadvantages to holding cryptocurrency. They include:
No insurance. There is no insurance on funds held in cryptocurrency. Funds deposited in a bank account in the U.S. are typically insured through the Federal Deposit Insurance Corporation (FDIC). If the bank loses your money, you are covered up to $250,000 per account holder. There is no recourse if you or your custodian lose your cryptocurrency.
No way to dispute transactions. If you accidentally send too much cryptocurrency to someone, or you do not receive what you were supposed to in exchange, there is no way to dispute or reverse a transaction. All transactions confirmed on the blockchain are finalized. The only way to get your money back is if the other party agrees to send it to you.
Easy to lose access to funds. If you lose your private key, you no longer have access to your funds. The private key is necessary to sign transactions and write them to the blockchain. Make certain to back up your private key in multiple places.
High volatility. The prices of many cryptocurrencies are extremely volatile. This can make it difficult to use as a means of paying for goods and services since retail prices would need to fluctuate to adjust for the volatility of the currency. It can also make it difficult to stomach as an investor when the price can easily swing more than 10% on any given day.
How to mine cryptocurrency
No cryptocurrency guide would be complete without telling you the reader how to "mine" it. Mining is only possible for SHA-256, proof-of-work cryptocurrencies, and not token coins (which are not real cryptocurrencies).
Mining cryptocurrency is the process of using your computing power to verify transactions on the blockchain. When you verify a block, you receive a reward and collect some fees from the transacting parties.
In order to get started mining cryptocurrency, you will need to have a computer (or a collection of computers for "pool mining") you can dedicate to the process. The computer should have energy-efficient processors in order to make sure you don't spend more on electricity than you earn from mining.
For mainstream big-cap SHA-256, proof-of-work cryptocurrencies there are really only two viable processor options to mine most cryptocurrencies: GPUs or ASICs. A GPU is a graphics processing unit typically found in gaming PCs or high-end PCs used for graphics rendering. ASIC stands for application-specific integrated circuits. It is a chip designed specifically for one task -- mining a certain cryptocurrency.
The advantage of ASICs is that they're far more efficient. The disadvantage is that they're much less flexible at what you can mine using them, and they're more expensive than GPUs.
Once you have the hardware, it is just a matter of setting up a cryptocurrency wallet and some mining software. Be sure to store your mining computer in a cool and well-ventilated part of your house since it will generate a lot of heat. And make certain you keep it connected to the internet in order to mine all day.
Once everything is set up, it is a pretty hands-off process.
In order to mine a relatively new SHA-256, proof-of-work cryptocurrency all you need is a relatively new PC that supports Windows, Mac, or Linux (whichever platform the currency has its core software available for, which sometimes it is multiplatform so any PC with a 4 core x86-64 bit processor will work - for CPU mining coins).
The AVLP Team is working on a SHA-256, proof-of-work cryptocurrency akin to Bitcoin, and will be releasing it soon! Keep an eye out for news and upcoming updates on that.