What is cryptocurrency? The Complete Beginners Guide 2017
I originally posted this article on a-zcrypto.com
Hundreds of blogs have been written about what is cryptocurrency and how to trade and earn money through them.
Yet, most of the new traders find it difficult to start investing in cryptocurrency. This is because most of them don’t know what cryptocurrency actually is and how does it work.
I’ve been interested in the cryptocurrency market since quite some time now. But, to be honest, I’ve been quite reluctant about trading in them. There’s too much risk involved and its quite confusing at the beginning.
The first time I saw them as viable for trading was when I noticed that the overall cryptocurrency market capitalization had gone from $25bn to over $100bn, all within 6 months (since the beginning of 2017).
This level of growth is quite extraordinary (and uncommon). That’s when I realized cryptocurrency is here to stay.
… for the long term.
Now that I’ve done more research on cryptocurrencies and have actually started trading them, I can confidently say that there are tremendous new opportunities to be explored. You can literally become a millionaire simply off one great trade.
But, there are big risks involved too.
Without further ado, let me walk you through all the fundamentals you need to know before you start trading.
For the crypto veterans, this guide will be quite simplified, since my goal is to make it as easy to understand as possible so that the novice traders can get the gist of the basic concepts and make rational trading decisions accordingly.
What is cryptocurrency?
As the name suggests, cryptocurrency is a combination of two words, “crypto”, since it uses cryptography to secure the transactions and to control the creation of new coins; and “currency” since it is a form of digital money.
One of its defining feature is that it is a decentralized currency. It is not tied to a particular country, and thus, not issued by any central authority, making it immune to government interference or manipulations.
The cryptocurrency developers build the cryptocurrency protocols on advanced mathematics and computer engineering principles which makes them virtually impossible to break or to duplicate.
Moreover, unlike the fiat currencies (USD, INR and other govt. issued currencies), most of the cryptocurrencies have a finite supply. Their source codes contain instructions which outline the maximum no. of units that can and will ever exist.
Over time, it becomes difficult for miners to produce cryptocurrency units until the maximum limit is reached after which they cease to be mined altogether. Thus cryptocurrencies, unlike fiat currencies, are designed to decrease in production over time, which makes them inherently deflationary.
Key features of cryptocurrencies
1. Decentralized:
This is the defining feature of cryptocurrencies.
A decentralized market is one that consists of a network of various technical devices that enable investors to create a marketplace without a centralized location. It is a way of taking power away from big institutions and distributing it to everyone else.
Cryptocurrencies are not tied to a particular country. They are not issued by any central authority. Thus, they are immune to government interferences or manipulations. Instead of a government that prints money for itself, everyone can mine cryptocurrencies.
Instead of putting trust in a government to back a currency and maintain its value, cryptocurrency’s value comes from the network of people using it.
Every person in the network is connected to every other member, so there’s no central point of failure. If any one person, or a group of people, disappear tomorrow, the value of cryptocurrencies will be unaffected by their absence.
2. Deflationary (finite supply):
We all know that fiat currencies (USD, INR) have an infinite supply. This is because the government, whenever they see fit, can print as many number of fiat currencies as they want, and whenever they do that each dollar/rupee you have is worth less. This causes inflation.
Most (not all) cryptocurrencies, on the other hand, are designed to decrease in production over time. Their source codes contain instructions which outline the maximum no. of units that can and will ever exist. Hence, cryptocurrencies are free from inflation.
3. Encryption:
Encryption is the process of converting information or data into a code, especially to prevent unauthorized access. It is the most effective way to achieve data security. To read an encrypted file, you must have access to a secret key (private key) or password that enables you to decrypt it.
When you use cryptocurrency as a medium of exchange, instead of using a single key, you use two separate keys; one for encryption (public key) and the other for decryption (private key). These keys are mathematically linked to one another.
The public key is the address that you share with others so that they can send you money (bits of data, bitcoins), while the corresponding private key is what you will use to send money to anyone else.
Remember, ONLY YOU should know what your private key is, do not share it with anyone, or else anyone who knows your private key can send all your money to any other addresses.
4. Transactions:
Cryptocurrencies use a distributed network to facilitate fast and globally accessible peer-to-peer (P2P) transactions without the need for third parties. In order to keep this secure, cryptocurrencies utilize the public key and private key system.
When a user completes a transaction, it is validated by a miner. Then it is checked by the remaining miners (they don’t need to mine the transaction again; a copy of the transaction is downloaded automatically) and then recorded in the blockchain. Once it has been recorded in the public ledger, it becomes irreversible.
5. Open source code:
An open source code software is one that can be freely used, changed, and shared (in modified or unmodified form) by anyone. Cryptocurrencies are typically open-source. This means anyone with the required technical knowledge can create and modify their own cryptocurrency.
Developers can also create API’s without paying a fee and anyone can use or join the network. Thus, coding a cryptocurrency is very less time consuming since virtually all the cryptocurrencies are based on the open source code of Bitcoin or Litecoin that is available on GitHub.
6. Public ledgers (Blockchain):
Each and every transaction is recorded in a public ledger known as the blockchain. The blockchain, as the name suggests, is a chain of continuously growing blocks each having a connection to the previous block leading all the way up to the first block (genesis block).
Each block contains information about different transactions that take place. You can literally trace back the transactions all the way back to the first transaction.
Even though the blockchain is a central record, there’s no official group of people who update the ledger and keep a track of everybody’s money like a bank does- its decentralised. In fact, anyone can volunteer to keep the ledgers updated (we know these people as miners). It all works because there are lots of people keeping track of the same thing, to make sure all transactions are accurate.
As soon as one miner validates the transaction, it gets automatically downloaded in the other miners’ ledgers. This makes the transactions immutable since the slightest change would mean that literally each and every miner’s copy of the transaction would have to be overwritten.
7. Mining:
Mining is the process by which transactions are verified, added and maintained in the public ledger. It is also the means through which new cryptocurrencies are released in the market. Anyone with access to the internet and suitable hardware can participate in mining.
The mining process involves compiling recent transactions into blocks and trying to solve a complex mathematical problem. The computer who first solves the puzzle gets to place the next block on the blockchain and claim the reward for solving this math problem and providing this critical function to the system.
For their hard work, the miners are rewarded with a small amount of cryptocurrency. Over time, the mining process gets more difficult and the block reward keeps reducing. (roughly every 4 years).
How do cryptocurrencies work?
Cryptocurrencies use a distributed network to allow worldwide peer-to-peer (P2P) transactions without relying on a third party. They use public key - private key system for security purposes. As soon as a transaction is made, it gets submitted to the public ledgers where it awaits confirmation.
The wallets use an encrypted electronic signature to provide mathematical proof that the transaction is coming from the owner of the wallet. The transaction then gets broadcasted to everyone else (miners) so that everyone who is keeping track can confirm the transaction and update their ledgers accordingly.
Thus, when you complete a transaction, you announce your account no, the account no of the other person (receiver) and the amount of cryptocurrency you want to send. Everyone else verifies and updates their ledgers, thus adding new blocks to the blockchain.
Whoever solves (mines) the math problems first gets to add the next block of transactions to the blockchain which then generates a new math problem that needs to be solved.
Anyone with the right computing power can volunteer to mine. Miners help in keeping the public ledgers up to date. In exchange for doing so, the miners are rewarded with a small amount of cryptocurrency.
Also, new coins can only be created by mining. Every single coin that exists was created to reward a miner. The miners also receive a small tip for each transaction they add to the ledger.
As soon as one miner validates the transaction, it gets automatically downloaded in the other miners’ ledgers. This makes the transactions immutable since the slightest change would mean that literally each and every other miner’s copy of the transaction would have to be overwritten which requires a very large amount of computing power which in inaccessible for the common man.
Why should you invest in cryptocurrency?
1. The ship hasn’t sailed – YET!
The one thing that has frustrated me all my life is the fact that I was always late to the party – be it stock market or the web development industry. The best thing about cryptocurrency is that the party is happening right now.
It’s still in the early stages. the overall cryptocurrency market capitalization has gone from $25bn to over $100bn, all within 6 months (since the beginning of 2017). Get in now and kick that 9-5 lifestyle.
2. Volatility
The cryptocurrency market is highly volatile. One moment you could have extreme profits, the next instance you could incur a loss. Thus, it is highly unpredictable.
This makes it very exciting (sometimes frustrating too). Make one great trade and you could literally become a millionaire (obviously that one great trade is extremely difficult to find).
3. Low transaction fees
Since the cryptocurrency miners are rewarded by the cryptocurrency network itself, and since there is no other third party involved, the transaction fees incurred is extremely low when compared to most banks and financial institutions.
4. Identity protection
Most cryptocurrencies provide fast and globally accessible transactions which are anonymous. When you make payments through your debit/credit cards, you first need to provide sensitive banking information which could be stolen or compromised. Cryptocurrency, on the other hand, can be sent directly to a recipient without any information other than total amount you want to send.
5. Security
Cryptocurrencies are built on advance mathematical principles which makes it virtually impossible to break, duplicate or counterfeit them.
Moreover, the transactions operate through public key – private key system which gives them added security.
6. Decentralised
Like I said earlier, it is not tied to a particular country, and thus, not issued by any central authority, making it immune to government interferences or manipulations.
What are the risks?
1. Zero-sum game
Remember, trading is always a zero-sum game. For everyone who benefits, someone else loses on the other side.
2. Volatility
Volatility goes both ways. One minute you could have immense profits. Check back after a few days and you could incur an unexplained fall in price.
3. Unreliable / unpredictable
The market is so volatile the its very hard to predict. Even technical analysis isn’t of much help here. Thus, it is sort of a gambling.
4. Frauds and scams
There are literally hundreds of brokers and exchanges. Beware of the fake ones.
5. Hackers
Since cryptocurrencies are in the early developmental stages yet, there’s always the risk of hackers.
How can u acquire cryptocurrency?
1. Mining
Mining is the only way to create new cryptocurrencies. Essentially all cryptocurrencies that exist, were created to reward miners.
2. Exchanges
Cryptocurrency exchanges are platforms where you can buy bitcoins and other altcoins in exchange for other assets, such as your conventional fiat currencies or different digital currencies. Some of the widely known exchanges are:
Worldwide
Poloniex
Bittrex
Coinbase
Kraken
Shapeshift
India
Zebpay
Unocoin
Coinsecure
Koinex
Each exchange has its own rules and regulations, so make sure you understand them before trading any significant amount of money.
Read Also : Top 5 Exchanges to buy bitcoins in India
How to store cryptocurrencies?
To store your cryptocurrencies on the blockchain, you need a “wallet”.
A cryptocurrency wallet is a digital wallet which lets you store, send and receive various cryptocurrencies. Each wallet has a public address and a private address.
The public address is used by others to send you money whereas the private address is the “password” that you use to send money to others. Never show your private address to anyone.
This wallet is simply an address on the blockchain. It's like how the website address a-zcrypto.com directs you to my website, on the internet. It doesn’t exactly “store” your money as a real-world wallet does. It just saves your public and the private keys which are necessary for your transactions.
Now that you understand the basics of cryptocurrency wallets, let’s move onto the different available options out there.
Hot storage
Hot storage is when you store your money in a device which is connected to the internet. It’s easier to access your funds on a hot storage. But, it is less secure.
1. Online wallets
They are the easiest to use among all, but also the least secure. They include creating an account on the exchange services.
2. Desktop/ Mobile wallets
They are much more secure. They can be downloaded on a particular device and can be accessed only through that device. Eg: MyCelium
Cold storage
Here the currency is stored in a device which is completely offline. It is the most secure form of storage which is good for long-term holders.
1. Hardware wallets:
Hardware wallets are physical devices where you can store your currencies. If any loss or damage occurs, they can be restored.
Eg:
• Ledger Nano S
• Trezor
2. Paper wallets:
They are the safest way to store your currencies. It includes printing out your public and private keys on a piece of paper and then safely storing them in a secure place.
Conclusion
So this was my complete beginners guide to cryptocurrency investing. I hope that it answered all of your questions.
There will be more detailed posts on all the above-mentioned topics.
For more such posts check out my blog at www.a-zcrypto.com