Have you need wondering how cryptocurrency works? Not to worry, this should help.
Unless you’ve been living under a rock over the last decade, you’ve probably heard of cryptocurrency. In the last few years as prices for cryptocurrencies like Bitcoin and Ethereum have soared and as more and more crypto millionaires have been minted, people have started to pay attention to crypto.
Still, there are some real barriers to entry into the crypto world. Many don’t understand it, how it works, what benefits it offers, or even how to get started. In this three-part blog post, we seek to answer these questions. This first one will address some basic knowledge about crypto that is necessary for understanding how it works. In part two, we’ll address some history, including pricing and risks associated with purchasing crypto. And finally in part three, we’ll provide a step-by-step guide for purchasing, storing, and keeping your crypto safe.
So, what is cryptocurrency?
Well, it’s a little complicated. But let’s start with blockchain technology which is the backbone of crypto.
A blockchain is a type of database. A database is a collection of information that’s stored electronically. An example of a database is a table. Unlike tables, in a blockchain, information is collected in groups called blocks. In the case of cryptocurrency, blocks contain transaction information.
Blocks have a certain storage capacity and when that capacity hits its limit, that block is chained to the previous block and timestamped. The new block also gets information about the previous block. In doing so, each new block reinforces the ones that came before it. The chain becomes resistant to modification since data in a block can’t be altered without altering the data in subsequent blocks. This process forms a chain of blocks and an irreversible data timeline.
Computers that are connected to and synchronized with a blockchain network work together to validate transactions and blocks. They also store a copy of the blockchain distributed ledger, a history of all previous transactions. This ledger is shared and synced across many computers and is accessible by many people.
The idea is that all transactions have many public “witnesses”. Participants can access the data on the ledger and can own an identical copy of it. Any changes to the ledger are copied to all participants so a central authority is not needed to authorize or validate transactions. Also, unlike a centralized ledger, a distributed ledger doesn’t have a single point of failure making it more secure and less prone to fraud and cyber-attacks.
What is decentralization?
This decentralization is a key benefit to cryptocurrency. A decentralized system is one that is not owned or controlled by a single or small number of entities.
In centralized systems, control is held by banks and governments. An example of this is traditional money (fiat).
In a decentralized system, as in the case of cryptocurrency, the blockchain is run and maintained using computing power owned by users around the world. This makes decentralized systems more democratic in nature. Activities within a decentralized system are distributed; therefore, it makes the system almost impossible to be shut down or controlled by a single authority.
The decentralized nature of crypto makes it so we don’t have to depend on and put our trust in the actions of a government or a bank to keep our money safe and influence the value of our money. The reality is that with fiat, you must trust a bank to hold your money, and hope that they don’t lose your money. Sure, governments create programs like FDIC Insurance, but that will only cover part of your losses. Governments can also print more fiat whenever they see fit. In other words, they can reduce the scarcity of their own currency and drive-up inflation.
Crypto creates scarcity
In most cases, there will only ever be a finite number of coins mined; this is the case with Bitcoin. This increases the scarcity of crypto coins and makes them deflationary. Its value will increase over time as it becomes scarcer and as demand increases.
The “trustless” system that crypto created facilitates peer-to-peer transactions. If I need to send money to someone using Fiat, I need to wire money through a bank, use western union, or some other intermediary that charges expensive fees. With a crypto wallet, I can simply send funds to another person’s wallet address. No third party necessary.
Stay tuned for the next part of the series which will focus on investing in crypto.