What is cryptocurrency?
Before understanding cryptocurrency, I’m going to explain some super important terms. These terms are virtual currency, blockchain, and distributed ledger.
A virtual currency is a digital representation of value only available in electronic form. Transactions involving virtual currencies occur through secure, dedicated networks or over the Internet. They are issued by private parties or groups of developers and are mostly unregulated. Virtual currencies include other types of digital currencies, such as cryptocurrencies and tokens issued by private organizations.
As a database, a blockchain stores information electronically in digital format. Blockchains are best known for their crucial role in cryptocurrency systems, such as Bitcoin. The innovation with a blockchain is that it guarantees the fidelity and security of a record of data and generates trust without the need for a trusted third party. Financial institutions such as JPMorgan Chase & Co. (JPM) are testing the use of blockchain technology to lower transaction costs by streamlining payment processing.
A distributed ledger is a database that is consensually shared and synchronized across multiple sites, institutions, or geographies, accessible by multiple people. A distributed ledger stands in contrast to a centralized ledger, which is the type of ledger that most companies use. A centralized ledger is more prone to cyber-attacks and fraud, as it has a single point of failure.
A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology — a distributed ledger enforced by a disparate network of computers. A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation.
Understanding Cryptocurrencies
Cryptocurrencies are digital or virtual currencies underpinned by cryptographic systems. They enable secure online payments without the use of third-party intermediaries. Cryptocurrencies can be mined or purchased from cryptocurrency exchanges. Not all ecommerce sites allow purchases using cryptocurrencies. In fact, cryptocurrencies, even popular ones like Bitcoin, are hardly used for retail transactions. However, the skyrocketing value of cryptocurrencies has made them popular as trading instruments. In addition, they are also used for cross-border transfers.
Types of Cryptocurrencies
Bitcoin is the most popular and valuable cryptocurrency. An anonymous person called Satoshi Nakamoto invented it and introduced it to the world via a white paper in 2008. There are thousands of cryptocurrencies present in the market today.
Bitcoin, which was made available to the public in 2009, remains the most widely traded and covered cryptocurrency. As of November 2021, there were over 18.8 million bitcoins in circulation with a total market cap of around $1.2 trillion. Only 21 million bitcoins will ever exist.
In the wake of Bitcoin’s success, many other cryptocurrencies, known as “altcoins,” have been launched. They include Solana, Litecoin, Ethereum, Cardano, and EOS. By November 2021, the aggregate value of all the cryptocurrencies in existence had reached over $2.1 trillion — Bitcoin represented approximately 41% of that total value.
In addition, each cryptocurrency claims to have a different function and specification. For example, Ethereum’s ether markets itself as gas for the underlying smart contract platform. Ripple’s XRP is used by banks to facilitate transfers between different geographies.
Advantages and Disadvantages of Cryptocurrency
Cryptocurrencies were introduced with the intent to revolutionize financial infrastructure.
Some advantages and disadvantages of cryptocurrencies are as follows.
Advantages
1. Cryptocurrencies represent a new, decentralized model for money. In this system, centralized intermediaries, such as banks and monetary institutions, are not necessary. Thus, a system with cryptocurrencies eliminates the possibility of a single point of failure.
2. Cryptocurrencies promise to make it easier to transfer funds directly between two parties, without the need for a trusted third party like a bank or a credit card company.
3. Cryptocurrencies do not use third-party intermediaries. In addition, cryptocurrency transfers between two transacting parties are faster as compared to standard money transfers. Flash loans in decentralized finance are a good example of such decentralized transfers. These loans, which are processed without backing collateral, can be executed within seconds and are used in trading.
4. Cryptocurrency investments can generate profits. Cryptocurrency markets have skyrocketed in value over the past decade, at one point reaching almost $2 trillion. As of Dec. 20, 2021, Bitcoin was valued at more than $862 billion in crypto markets.
5. The remittance economy is testing one of cryptocurrency’s most prominent use cases. Currently, cryptocurrencies such as Bitcoin serve as intermediate currencies to streamline money transfers across borders. Thus, a fiat currency is converted to Bitcoin (or another cryptocurrency), transferred across borders and, subsequently, converted to the destination fiat currency. This method streamlines the money transfer process and makes it cheaper.
Disadvantages
1. Though they claim to be an anonymous form of transaction, cryptocurrencies are actually pseudonymous. They leave a digital trail that can be deciphered. This opens up possibilities of governments or federal authorities tracking the financial transactions of ordinary citizens.
2. Cryptocurrencies have become a popular tool with criminals for nefarious activities such as money laundering and illicit purchases. Cryptocurrencies have also become a favourite of hackers who use them for ransomware activities.
3. In theory, cryptocurrencies are meant to be decentralized, their wealth distributed between many parties on a blockchain. In reality, ownership is highly concentrated. For example, an MIT study found that just 11,000 investors held roughly 45% of Bitcoin’s surging value.
4. One of the conceits of cryptocurrencies is that anyone can mine them using a computer with an Internet connection. However, mining popular cryptocurrencies require considerable energy, sometimes as much energy as entire countries consume. The expensive energy costs coupled with the unpredictability of mining have concentrated mining among large firms whose revenues run into the billions of dollars. According to an MIT study, 10% of miners account for 90% of their mining capacity.
5. Though cryptocurrency blockchains are highly secure, other crypto repositories, such as exchanges and wallets, can be hacked. Many cryptocurrency exchanges and wallets have been hacked over the years, sometimes resulting in millions of dollars worth of “coins” stolen.
6. Cryptocurrencies traded in public markets suffer from price volatility. Bitcoin has experienced rapid surges and crashes in its value, climbing to as high as $17,738 in December 2017 before dropping to $7,575 in the following months. Some economists thus consider cryptocurrencies to be a short-lived fad or speculative bubble.
- https://www.investopedia.com was used for the article.
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