What are cryptocurrencies?
Cryptocurrencies (virtual currencies, tokens) are a form of digital decentralized money designed for the purpose of exchanging digital information through a process made possible by certain principles of cryptography.
The transfer of funds operates on the internet, independently of central banking and governments. They are designed to be secure and, in many cases, anonymous.
Cryptography is a method of storing and transmitting data in a specific form that only those whom it is intended for can read and process. This is the process of converting readable information into an almost uncrackable code, to track purchases and transfers.
Every cryptocurrency is slightly different, but most share these basic characteristics:
- Irreversible. After a cryptocurrency is sent and the network has confirmed it, it is impossible to retrieve it.
- Anonymous. To open a wallet no ID is required, so anyone can do it. Depending on which token you utilize there are varying stages of anonymity.
- Fast and globally accessible. Transmissions across the network are instant and confirmation only takes a couple of minutes.
- High level of security. Cryptocurrencies use the latest cryptographic techniques, but they’re still in an early stage of development.
- They have a controlled supply limited by the network.
How they are created?
Simplified, the process can be explained as follows:
The transfer of funds operates on the internet, independently of central banks and governments, without the need of a third party.
Transactions are added and tracked in a public ledger – also known as the blockchain, via nodes on the network with consensus (agreement) achieved through a proof-of-work system referred to as mining.
For participation in this protocol (mining) one is rewarded with bitcoins.
What defines the price of a cryptocurrency?
- Supply/demand. Supply/Demand is an economic factor that moves the price of many things.
- Energy in the form of electricity to secure the blockchain. The energy put into securing blockchains can be intensive. Proof of work (POW) blockchains are the most popular form and electricity usage can be intense which of course, influences price.
- Blockchain difficulty level. The more secure the blockchain and the higher the difficulty of mining. This impacts the price and is connected with energy use in proof of work blockchains such as Bitcoin and Litecoin.
- The utility of the currency, and how easy it is to use and store. If you cannot use it for something, be it an investment or for payments, then it would have little or no perceived value
- Perceptions on its value by the public. The public perception of a cryptocurrency has a great bearing on the value of the currency.
- Price of Bitcoin. Bitcoin is often seen as the ‘reserve currency’ of the cryptocurrency world. Rises and falls to the price of Bitcoin often has a knock on effect upon other cryptocurrencies.
- Media. The media’s reporting on Bitcoin in either a positive, or negative way can have influence on the public perceptions of Bitcoin, and can influence its price.
- Investors. With all cryptocurrencies, especially smaller less known ones, investors can manipulate / inadvertently affect price.
- Scams. Cryptocurrencies can sometimes be developed as a scam. This method is often associated with a coin that promises the latest and greatest technology, but is also ‘pre-mined’ by the developers before release. This ensures they hold a good chunk of coin supply before coin release so when it is given value they dump their holdings, which crashes the value for other investors, but can potentially earn the scammers a large sum of money and it is often difficult to prosecute such scams, and in many jurisdictions impossible at present.
- Innovation. With many cryptocurrencies being a clone of Bitcoin minus adjusting numbers, innovation is another thing which can affect price.
- Confidence in traditional systems. When confidence in the traditional systems increase, such as the price of the U.S dollar going up, this can cause some people to go back to storing assets using traditional currency.
- Legal/Governmental issues. Legal and governmental issues can influence the price, if a government begins being oppressive with tax or asset laws, it can be trivial to hide assets in a cryptocurrency, this perceived value by a country of investors can cause changes in price. Legal moves which are positive for a cryptocurrency such as making them official as a currency can have a positive effect, while a country banning it could have a negative effect.
What is a Blockchain?
Cryptocurrencies make use of distributed ledger systems known as blockchain protocols to securely transfer holdings. The main power of blockchain is its ability to distribute information in an amazingly well-organized, secure and transparent way.
A blockchain is a kind of network or web of nodes, where each node represents what’s called a miner.
A Miner can be an individual with one computer or a huge group of computers. Everyone, around the world can participate in the mining process.
By connecting your computer to the blockchain to mine, your computer is not only helping verify current batched transactions of various users, but it is also helping to secure and ensure the network as a whole for the future.
For supporting the network and their energy, time spent and work done running mining software, miners are rewarded with a block reward fee.
What is Mining?
The mining process is known as a proof-of-work system and it is what gives value to the coins. Mining involves the addition of transaction records; the confirmation process adds them to a public ledger.
For this process the “miner” must solve a progressively-complex computational problem. Mining is open source, so anyone can confirm the transaction. The “miner”, after solving the problem, adds a “block” of transactions to the ledger. Once a block is added to the ledger, all relating transactions are permanent.
For the effort and energy spent a small transaction fee is added to the miner’s wallet and a few new coins are created.
What is transaction?
A transfer of funds between two digital wallets is called a transaction. That transaction gets added to a public ledger (block chain) after which both parties have their transaction confirmed.
The confirmation process takes a few minutes while “miners”, through the mining process, approve transactions and add them to the public ledger.
When a transaction is made, wallets, with encrypted piece of data called a cryptographic signature, provide mathematical proof that the transaction is truly coming from the owner of the wallet.
What is a digital Wallet?
This is a software program where cryptocurrencies are stored and digital wallets enable the sending and receiving of cryptocurrencies.
As cryptocurrencies are virtual money, in the same way a digital wallet is virtual storage.
There is a private key (secret number) for every cryptocurrency address that is saved in one’s wallet.
Digital wallets come in different forms:
- Desktop. Provides the user with complete control over their wallet, enabling the user to create a cryptocurrency address for sending and receiving virtual currency. Desktop wallets are as the name suggests, installed on a desktop computer. The best known are Bitcoin Core, MultiBit, Armory, Hive OS X, Electrum, etc.
- Mobile. An application which can be installed on a smartphone. It carries out the same functions as the desktop type but through its mobility it overcomes the static nature of the former. It also facilitates making payments in physical stores by using “touch-to-pay” via NFC scanning a QR code. The most well-known are: Bitcoin Wallet, Hive Android and Mycelium Bitcoin Wallet.
- Web. Web wallets allow usage of cryptocurrencies on any browser or mobile. As a private key is stored online it is very important to choose a web wallet with extreme caution. The most popular web wallet providers are: Coinbase and Blockchain.
- Hardware. This is still in its development phase and the number is very limited.
- Encrypting the wallet with a strong password,
- Storing it offline.
What is an ICO (Initial Coin Offering)?
ICO is a method of raising funds by issuing cryptocurrency tokens. It is used by startups to bypass the rigorous and regulated capital-raising process required by venture capitalists or banks.
During an ICO, a company typically sells part of its cryptocurrency tokens in exchange for legal tender or other cryptocurrencies, but usually for Bitcoin.
The funding is used as a medium to distribute tokens to the market and funds expenses by the founding team.