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How Does Cryptocurrency Work?

For years now, banks and governments have been holding the reins of our monetary system. We rely on them to issue the fiat currency we use and determine its value.

Banks collect our personal information, approve or reject our requests, oversee and keep track of money transactions, enable cross-border payments, etc. These services cost extra but apart from cash, people lose time, privacy, and control over their own money.

Enters Bitcoin, the world’s first cryptocurrency. Suddenly, all of the above can be executed in a decentralized manner by a complex algorithm. A new form of cash whose value can jump up exponentially. It’s expected of you to have questions. In fact, we all have questions.

Today, our team will help you grasp the main concepts behind these assets, how they work, what are the most popular cryptos, and how to use them.

What’s Cryptocurrency?

The “crypto” in cryptocurrency stands for cryptography, the process of converting ordinary data into unintelligible code for secure communication. In our modern digital era, cryptography is based on a combination of mathematical theory and computer science.

In 2009, a developer under the pseudonym of Satoshi Nakamoto made a breakthrough in cryptographic technology, designing an impenetrable digital ledger now-called the blockchain

Blockchain is the underlying technology behind almost all digital assets and the reason why they can exist outside of the centralized monetary system and its institutional trust-based model. Cryptocurrencies are part of peer-to-peer (P2P) networks where money transactions are faster, cheaper, and more private.

Cryptocurrencies enjoy the status of currency because although virtual they’re still fungible, divisible, and countable, and they’re becoming increasingly valued as mediums of exchange and stores of value.

Blockchain Technology and Verifying Transactions

To understand how cryptocurrency works, we have to start with blockchain technology. The main purpose of this digital ledger is to ensure a cost-effective exchange of information and securely store that information after (in this case that information would be money transactions).

This is only possible if the whole P2P network works together to verify and add the transactions to the ledger which is basically what ”mining” cryptocurrency is all about. For the purpose of illustrating the mining process, we’ll focus on Bitcoin’s blockchain.

Bitcoin’s P2P network consists of volunteers/miners operating on their computers or mining hardware known as nodes. To mine new bitcoins, the nodes run the incoming transactions through a hash function – in Bitcoin’s case, that’s the SHA-256 function – multiple times until they arrive at a solution, i.e. the right hash value. This is a complex algorithmic process that takes time and consumes a lot of computational power. 

When one of the miners solves the problem, he/she broadcasts it to the whole network and waits for its approval from the majority of the network. Only then, the transaction is verified and can be added to the next chained block of data (hence: blockchain). 

To eliminate the risk of double-spending and prevent outsiders from making changes to the blockchain or erasing data, every new block contains the hash value of the previous block. Therefore, if someone wants to meddle with the stored data, they would have to go all the way back and change every block. This is considered practically impossible because they would have to generate enormous computational power to outperform over 50% of the P2P network. 

This process of mining new coins and verifying transactions is known as the Proof of Work consensus mechanism. Since Bitcoin’s emergence, the technology has continued to work on more sustainable solutions which is why PoW is no longer the only mechanism although it remains the most common one among cryptocurrencies.

What Are the Most Popular Cryptocurrencies?

Bitcoin

Bitcoin (BTC) is the first and most popular cryptocurrency in the world. It was launched in 2009, by Satoshi Nakamoto, who explained the mechanisms and technology behind the first fully-fledged electronic payment system built on cryptographic proof in his 2008 whitepaper Bitcoin: A Peer-to-Peer Electronic Cash System>. At the moment 1 BTC is worth over $10,000 with a total market capitalization of more than $195 billion!

It’s a great long-term investment that has continually brought high returns to investors. Moreover, an increasing number of merchants, online platforms, and leading companies are starting to accept Bitcoin payments for their goods and services.

Ethereum

Ether or better known as Ethereum (ETH) is the second-largest cryptocurrency by market capitalization with over $38 billion towards the end of 2020. Ethereum was launched in 2015 by Russian-Canadian developer Vitalik Buterin. Buterin envisioned a cryptocurrency that would be more than just a store of value. He predicted the smart economy of the future where businesses make self-executable contracts and developers build decentralized applications. This is exactly what the Ethereum blockchain is all about. Since 2017, third-parties can launch their digital tokens known as ERC-20 tokens on Ethereum’s blockchain.

Litecoin

Litecoin (LTC), or the silver to Bitcoin’s gold, was created by a Bitcoin aficionado when the crypto market was still in its infancy. After studying Bitcoin’s blockchain and mechanism, Charlie Lee, a former Google employee, launched his own crypto project in 2011. Litecoin was supposed to be used side by side with Bitcoin but instead of long-term investments and large purchases, Litecoin would be more suitable for small everyday purchases. In order to achieve that, Charlie focused on making Litecoin’s blockchain more scalable.

Ripple

Ripple (XRP) is a joint crypto project between OpenCoin developer Ryan Fugger, software engineer Jed McCaleb, and angel investor Chris Larsen. Initial misunderstandings led to McCaleb’s departure as he went on to work on other projects (Stellar Lumens). Nevertheless, Ripple’s ecosystem continued to grow and the coin is now fourth by market cap. The main use case of Ripple is making international payments that are faster and cheaper and that would benefit both retail investors and central banks.

What Are the Use Cases of Cryptocurrency?

Few years ago, it seemed less likely that cryptocurrency was the future of our finances but things have changed since. There’s a raised level of awareness and crypto usage among the mainstream population mostly because there are more and more online crypto platforms, media coverage, shops and restaurants that accept crypto as payment, etc. There are even crypto debit cards.

If this popularity continues, assets with a fixed supply such as Bitcoin will become scarce and their price would go up significantly to the benefit of Bitcoin investors. Moreover, a lot of investors simply choose crypto to diversify their portfolio.

Finally, there are those who see crypto as more secure so they exchange their fiat currencies for crypto ones and store them in a digital wallet or open a retirement savings account with us, Coin IRA.

Final Thoughts

We hope you found our guide on how cryptocurrencies work as detailed and informative as we intended for it to be.

If you’re curious to learn more about cryptocurrency IRAs and how to invest your crypto in retirement savings, don’t hesitate to contact Coin IRA today. As one of the pioneers in the cryptocurrency IRA industry, our representatives have plenty of experience helping investors just like you make cryptocurrencies an important part of their investment portfolios.

Don’t wait for cryptocurrencies to double in price again before you make your move. Try your hand at cryptocurrency and contact our Coin IRA team today.