Cryptocurrency Explained

You may or may not have heard about a new “trend” that is quickly starting to become a manic craze in the digital world. It’s called cryptocurrency and the most prominent version of cryptocurrency is called ‘Bitcoin’.

Before we dive into Bitcoin itself, let’s clear up what the heck a cryptocurrency even is.

Cryptocurrency

Cryptocurrency is a digital asset designed to work as a medium of exchange using cryptography to secure the transactions and to control the creation of additional units of the currency. Source

If that doesn’t make any sense don’t worry, it’s a little bit confusing at first, but I’ll see if I can simplify it a bit into something more bite-sized.

U.S. Dollars ($) are a paper-based currency that is given a certain value based on a finite amount of gold. The gold standard.  Bitcoin, the largest and most prominent crypto, isn’t based on a finite physical commodity, such as gold. Instead, its value is derived on a finite amount of Bitcoins. 21 million to be precise. So, there in lies the “value” of a single bitcoin coin. Anything with a finite supply eventually has a value that society puts on it. Gold, silver, titanium, etc are all examples of a physical good with a value that fluctuates depending on market demand and total amount that is in existence.

Imagine if I had only 1 nickel then gave you that 1 nickel. You now have 1 nickel and I have 0 nickels. You own that 1 nickel and can do anything you want with it, since it’s yours after all. I can’t tell you what to do with it and I can’t give you any more since I only had 1. You are free to give it to your mother as a horrible Mother’s Day gift, or you can give it to a kid on a playground and make their day, it’s all yours. It is pretty easy to understand this transaction because it happens every time we spend money, or give money in exchange for a service.

But, what if instead of giving you an actual, physical nickel, I gave you a digital nickel. The problem is you have no idea if that nickel is worth anything or if it even truly exists.

What if I don’t even have a nickel! This conundrum is called the double-spending problem and it exists with almost every digital currency in existence. Until, Cryptocurrencies. 

The Blockchain

We need some sort of ledger that allows me and you to see that the digital nickel I gave you was actually mine, and now is actually yours. So, we make a spreadsheet together and write down our transaction and the deal is done. The nickel is yours, right? Well, yes unless I am the one to keep that ledger and then alter it maliciously by adding more nickels to my account even if I don’t actually own them. The whole system gets screwed up and no one can be trusted anymore.

This problem was solved with the creation of Bitcoin and the blockchain. Blockchain = Ledger. Essentially, it’s just a endless transactional ledger comprised of ‘blocks’ that track all of the transactions that occur within it.

Bitcoin uses the same type of ledger system we used when we traded our nickels. The key difference though, is that instead of only me or only you having access to the ledger, everyone who participates in Bitcoin transactions gets a copy of it and can transparently see how many “nickels” are in supply at any given time. No more cheating and saying you have more “nickels” or Bitcoin than is actually there.

Things start to get even more interesting when you realize you can send more than just digital money with the blockchain ledger. You can attach little notes, contracts, etc and there is no way to modify or cheat the system because any participant can see the transaction and verify its existence.

Mining

Remember when I mentioned there is finite amount of bitcoin? 21 million. Well, currently there are 14 million in circulation, with about 1/3 left to be “mined.” Yes, mined like mining for gold. Are you seeing the similarities yet? New Bitcoins are created (or mined) by very techie people with very, very powerful computers that must solve complex equations, called Hashes. This part isn’t very important to understand the technicals of, but knowing where these digital coins come from can help with grasping the entire concept. So, when these miners and their computers spend enough time and power solving these complex equations, eventually they will have solved one and are reward with a certain number of bitcoins for all of there time and effort. The more and more equations that are solved, the less and less they are rewarded and the more complex the equations become. The assumption being, computers will become faster as the equations become harder. The very last of the 21 million bitcoins will be “mined” at approximately year 2140. Longer than anyone reading this will be alive, unfortunately. After the miners receive there reward, they are free to do what they want with it. Sell it, keep it or even lose it if they are careless. (Online “wallets” that store your coins all have passwords to keep them secure, lose the password, and you lost your coins.)

There are over 2100 different crypto currencies out there today, almost all of them will never gain traction, but a few have. Bitcoin, Ethereum, Litecoin & Ripple are all examples of the top 4 crypto currencies being used today. And they all have wildly different values at the moment. Bitcoin just today reached an all time high over over $6,000 per coin, while Ripple is worth only $0.20 per coin. Quite the spread. But each coin has something unique about them that differentiates them from the rest. I won’t go into the differences because it gets quite technical and I don’t really fully grasp it all either. So.. Yeah.

Hopefully this all helped to clear up some of the mystery behind Bitcoin and cryptocurrencies or oped your eyes to the possibilities of it and the blockchain technology itself.

I am invested in Bitcoin, Ethereum, Litecoin and Ripple. I strongly believe in the underlying technology and I am spreading out my eggs across the different coins to diversify as much as possible.

Want to get started and invest in cryptocurrencies today? Visit Coinbase.com

Want to read an article from a fellow finance blogger about Bitcoin? Check out Full Time Finance

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2 comments

  1. For Bitcoin: It’s the user base, hype, and being essentially the first to market. Most alt-coin transactions first go through bitcoin, then BTC is spent to purchase the alt-coin.

    For Ethereum: If I remember correctly, it has the largest # of enterprises already on board to support the tech via the EEA (Enterprise Ethereum Alliance). Maybe the companies won’t stay on board, but the momentum seems to be there already. I’m not sure Ether will ever be used as a payment system, as much as an enterprise solution for maintaining contracts, ledgers, etc.

    For Litecoin: I am thinking its value will always be less than that of Bitcoin, so I think it could become the coins to bitcoins dollars. It also is the 3rd largest by market capitalization, not counting the Alt-coin or non-mineable coins.

    For Ripple: Simply, it’s the 3rd largest by market cap. and costs only a mere 0.20¢ / coin. This is pure speculative and hoping it goes up to even a dollar. This “feels” like the most risky play, but I have no idea. Also, it can’t be mined, which I find interesting compared to the others.

    Finger’s crossed one of these comes through, although I have highest hopes for Bitcoin, Ether and Litecoin.

    Like

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