The term “cryptocurrency” is now known to almost all people, despite the fact that many of them are not even interested in the principles, features and ways of mining “virtual money. Nevertheless, cryptocurrency was able to do what many technologies before it could not – not only to penetrate the global financial market, but also to make significant changes in it. It’s time to thoroughly understand what “virtual coins” are, what their main advantage is and the reason for their unprecedented popularity.
What are they
The term “cryptocurrency” was born in 2011, thanks to Forbes magazine, which introduced it. The name reflected a special kind of electronic payment medium, which was a complex mathematical code. The word “crypto” itself, which is present in the name, deciphers the principle of operation of the “currency”, which uses cryptographic elements in the form of a unique digital signature. They are necessary for the circulation of finances.
It is very difficult to compare cryptocurrency with fiat money, because “cryptocurrencies” have no physical counterparts, that is, they exist exclusively in digital form. Moreover, virtual money is based on the principle of decentralization, which makes it very different from conventional funds. That is, this resource is not regulated by the central bank or other financial institutions, which rules out any attempts to influence or change its value. The blockchain technology, on which cryptocurrencies are based, provides a similar structure.
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How Cryptocurrency Works
Let’s take a closer look at what a cryptocurrency is and how it works. Bitcoin, as the main engine of the whole sphere and its primary popularizer in the world, is worth taking as an example. All digital transactions that take place within a single cryptocurrency are a chain of blocks. It should be seen as a single collective register of a public nature. Such a system makes it possible to determine the amount of currency in each wallet, as well as to account for any spending. The integrity and chronological order in the blockchain is maintained through complex cryptographic calculations, which underlie the entire system.
The main way users’ wallets interact is through a transaction. Each such transaction is embedded in a block and stored in the entire chain that follows. This ensures the legitimacy of the transaction and protects it from any manipulation, be it hacking, overwriting data, or others. If a transfer does not contain a unique digital signature, it will not be identified in the system and will be considered invalid.
To better understand how cryptocurrency works, let’s look at its main features and structure:
- Cryptocurrency does not have a single administrator, which allows it to be a decentralized resource.
- All members of the system are the custodians of the data simultaneously.
- Each new block is found by the miners about once every 10 minutes. It contains encrypted information about all previous transactions.
- A fee is paid for finding new blocks.
- The system can only be hacked if more than 50% of all computers in the network are accessed. This is the only way to overwrite the information of previous blocks. At this time, this is considered impossible.
- Cryptocurrency mining is carried out by complex mathematical calculations, which are performed on a computer or special equipment. This process is called mining.
What is secured
Cryptocurrency collateral should only be considered with real fiat money in mind. After the measure of money has become not gold, and the U.S. dollar, the global financial sphere has become fully centralized, which is provided by the activities of central banks and other financial institutions. The main reason for abandoning the dollar was the fact that this resource is exhaustible. The same principles are laid down in the basis of digital currency. However, virtual money is influenced neither by the “printing press”, through which governments of different countries regulate the value of currency, nor the banking system.
Cryptocurrency is often compared to gold, using the same word for it – “mining. Only instead of real rock, miners “dig” the digital resource. Its demand is ensured by:
- General trust and high demand.
- The security of the system, which is achieved by blockchain technology.
- Recognition of a financial instrument (simply put, you can buy something for cryptocurrency only if it has value).
- Lack of ability to print new money uncontrollably.
Let’s take the example of the main cryptocurrency, bitcoin, as an example of how to issue money. The peculiarity of each cryptocurrency is that the number of tokens/coins in it is always predetermined. For example, for bitcoin, the maximum issue is 21,000,000 bitcoins. This is an example of a controlled issue with a certain final number of coins. The main example of coins with unlimited issuance is Ethereum. In such a case, it is controlled by adapting the issue to the use of the network, which is calculated based on its total value.
Capitalization and exchange rate
In simple terms, the capitalization of a cryptocurrency is the total value of all the currencies in circulation. This is an important indicator for investors, which directly determines the “weight” and the demand for coins, as well as reflects the development of the cryptocurrency market.
The rate of cryptocurrency, as in the case of other financial units, is determined by the demand. Today, virtual coins are the same instrument as any other currency on the exchange. That is, the rate is formed by the same financial laws as in the case of the dollar, euro and other fiat money. The exchange rate is influenced by:
- Rumors and general financial policies.
- Activities of major market players.
- Buying, selling and pumping (temporary and artificial appreciation).
- News and events.
- Rate corrections.
- Trending activity.
The notion of “fork”, which is translated as “fork” or “fork”, clearly shows the essence of this tool. It can be initiated by the project team or its developers. Conducting a fork means branching off a cryptocurrency, which essentially separates from the original “coin,” creating a separate resource. Most often it happens to change the rules of the network, introducing significant changes in them.
There are two types of forks:
- Hard fork;
- Soft fork.
Hard fork is a strong divergence of course with a change of rules, or a complete separation. Units of the old system are not supported by the new system and vice versa. A good example is Ethereum and the creators’ conflict, which split into the original currency and Ethereum Classic after a hardfork.
Softforks are less significant rule changes. The main difference is “backward compatibility,” that is, when old transactions can be recognized by new nodes. Reasons for softforces can be either the introduction of any significant changes to network conditions, or steps to avoid centralization or other threats to the project.
Mining and other ways of obtaining
Mining is the main way of obtaining cryptocurrency, which is the performance of complex mathematical tasks. It is also possible to obtain “coins” by buying tokens in the form of investments in the project, as well as by direct purchase The process of mining is directly affected by two indicators – the complexity of the network, which determines the efficiency of the equipment, as well as the rate itself. If we evaluate the process of buying cryptocurrency, it is almost no different from the usual monetary relations on currency exchanges. The only difference is that cryptocurrency resources are stored in special wallets of the owners.
It is worth considering that there are several types of mining:
- Mining with the help of mining pools (one member of the network has long been unable to counteract the enormous complexity of the network, so miners join together in pools to multiply the computing power).
- Cloud mining (most often it is a scam, so it almost completely lost its reputation).
The process itself is carried out either with video cards (combined into farms), or on special devices (asics).
Advantages and disadvantages
Let’s consider the main pros and cons of cryptocurrencies. The undeniable pluses include:
- The absence of direct restrictions. Anyone can mine digital money, but the potential and profitability will be limited by the power of the equipment.
- Anonymity of operations.
- Decentralization, which excludes any manipulation of the cryptocurrency.
- Transparent ways of mining and conditions (users have all the information available, from the final number of coins, to the rate, to the complexity of the network and other indicators).
- High level of protection (according to the current estimates of economists, it significantly exceeds the protection of fiat money).
- Minimal or no commissions.
The advantages of cryptocurrencies are very impressive, but they also give rise to a number of disadvantages, on the elimination of which the best minds on the planet are actively working. Potential disadvantages include:
- Loss of the wallet password entails the loss of all accumulated funds without any appeal.
- High volatility, due to which the exchange rate can change drastically (within the range of fluctuations from 100 to 300%).
- Vulnerability to the policies of central banks and other financial institutions. It is important to understand that the popularity of cryptocurrencies is supported by the general interest of participants and the demand for “coins”. This can be changed by regular financial regulation in individual countries.
- The growing complexity of the network, which makes it more difficult and less profitable to mine cryptocurrency.
Regulation of virtual currencies
Cryptocurrencies are just emerging in the legal field. Although many countries have begun to regulate the issue, in some regions the digital currency still lacks state governance and legal interpretation.
If we look beyond individual countries and consider the status of cryptocurrency on a global scale, one of the most important regulators is the Act (Uniform Regulation Of Virtual-Currency Businesses Act), which was approved by the House of Delegates of the American Bar Association in February 2018. The U.S. Federal Reserve Bank, the U.S. Department of the Treasury, and other agencies were involved in creating the act. The act regulates the definition of cryptocurrency, the licensing of participants, the application and other conditions of any activity related to digital currency.
Cryptocurrencies have not been legally legalized in Russia. On October 5, 2017, the Bank of Russia refused to legalize cryptocurrencies as a means of payment in the country. Despite the disapproval of “private money”, the cryptocurrency sphere in Russia is steadily developing, albeit without state regulation.
For a long time, the cryptocurrency market was called an economic bubble, a scam and other words that should inspire fear of the new system. But by the end of 2018-beginning of 2019, the cryptocurrency sphere had gained tremendous momentum. The capitalization of “coins” amounts to hundreds of millions of dollars, and major cryptocurrencies have long been integrated into the international financial system.
Despite certain difficulties in mining, as well as the potential seizure of many algorithms by companies producing ashik-devices, this has had almost no effect on the entire sphere of digital currencies. The only exception is rates, which have fallen back to their real values after a strong rise due to hyperpopularity.