Table of contents
- How do cryptocurrencies work?
- What are the advantages of using cryptocurrencies?
- What are the drawbacks of using cryptocurrencies?
- The Bottomline
In 2009, Satoshi Nakamoto introduced the world’s first cryptocurrency, Bitcoin. Initially designed as an electronic peer-to-peer cash system, Bitcoin’s scarce nature has also allowed it to become a lucrative store-of-value currency. When it was first traded in 2010, Bitcoin was only valued at around $0.0008 to $0.08. But today, the price of Bitcoin continues to soar, with its value exceeding $65,000 in November of this year, according to Statista.
The success of Bitcoin has inspired the emergence of other ‘cryptocurrencies’ such as Ethereum, Litecoin, and Tether. In essence, cryptocurrencies are a novel kind of digital asset that are secure by cryptography, which makes them immune to double-spending or counterfeiting efforts. In addition, cryptocurrencies are not issued by a central authority, making them resistant to government intervention and manipulation. The high profit potential and decentralized quality of cryptocurrencies have made this revolutionary technology a household name across the globe.
In this article, let’s take a closer look at the technology behind cryptocurrency, its pros and cons, and how one can make money off of it.
How do cryptocurrencies work?
To understand how cryptocurrencies work, it’s important to first grasp the concept of the blockchain. In a nutshell, the blockchain is a database where blocks that contain data are linked together. After a block is filled with data, succeeding data will then be stored in a fresh block, while still being chained to the previously filled block.
The main purpose of the blockchain is to let digital information be recorded and distributed, as well as prevent it from being edited or altered. All of this is possible because the blockchain is not hosted at a single location, nor contained by a lone entity. Participating nodes across the globe contain identical copies of the blockchain, which protects the data from manipulation or deletion. In addition, all of the data in the blockchain is encrypted, which further bolsters the security of the system. This unyielding aspect of the blockchain has allowed it to become the perfect foundation for immutable ledgers, which are records of transactions that are resistant to being altered or deleted.
These immutable ledgers are the basis for cryptocurrencies. Each ledger entry represents a cryptocurrency ‘token’ — a virtual representation of the crypto system’s tradable assets or utilities. Anyone who holds a crypto token can use it for economic and investment purposes, as well as to access any goods or services offered by the crypto provider.
Blockchains play a critical role in the existence of cryptocurrencies. In addition, blockchain tech also assures the security and fidelity of the data on it, effectively eliminating the need for third party verification. And because the data is spread across a network of computers, the blockchain makes it possible for cryptocurrencies to exist without being regulated and overseen by a central authority.
But there’s more to blockchain technology than just serving as the backbone behind cryptocurrencies. Business Insider highlights how blockchain technology provides value to other industries, too, as applications of it have been reported in various sectors including government, healthcare, media, and energy.
Aside from their practical applications, cryptocurrencies can also be traded for profit despite not being backed by anything or by a central bank. The worth of a cryptocurrency can be derived in three ways: speculation, scarcity, and application. Wealthsimple note that no matter how a cryptocurrency gets its value, there is usually a high value attached to it, and this is why it is a popular asset among investors today. Using various platforms such as crypto exchanges such as Coinbase or Binance, investors can buy and sell their crypto assets for profits with ease.
What are the advantages of using cryptocurrencies?
It’s a cost-effective mode of transaction
Cryptocurrencies have mostly been used to send money across borders with ease. Because it eliminates the need for a third-party provider such as PayPal or VISA to verify a transaction, there’s no need for users to pay the hefty fees that are usually attached to fund transfers.
It encourages individual ownership
Unlike in a traditional banking system where the stewardship of your funds is delegated to a third party, cryptocurrencies allow you to fully manage your own assets. The private and public encryption keys that are attributed to your cryptocurrency network address are solely overseen by you as the user. This allows you to exercise full control over all your crypto assets and circumvent the limiting terms and conditions of a financial institution.
It’s highly secure and private
As we’ve mentioned, the data stored on the blockchain cannot be altered, modified, or deleted. Using different cryptography algorithms, the blockchain makes it almost impossible for hackers and cybercriminals to access the data stored on it. In addition, the immutable nature of cryptocurrencies thwarts fraud attempts as it doesn’t allow for the reversal of any transaction.
What are the drawbacks of using cryptocurrencies?
Its market can be extremely volatile
The lack of an inherent value, as well as the ties to tangible and intangible assets makes cryptocurrencies highly volatile. In addition, NDTV notes that the newness and niche usage of the technology are also factors that contribute to the volatility of the crypto market. This makes holding and investing in crypto a high-risk activity.
It consumes a lot of energy
Most cryptocurrencies are finite in supply, which means that there’s a cap to the number of coins circulating in the market. However, not every coin is entered into circulation. In order to uncover these coins, individuals need to ‘mine’ by solving highly complex puzzles using advanced computers. This process requires significant computational power and electricity input, so much so that it uses more electricity than entire countries, according to The Guardian.
It fosters a high rate of illegal transactions
Because cryptocurrencies are decentralized and free from government intervention, it has been used as the mode of payment for many illegal deals. In addition, the laws and regulations surrounding crypto are not yet set in stone. The privacy and security of cryptocurrencies have made it difficult to trace down and keep tabs on the activity of illegal criminals.
Cryptocurrencies have truly taken the world by storm. Most are enamored by its potential use across all industries, with it offering advantages that a lot of consumers look for in a currency today. Moreover, a lot of the interest surrounding cryptocurrency is due to its profitable, but highly volatile, market.
However, one should understand that there are a lot of risks attributed to this revolutionary tech. Hopefully, the mass adoption and acceptance of cryptocurrencies can one day mitigate its risks and lead to a more stable and secure market.