What is Cryptocurrency?

Cryptocurrency is a form of virtual currency that relies on digital cryptography. 

In the wake of the Great Recession of the late 2000s, some people started to have less trust in conventional, traditional, centralised banking. There was a movement to create a medium of exchange that was not governed by banks or governments. That is how the cryptocurrency market as we know it today was born. 

Below, we take a closer look at the cryptocurrency definition in detail, including its characteristics, advantages, and disadvantages. We also recap how to acquire cryptocurrency and discuss different types of e-wallets.

Highlights

What is cryptocurrency?

Cryptocurrency, also known as crypto, is a digital or virtual currency. 

How does crypto work? 

The crypto part of its name comes from how the item is stored. Rather than appear in physical form – although some collectible physical crypto coins do exist – it is based on digital information. This data is encrypted, meaning that it is not possible to either double spend money or, perhaps more importantly, for crypto to be counterfeited. 

Cryptocurrency exists on the blockchain. The blockchain is a decentralised ledger – a database – which cannot be altered and does not answer to a single, centralised authority. Almost every cryptocurrency, with a few notable exceptions, such as Ripple Labs’ XRP, is based on the blockchain. 

History of cryptocurrency

Cryptocurrency became popular in the wake of the financial crisis of the late 2000s. However, the idea behind crypto had been around for a little while before that.

In 1982, computer programmer David Chaum posited the idea of an electronic currency called ecash. In 1995, the digicash virtual currency was launched. It required users to download software, and use it to withdraw money from a bank, before sending it using private codes to someone. Digicash was designed to be untraceable.

In 1998, Nick Szabo came up with the idea of bit gold, a virtual currency which would be based on something, not unlike a blockchain. Users would add to the ledger and verify transactions by, at least in part, solving increasingly complex mathematical equations. Although bit gold only existed in theoretical form, it had an influence on the next stage of crypto.

In 2009, a developer, or possibly a group of developers, calling themselves Satoshi Nakamoto created bitcoin (BTC). The cryptocurrency was supported by the Bitcoin blockchain, with people called ‘miners’ solving increasingly complex mathematical equations in order to add new blocks of data to the blockchain and being paid rewards in bitcoin in what has become known as a proof-of-work (PoW) consensus mechanism.

Bitcoin proved to be popular, and other cryptocurrencies sprang up. In 2012, the Peercoin (PPC) blockchain changed how people added blocks to it. Rather than solving problems, people who held the chain’s native token could stake it, or set it aside, in order to add blocks to the blockchain and earn rewards for doing so in a method which is known as proof-of-stake (PoS). 

Another key development at this time was the use of smart contracts – computer programs which automatically execute once certain conditions are met. It was the Ethereum blockchain and its ether (ETH) coin which went live in 2015 that really helped promote smart contracts. Ethereum became popular with developers, who were able to use it to create their own platforms and decentralised applications (DApps) which, in turn, had their own cryptocurrencies. 

Types of cryptocurrency

One of the most crucial splits in the world of cryptocurrency comes in the form of coins and tokens. The term token covers all cryptocurrencies. Coins, however, are only cryptocurrencies that are based on their own blockchain. 

For instance, ETH is a coin, because it is based on the Ethereum blockchain, but uniswap (UNI) is a token, because although it is based on Ethereum, it is not that blockchain’s native token. This may seem like a very niche distinction, but knowing the difference is a crucial part of understanding cryptocurrency. 

Another crypto category you will hear about is altcoins. These are crypto coins that are not bitcoin.

Stablecoins are cryptocurrencies which are designed to be pegged to the value of a fiat currency, in most cases the US dollar (USD). Some stablecoins are backed by assets, while others, known as algorithmic stablecoins, are designed to be linked to another crypto. In those cases, the other crypto is burned, crypto slang for deleted, when the price of the stablecoin is too high, and the stablecoin itself is burned when it falls too far below its peg. 

Finally, there are memecoins. These cryptos usually have little real world utility, but have proven popular in the wake of dogecoin (DOGE) enjoying a notable bull run in early 2021. 

Cryptocurrencies can have different functions, too. These include:

• Utility. Utility coins and tokens are cryptos which allow the holder access to the features of a particular blockchain-based project, such as being able to carry out transactions or purchase items in the system.

• Governance. Governance coins and tokens allow their holders to take part in votes on decisions affecting the platform’s future.

• Transactional. Transactional coins and tokens are used, as their name suggests, to carry out transactions, exchanged for goods or services. 

• Platform. Platform coins and tokens are linked to dApps, and are used to help support the dApp.

• Security. Security coins and tokens represent a traditional asset. A stablecoin which is pegged to a fiat currency could, potentially, be considered as a kind of security coin. 

How to buy cryptocurrency

Cryptocurrency can be bought, sold, or traded on exchanges. There are two different kinds of crypto exchange:

• Centralised exchanges, or CEXes, have a centralised authority and maintain fixed lists of cryptos and crypto pairs that can be traded. 

• Decentralised exchanges, or DEXes, do not have a central authority, with it possible to trade whichever pairs you want, providing you can find a buyer or seller.

There are also crypto derivatives, things that are not cryptocurrencies themselves but derive their value from an underlying crypto asset.

• Cryptocurrency futures: derivative contracts between two traders that speculate on the future price of an underlying crypto asset on a specified date.

• Cryptocurrency options: derivative contracts that give the trader the right, but not an obligation, to buy or sell an underlying crypto asset at a specified price.

• Cryptocurrency contracts for difference (CFDs): derivative contracts where a broker agrees to pay a trader the difference in the value of an underlying crypto asset between two dates – a contact's opening and closing.

Pros and cons of cryptocurrency

Some of the potential cryptocurrency advantages include: 

• Untraceable: Cryptocurrency is designed to give its users privacy, meaning that who uses what cannot be traced. 

• Faster: The blockchain is designed to be relatively quick and, in some cases, it can transfer money across borders at a fraction of the time and cost that regular fiat currency can be transferred. 

• Decentralised: Since it is almost always based on the blockchain, it is, at least theoretically, less likely to crash because of one person’s actions.

• Low transaction fees: Many blockchains and blockchain-based platforms only charge for the amount of time it takes to process a transaction. 

• Security: Cryptocurrencies are designed to be impossible to counterfeit. 

On the other hand, there are a few potential drawbacks:

• Legal concerns: As crypto is untraceable, it can be used for illegal purposes. 

• Unregulated: Crypto is unregulated which means that, should the people behind a crypto pull the plug on their token, there is no way of getting your money back. 

• High energy consumption: With the PoW consensus mechanism, the amount of computing power required is high, meaning more energy costs and potential environmental damage.

• Limited use: A lot of places do not take crypto as payment and, even when they do, the list of coins and tokens available to pay with is relatively small.

• Risk of theft: Crypto exchanges have fallen victim to hacks in the past, with millions of dollars worth of crypto taken.  

Important thing to note here is crypto’s heightened volatility. While it may offer the potential to make larger profits, it may also result in larger losses. As such, increased volatility makes cryptocurrencies risky. 

Potential investors and traders should weigh up the cryptocurrency pros and cons before deciding whether or not to get into the market.  

It is also worth noting that cryptocurrency is highly regulated in some places and less so in others. As of March 2023, countries where crypto is illegal include:

• Algeria

• Bolivia

• Morocco

• Nepal

• Afghanistan

• China

There are other countries where owning crypto is not in and of itself illegal, but there are still restrictions on its usage and sale. These include:

• Turkey

• Canada

• Bangladesh

• Indonesia

• Jordan

• Nigeria

• Colombia

In some jurisdictions, such as the US, crypto is legal but taxed. In some countries, such as Malaysia and Belarus, crypto is not only legal, but exempt from tax; while in other countries, such as Germany and Singapore, certain crypto holdings are tax-free.

Cryptocurrency wallets

If someone wants to move a cryptocurrency away from an exchange, they can get a crypto wallet. A crypto wallet is a program which exists to prove ownership of crypto. It does so by the use of crypto keys. Public keys identify someone is on the network, while private keys show that they are the rightful recipient of a payment. 

In order to access keys, users will need to remember a password. In most cases, if they do not remember it then they will be unable to access their wallet. 

There are wallets based on smartphone apps; ones which are downloaded onto your computer as software; there are hardware kinds, stored on the likes of USB devices, and there are also ones which operate online.

The future of cryptocurrency

With a dynamic and volatile market like cryptocurrency, it is hard to predict its future. The market has been through a highly volatile two years, with cryptos reaching new heights only for coins, tokens, exchanges and the market itself to face collapse. 

Conclusion

Cryptocurrency is a form of digital currency, usually based on the blockchain. Its use has proven to be controversial, with some countries banning it altogether. The market as a whole is highly volatile, with dizzying peaks coming before devastating lows. 

Therefore, if someone wants to invest in or trade cryptocurrency, it is vital that they do their own research, keeping in mind that prices can go down as well as up, and never investing or trading with more money than they can afford to lose. 

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