Cryptocurrency is digital money that is secure and confidential, or anonymous.
It is associated with using the process of converting information into a code (almost uncrackable code), to keep track of purchases and transfers. The method used is known as cryptography and is associated with the internet.
How was it born?
The idea for secure transaction access and communication arose out of World War II when information was as precious as arms and ammunition. Coding of information and protecting currency evolved through mathematical calculations and science to secure money, data, and communications online. Cryptography was actively used during this time to process and verify transactions smoothly and discretely.
Cryptocurrency emerged as a fluke born out of another invention by Satoshi Nakamoto (the unknown inventor of Bitcoin) in 2009. It was never intended to become a currency but was instead supposed to be a ‘Peer-to-Peer Electronic Cash System’. It was originally meant to be like a peer-to-peer file sharing system for cash transactions. Bitcoin is still the best-known cryptocurrency online and there are now more than 1000 Bitcoins available. As of November 2017, Bitcoin is now worth more than USD 10,000 and has become a boon for investors.
What’s the Risk Factor?
Cryptocurrency is part of a decentralized digital cash system. In order to understand it better, think of the building blocks of our regular financial systems. You need a payment network filled with accounts, transactions, balances, and tracking. The biggest risk associated here is to ensure no one spends the same amount more than once. This tracking is done through centralized networks that keep real-time tracking online 24/7.
In decentralized networks, the central tracking server is missing. Here’s the tricky bit – every peer in this network must have a list of all transactions to check the validity and any attempts to double spend in future transactions. This needs an absolute and complete consensus of all peers in the network. If any peers disagree even about minor balances, the chain goes for a toss and everything is broken. So how is it possible to achieve complete consensus without a central authority? Nobody thought it could work, but it did! Satoshi proved them wrong.
So what exactly are cryptocurrencies?
Cryptocurrencies are limited entries in a database and are unchangeable without fulfilling specific conditions.
Bitcoin is part of a network of peers. Every peer has a record of all transactions and balances. A transaction (like regular financial transactions) can be something like, “John gives ABC Bitcoin to Jane” and is signed and verified by John’s private key access. This public key cryptography is nothing special. Once this transaction takes place, it is broadcasted to all the peers in the network. Again, this is nothing special either. This chain of transactions is made public to all peers only after it gets confirmed.
Confirmation is crucial when dealing with cryptocurrency.
Unconfirmed transactions can be forged. Once the transaction gets confirmed it cannot be reversed and cannot be forged. It becomes part of an immutable transaction history called blockchain. Miners confirm Blockchains – that is their job. They view the transactions, stamp them as legitimate and broadcast them in the network.
Cryptocurrency miners need to invest some part of their computers to qualify to become miners. They have to find a hash (cryptographic function) that connects new blocks with earlier ones. This is usually called Proof of Work and Bitcoin is based on the SHA 256 Hash algorithm.
How do we benefit from this?
Cryptocurrencies are simply entries that are secured by strong cryptography in decentralized consensus databases and are beyond the purview of banking and financial systems. They are not secured by people but by mathematics. Cryptocurrencies are irreversible, anonymous (it is very difficult to track the pseudonym of the account holder to real-world identities), global, fast, extremely secure, and permissionless (you do not need a bank authority to transfer or deal in cryptocurrency).
Coming to monetary properties, cryptocurrency is in controlled supply (limited tokens available – all cryptocurrencies control supply through special code), no debt (cryptocurrencies don’t represent any debts like in financial systems). Cryptocurrency is as legitimate as gold. Your money is also completely secure from political influences and has been promised to increase in value over time. Cryptocurrencies are private and anonymous enough to serve as payments in deregulated markets.
Cryptocurrency has boomed in terms of speculation and has given birth to dynamic and fast-growing markets for investors and speculators with its rising value. The daily trade value of Bitcoin sometimes exceeds major European stock exchanges and gives higher benefits to investors than financial funds.
People all over the world are currently buying Bitcoin as protection against the devaluation of their national currencies. Institutional investors are buying up cryptocurrencies to further their investments and increase the rate of return over short terms. Most people today are opting for Bitcoin as hedges against turmoil and capital controls in regulated financial market economies.