Cryptocurrency | What is a Cryptocurrency | How Cryptocurrency Works
Cryptocurrency is digital money. It means there’s no physical thing like coin or bill — it’s all online. You can transfer cryptocurrency to anyone online without a go-between, like banks. Bitcoin, Ether is a very known cryptocurrency, but new cryptocurrencies continue to be created.
People might use cryptocurrencies for fast payments and to avoid transaction charges. Some might get cryptocurrencies as a good investment, hoping the value of crypto goes up. You can buy cryptocurrency online or get it through a process name called “crypto mining.” Cryptocurrency is stored in a digital wallet, either online, on our computer, or on other hardware.
contents:
Initial problem: digital money is not possible without a middleman
First cryptocurrency Bitcoin
A movement arises
The blockchain concept in a nutshell
Bitcoin isn’t the only cryptocurrency
Why do cryptocurrencies have value?
Blockchain is more than just currency
Bitcoin curse or blessing?
Comparison of cryptocurrencies — classic financial products
Bitcoin and the eternal bubble
Assess personal risk
So why should I buy cryptocurrencies?
Which cryptocurrency program 2021 is best to beginner to advance
Initial problem: digital money is not possible without a middleman
Cryptocurrencies emerged from a specific problem. For example, if a person gives their friend a 50 euro note in “real” life, this is a process without an intermediary. In other words: The transaction takes place directly from A to B without anyone else knowing about it. No one can prevent it. In contrast, this type of transaction does not exist on the Internet. And that’s not just limited to money — other values also play a role. Of course, money can be sent with PayPal or similar service providers or a digital bank transfer can be made. The difference is that users are dependent on institutions such as banks or payment service providers in these transactions.
In systems based on such central institutions, people always have to come to terms with them. Without it, we cannot undertake a single economic transaction. That inevitably gives these bodies great power. PayPal may cancel transactions or even freezes entire accounts because the owner has violated the general terms and conditions. In this country, we trust our banks and believe that we can dispose of our money at any time. Nonetheless, it has often happened in the past that this is precisely what is not the case. An example of this is the so-called “bank run”, in which too many people want their reserves to be paid out in cash at the same time. Come also, that middlemen earn money in almost all transactions — through bank fees, transaction fees, brokerage fees. etc.
The effects of this concentration can be felt in the last few years primarily in the central banks, whose monetary policy has influenced the fate of entire continents. With the euro rate so low and central banks printing money en masse to keep the economy going, conservative savers in Europe have had a bad hand. We have long since come to terms with the fact that “everything used to be cheaper” due to constant inflation. Of course, that’s not entirely true, because wages are also rising. However, saved assets are consequently devalued by these processes.
Over the years there have been many counterproposals to the dependence on central currencies, especially and especially on the Internet. The basic problem, however, remained the same. Once a company issues a digital currency, all users of the currency are dependent on the weal and woe of that institution. This is one of the reasons why digital tokens have never really caught on as a means of payment on the Internet. Another way that corporations and individuals cannot offer the security that a central bank has as an extension of the government.
First cryptocurrency Bitcoin
The breakthrough came in October 2008 by a man named Satoshi Nakamoto. In a “white paper” he described new technology. It should make it possible to carry out transactions in a digital currency in such a way that all participants can trust the correctness of the transactions. There is no central point that monitors the account balances. The digital currency Bitcoin was born. With it, the concept of the so-called blockchain and decentralized consensus established itself.
A movement arises
The breakthrough in a level of trust on the Internet that did not require a middleman and the possibilities associated with it was initially only clear to a few. Above all, followers of the philosophy of individual freedom of action and freedom of thought (English “Libertarian”) found increasing pleasure in this independent form of money. There were also technology enthusiasts who played with the software and began to “mine” Bitcoins (Bitcoins are generated through mining). Out of passion, a worldview for money, values , and property that is specific to Bitcoin enthusiasts, which is still the cornerstones of this movement.
- “Be your own bank” — The focus is on sovereignty over your own financial resources. Nobody should have the power to devalue (inflation), control, or confiscate money.
- Nobody should have the right to censor, prohibit or prevent payments.
- The privacy granted to every citizen is also important to transactions on the Internet.
- All fiat currencies (money issued by governments) have no long-term future because they are inflationary and have not been “backed” by anything since the gold standard was abolished.
- The separation of money creation and the state, so that monetary and interest rate policy also follows the laws of the free market.
- Bitcoin is a digital gold substitute as a crisis currency, with several properties that gold does not have (divisibility, ease to ship, and to store).
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The blockchain concept in a nutshell
Instead of controlling or storing information, data, or monetary values via one place, all processes are stored at regular intervals in blocks (= block) in a continuous transaction list (= chain), which is distributed on many thousands of computers in the network. This decentralized storage on its own is not sufficient to establish a sustainable relationship of trust.
Every single action is additionally approved by the network. Valid transactions are then bundled in a block and added to the blockchain through complex computing processes. This process, known as mining, requires a lot of computing power. The entire process that establishes trust in the transaction history is known as the Proof of Work. The term “cryptocurrencies” comes from the fact that some of the processes use cryptographic encryption methods. Since the blocks build on each other, it is almost impossible to add incorrect transactions to an older block in the blockchain.
This method means that not just one or a few middlemen are involved in transactions. There is constant mutual control throughout the network. Also, the system fulfills two properties that are crucial for a global network. Due to the users and miners spread all over the world, it is not possible to switch off the system. And the account balances that result from the transaction history cannot be manipulated.
Bitcoin isn’t the only cryptocurrency
The first use case for blockchain technology, which is also known as Distributed Ledger Technology due to its storage in many “business books”, was the cryptocurrency Bitcoin. Bitcoin works as a currency from “real” life: 1 Bitcoin can be divided into many smaller units. With the coins, users pay for services and goods, they use them to buy in online shops or exchange Bitcoins for other currencies. All movements are seamlessly documented in the Bitcoin blockchain (but without personal data). But digital cash is not the only use for non-changeable transaction history.
In the years that followed, programmers developed many new cryptocurrencies, protocols, and systems based on blockchain technology. Some have copied Bitcoin with different properties. Others try to create completely new use cases. Many currencies have their own individual blockchain or storage method.
Why do cryptocurrencies have value?
In most cases, people hear about Bitcoin & Co. for the first time because the price has reached a new high or there has been a crash. But why does the value fluctuate so much? And why do cryptocurrencies have any value at all? You have to know why something is valuable to people in the first place.
The current value of cryptocurrencies primarily reflects speculation about their future use. In the early days of the Internet, investors valued the returns from the new technology so high that a bubble occurred in 2000 (“dot-com bubble”). We are now seeing something similar. The difference is that investors don’t buy shares in a company, they buy the supposed digital equivalent of gold — a limited resource that has a use.
Compared to precious metals, cryptocurrencies offer several advantages. While storing gold is inconvenient and costly, bitcoins can be held without financial outlay. The coins can also be divided up as desired and sent around the world. Most blockchains can be exchanged for other currencies or items within fractions of a second. The transactions only require a small amount of technology and a few clicks.
The current price is always the amount that someone is willing to pay for a bitcoin, or for which someone would like to sell their bitcoin. Bitcoin is no different from stocks, gold, or other prices based on supply and demand.
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Blockchain is more than just currency
Digital money is the most obvious use case for blockchains. But a decentralized transaction history can be more than just a currency basis. Companies, especially from the financial sector, industry, and logistics, expect unprecedented transparency from this. Many large corporations are currently researching the topic with their own departments. In the legal field, blockchains could replace contracts and middlemen in the long term. And if you look at the Internet of Things or artificial intelligence, a chain of traceable transactions would make many processes easier.
Bitcoin curse or blessing?
When the Bitcoin price experienced its biggest rise to date towards the end of 2017, a gold rush mood ensued. For years, conservative experts and the media had warned against investing in cryptocurrencies. A total loss is possible, was the most frequently cited argument. Further criticism went to the unpredictability of the courses, the still young age of the new currencies, and the cases of fraud and usage in the “dark web”. In fact, Bitcoin was and is also used for criminal purposes. But the same can be said about cash. All in all, public opinion about Bitcoin & Co. was bad. On the other hand, there was a community of enthusiastic Bitcoin advocates that had grown over the years, who propagated nothing less than a revolution in the financial markets and a move away from government-backed “fiat” money like the euro. On the one hand, the coins appear as an insecure and barely transparent investment. On the other hand, if you have the right nose, the investment promises high returns. This “High Risk, High Reward” situation has led to the fact that, up to now, the crypto community has mainly been fraught with risk-takers. Many less idealistic investors are now asking themselves — not least because of this rapid increase — whether it might not make sense to invest a small part of their own portfolio in this new asset class. On the other hand, if you have the right nose, the investment promises high returns.
This “High Risk, High Reward” situation has led to the fact that, up to now, the crypto community has mainly been fraught with risk-takers. Many less idealistic investors are now asking themselves — not least because of this rapid increase — whether it might not make sense to invest a small part of their own portfolio in this new asset class. On the other hand, if you have the right nose, the investment promises high returns. This “High Risk, High Reward” situation has led to the fact that, up to now, the crypto community has mainly been fraught with risk-takers. Many less idealistic investors are now asking themselves — not least because of this rapid increase — whether it might not make sense to invest a small part of their own portfolio in this new asset class.
Comparison of cryptocurrencies — classic financial products
As with any investment, it is worthwhile to put the individual financial product in a larger context. Understanding how investments in cryptocurrencies work and how they compare to other products can make an informed decision. In contrast to “classic” investment formats such as stocks, funds, and savings deposits, investments in cryptocurrencies are hardly regulated. To put it more simply, this means that legislators and the tax authorities do not yet set as many rules of the game. It is also clear that no one can say how the asset class will perform in the future. While there has been a demand for gold for thousands of years, for example, which will probably still exist in 50 years, it is already difficult to look a year into the future with cryptocurrencies. This uncertainty harbors both risks and opportunities.
Bitcoin and the eternal bubble
Bitcoin can now look back on over 10 years of history. During this time, the rate has risen from a few cents to EUR 46,438.13. This suggests that Bitcoin is in a speculative bubble. Are cryptocurrencies just an entertaining trend that makes a few rich and leaves the masses with big losses?
The fact is: Bitcoin & Co. are still an experiment that has never been done before. Nobody can say how it will turn out. So far there have actually been a handful of speculative bubbles with strong price gains, followed by strong falls. This last bubble burst at the end of 2017. The price lost more than 50 percent in the following months. But it is also a fact: After every bubble, the price has so far remained at a stronger level than before. So far no one has kept his bitcoins for more than two years and is in the red. Interest in cryptocurrencies and blockchain applications has been growing steadily for years, and media coverage has completely changed. While in the beginning there were almost exclusively skeptical or bad reports about Bitcoin, More and more people now understand why it could be an alternative to government money. The public is slowly starting to take Bitcoin seriously. Cryptocurrencies will not disappear from the scene anytime soon. The risk decreases but with it the opportunity for returns.
Assess personal risk
Even and especially for cryptocurrencies, staying power is needed. Anyone who invests in stocks or funds plans at least for a period of five years. Experts even recommend an investment horizon of up to 15 years. Trades that are aimed at short-term profits are classified as speculation. The same goes for cryptocurrencies. Frequent trading in cryptocurrencies can be just as lucrative as day trading on the stock market, but it is not something for ordinary investors. The majority of investors keep cool and prove that patience is key. Acquiring and holding coins — even in supposedly bad times — has a tradition in the crypto scene (see “ HODL”). The long investment horizon is also recommended for tax reasons. Profits from the sale and exchange of cryptocurrencies are not taxable if the buyer holds the coins for more than a year. Incidentally, this also applies to trading cryptocurrencies with one another!
Taking all factors into account, it becomes clear that Bitcoin is always about personal risk. Investors should therefore be aware
The reason is obvious. Basically, there are probably only two end scenarios for cryptocurrencies:
- Bitcoin & Co. will no longer be significant in 10 years. At that point, the entire investment would have disappeared.
- Cryptocurrencies are revolutionizing the financial world. Or at least they bring great advantages in certain areas. The invested capital would multiply (if the investor bets on the right horse).
A middle ground is not obvious.
At the moment, this is admittedly the case with hardly any cryptocurrency. However, many proponents like to compare the current status of blockchain technology with the beginnings of the Internet. Back then, too, there were many visions, just as much immature technology and failed companies. However, it will only become clear in the next few years whether the long-term success of the Internet will also prove to be true for cryptocurrencies. In any case, despite its 10-year history, this new technology is only in its early stages.
So why should I buy cryptocurrencies?
Even if the chance that cryptocurrencies will prevail is only a few percent, it can make sense to invest a small amount due to the possible return. It always depends on the personal risk profile.
The following questions assist in making a personal assessment of investing in cryptocurrencies:
- Have I invested the majority of my portfolio is mostly secure forms of investment (funds, fixed-term deposits, …)?
- Do I have any money left that I would like to put into an investment with more risk and potential return than stocks, for example?
- Am I interested in this future topic and do I want to actively support it?
- Do I get annoyed if I decide not to invest and instead benefit others?
- As an early adopter, do I want to benefit more from the potential benefits of cryptocurrencies?
- Am I technically fit so that I don’t mind the sometimes complicated backup and safekeeping processes?
If the answer to these questions (especially the first two) is rather no, then cryptocurrencies are most likely not an option at the moment.
Bitcoin stands for personal responsibility and independence. If you invest with solid basic knowledge, willingness to persevere, and a certain willingness to take risks, cryptocurrencies can be a good addition to other asset classes. And in contrast to gold, bonds, and the like, there is one thing above all that doesn’t get boring with cryptocurrencies!
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