Since the inception of bitcoin, cryptocurrencies have taken the world by storm. Pretty much everyone in the world has heard of them, but do they really understand it? Over the years, we have seen the introduction of thousands of cryptocurrencies, each claiming to be different from one another and offering users something different. The success of bitcoin spurred interest in cryptocurrencies, with the asset’s value surging in late 2017 before crashing over 60% in 2018. BTC took significant time to recover before setting new records in 2021.
Such a massive surge made the world notice, making crypto almost impossible to ignore. But let’s take a step back. What are cryptocurrencies, how do they work, and what are they used for? This article will explain these points and discuss their types, advantages, and disadvantages. By the end of this piece, you will have a much clearer idea of the term “cryptocurrency.”
Key Points
- A cryptocurrency can be described as a digital asset based on a vastly distributed network.
- Cryptocurrencies and their underlying blockchain technology are very disruptive.
- Cryptocurrencies have many advantages, such as faster and cheaper money transfers. Decentralization also means that they do not have a single point of failure.
What Is Cryptocurrency?
Cryptocurrencies are digital currencies or tokens that run on cryptographic systems. Cryptocurrencies fulfill a host of roles but are primarily used as a mode of payment and store of value. Cryptocurrencies such as bitcoin are created through a process called proof-of-work (PoW) mining. Until recently, ETH, the native token of the Ethereum blockchain, was also created through PoW until it switched to the Proof-of-Stake (PoS) consensus mechanism.
Cryptocurrencies have two primary qualities.
- Digital – There are no physical cryptocurrencies in existence. Instead, they are entirely native to the internet. You cannot hold or feel a cryptocurrency.
- Decentralized – Cryptocurrencies are decentralized, with transactions stored on a public ledger. Decentralization means that every node on the network has a copy of all transaction details.
How Does Cryptocurrency Work?
Cryptocurrencies like Bitcoin are created through a process called mining, which involves users, called miners, utilizing computing power to solve complex problems, validate transactions, and mint tokens. Alternatively, users can purchase cryptocurrencies directly from exchanges, brokers, or other users, which can then be stored in dedicated, encrypted wallets.
Users require a cryptocurrency wallet to conduct cryptocurrency transactions and participate in the web3 economy. The wallet does not actually hold any cryptocurrency. Instead, it holds the user’s private keys and public address. The private key allows you to access your crypto, while the public address allows you to receive crypto.
Each time a user initiates a transaction, they authorize the transfer of a specific amount of cryptocurrency from their wallet to the designated wallet of the receiver. All transactions are encrypted and signed off by the user’s private keys. Once the block containing the user’s transaction is confirmed, the ledger is updated, and the new balances are reflected in both wallets.
What Is Cryptocurrency Used For?
Today, cryptocurrencies have several debates around their use cases and whether they are used as currencies or commodities. The most visible use case of cryptocurrencies is an alternative to traditional fiat currencies. However, they were not created as a substitute for fiat. In reality, they can be used in several other methods. For example, Filecoin allows users to rent computer storage space for the decentralized web, with the FIL token driving its network. Ethereum was launched in 2015, powers smart contracts and decentralized applications, and is powered through the ETH token.
Let’s look at some of the most prominent use cases regarding cryptocurrencies.
Transactions And Digital Payments
Cryptocurrencies are set to play an important role in the Web 3.0 ecosystem. Crypto’s decentralized nature, along with low transaction costs, high security, and privacy, has attracted investors, both experienced and novice, to enter the cryptocurrency ecosystem. Users can also use cryptocurrencies to make payments on e-commerce websites that accept them as a payment mode. Several prominent companies have started accepting cryptocurrencies as payments, including Mcdonald’s, Starbucks, Visa, Pepsi, and Mastercard.
Store Of Value
Cryptocurrencies such as bitcoin have become popular as a store of value, allowing users to store and transfer value easily. Bitcoin has also emerged as a popular hedge against inflation, replacing traditional avenues such as gold. This has earned it the moniker of “Digital Gold.”
Tokenization
Cryptocurrencies have also given holders the ability to tokenize physical assets and link them to digital ones. Holders can now tokenize art, copyrights, music, stocks, and even real estate and represent them through digital assets. These asset-backed tokens have intrinsic value, which is connected to the underlying asset.
Giving Control Back To Users
Cryptocurrencies such as bitcoin look to give control of assets back to their owners, restricting the role of centralized institutions over users’ financial activities. This is useful in volatile economies where citizens may not have access to financial institutions or their wealth is greatly affected by hyperinflation.
Hedge Against Inflation
The re-emergence of inflation has seen a renewed interest in cryptocurrencies such as bitcoin, replacing traditional hedges such as gold and real estate. Investors have gotten wary of using gold as a hedge, and the housing collapse of 2008 put an end to real estate being viewed as a solid hedge as well. Investors increasingly view bitcoin as the best hedge against inflation, calling it digital gold. Like its traditional counterpart, bitcoin has a finite supply, meaning as demand increases, so will the price.
A good hedge against inflation is an asset that grows in value greater than the prevailing inflation rate. By that metric, Bitcoin has undergone a staggering increase in value since its inception, making it an ideal hedge against inflation.
What Are The Advantages Of Cryptocurrency?
Cryptocurrencies have several advantages. Let’s look at some of them.
- Cryptocurrencies enable the seamless transfer of value directly between users, cutting out intermediaries such as banks. This makes transactions significantly cheaper. All transactions are secured by public and private keys, making them highly secure as well.
- The removal of intermediaries also makes transactions significantly faster than standard transactions. One good example is the concept of Flash Loans in DeFi, which are processed without requiring any collateral.
- Cryptocurrencies generate significant profits, with their value surging over the past decade. At one point, the cryptocurrency market surged past $2 trillion in valuation.
- Cryptocurrencies streamline the transfer of funds across borders, with the remittance industry using bitcoin as an intermediate currency to transfer funds across countries. This also makes remittances faster and cheaper.
In Closing: The Future
While cryptocurrencies are still at a very nascent stage, there is no denying they have come a long way. Their staggering evolution has allowed users to transfer, store and spend value differently, while DeFi has opened up the financial section to users who did not have access to the traditional financial system. There is no doubt that cryptocurrencies, and the larger crypto industry, are here to stay.
