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Understanding Cryptocurrency (Things You Should Know Before Starting Trading)

What is cryptocurrency?

A cryptocurrency (or crypto) is a form of digital cash that enables individuals to transmit value in a digital setting.

You may be wondering how this sort of system differs from PayPal or the digital banking app you have on your phone. They certainly appear to serve the same use cases on the surface – paying friends, making purchases from your favorite website – but under the hood, they couldn’t be more different.

Cryptocurrency is unique for many reasons. Its primary function, though, is to serve as an electronic cash system that isn’t owned by anyone party.

A good cryptocurrency will be decentralized. There isn’t a central bank or subset of users that can change the rules without reaching a consensus. The network participants (nodes) run software that connects them to other participants so that they can share information between themselves.

The decentralization of cryptocurrency networks makes them highly resistant to shutdown or censorship. In contrast, to cripple a centralized network, you just need to disrupt the main server. If a bank had its database wiped and there were no backups, it would be very difficult to determine users’ balances.

In cryptocurrency, nodes keep a copy of the database. Everyone effectively acts as their own server. Individual nodes can go offline, but their peers will still be able to get information off of other nodes.

Cryptocurrencies are therefore functional 24 hours a day, 365 days a year. They allow for the transfer of value anywhere around the globe without the intervention of intermediaries. This is why we often refer to them as permissionless: anyone with an Internet connection can transmit funds.

What is public-key cryptography?

Public-key cryptography underpins cryptocurrency networks. It’s what users rely on to send and receive funds.

In a public-key cryptography scheme, you have a public key and a private key. A private key is essentially a massive number that would be impossible for anyone to guess. It’s often hard to wrap your head around just how big this number is.

For Bitcoin, guessing a private key is about as likely as correctly guessing the outcome of 256 coin tosses. With current computers, you wouldn’t even be able to crack someone’s key before the heat death of the universe.

Anyways, as the name might suggest, you need to keep your private key secret. But from this key, you can generate a public one. The public one can safely be handed out to anyone. It’s feasibly impossible for them to reverse-engineer the public key to get your private one.

You can also create digital signatures by signing data with your private key. It’s analogous to signing a document in the real world. The main difference is that anyone can say with certainty whether a signature is valid by comparing it with the matching public key. This way, the user doesn’t need to reveal their private key, but can still prove their ownership of it.

In cryptocurrencies, you can only spend your funds if you’ve got the corresponding private key. When you make a transaction, you’re announcing to the network that you want to move your currency. This is announced in a message (i.e., transaction), which is signed and added to the cryptocurrency’s database (the blockchain). As mentioned, you need your private key to create the digital signature. And since anyone can see the database, they can check that your transaction is valid by checking the signature.

What is the difference between cryptocurrencies and tokens?

At first glance, cryptocurrencies and tokens appear identical. Both are traded on exchanges and can be sent between blockchain addresses.

Cryptocurrencies are exclusively meant to serve as money, whether as a medium of exchange, store of value, or both. Each unit is functionally fungible, meaning that one coin is worth as much as another.

Bitcoin and other early cryptocurrencies were designed as currency, but later blockchains sought to do more. Ethereum, for instance, does not just provide currency functionality. It allows developers to run code (smart contracts) on a distributed network, and to create tokens for a variety of decentralized applications.

Tokens can be used like cryptocurrencies, but they’re more flexible. You can mint millions of identical ones, or a select few with unique properties. They can serve as anything from digital receipts representing a stake in a company to loyalty points.

On a smart-contract-capable protocol, the base currency (used to pay for transactions or applications) is separate from its tokens. In Ethereum, for instance, the native currency is ether (ETH), and it must be used to create and transfer tokens within the Ethereum network. These tokens are implemented according to standards like ERC-20 or ERC-721.

What is a crypto wallet

Essentially, a cryptocurrency wallet is something that holds your private keys. It can be a purpose-built device (a hardware wallet), an application on your PC or smartphone, or even a piece of paper.

Wallets are the interface that most users will rely on to interact with a cryptocurrency network. Different types will offer different kinds of functionality – evidently, a paper wallet cannot sign transactions or display current prices in fiat currency.

For convenience, software wallets (e.g. Trust Wallet) are considered superior for day-to-day payments. For security, hardware wallets are virtually unmatched in their ability to keep private keys away from prying eyes. Cryptocurrency users tend to keep funds in both types of wallets.

Is cryptocurrency anonymous?

Your name isn’t connected to your cryptocurrency addresses – they look like random strings of numbers and letters on the blockchain. Be careful when assuming that this makes you anonymous, though. You’re pseudonymous – you still have a sort of on-chain identity, it just isn’t the one you use in real life.

There are certain methods that may allow people to tie IP addresses to your activities. On this front, things like dusting attacks and other analysis techniques can be used to deanonymize you. Remember that blockchains are essentially massive public databases. If you’re concerned about your privacy, you should try to make it as difficult as possible for others to link your transactions to your name. Cryptocurrencies like Bitcoin aren’t private by default, but methods like coin mixing and CoinJoins can make analysis heuristics unreliable.

A small subset of cryptocurrencies (known as privacy coins) are able to obfuscate the source, destination and amount of funds in transactions, using methods like Confidential Transactions. They have stronger privacy by default but are not totally resistant to deanonymization.

Is cryptocurrency valuable?

In financial systems, value is a shared belief. Just like with anything valuable, the value isn’t inherent to cryptocurrency itself – it’s assigned by people. In other words, something has value if people believe it does. This is true regardless if the object of value is a precious metal, a piece of paper, or some bits in a database.

With all that said, some consider cryptocurrencies and Bitcoin, something akin to a scarce digital commodity. Due to its predictable issuance rate and monetary policy, some argue that Bitcoin may act as a store of value in the future, similar to gold. Since Bitcoin has existed only for a little more than a decade, it’s yet to be seen whether it will stand the test of time in this regard.

Are all digital currencies cryptocurrencies?

No. You might have heard that many nation-states and central banks are working on creating their own versions of digital currency. However, these are just that – digital currencies. As a matter of fact, they’re often collectively referred to as central bank digital currencies (CBDCs). These are essentially digital versions of fiat money, and they don’t enjoy most of the benefits of cryptocurrencies. They are issued and declared legal tender by a central government and typically don’t use a distributed ledger, such as a blockchain, to keep a record of transactions.

You might also have heard about Facebook Libra, another type of digital currency. On the plus side, it’s planned to be built on an open-source blockchain system. However, it wouldn’t be permissionless such as Bitcoin or Ethereum, meaning that participants would need more than a simple Internet connection to use it. What’s more, the project and the activity on it would be run and managed by an association made up of a few selected members.

So, despite CBDCs and other forms of digital money making use of blockchain or cryptography, they’re quite different from cryptocurrencies such as Bitcoin.

What is the market capitalization of a cryptocurrency?

When you’re looking at the price of a cryptocurrency, you only see part of the picture. An equally important metric is how many individual units of that cryptocurrency exist out there, i.e., the supply.

More specifically, to assess the valuation of a cryptocurrency network, you need to know how many individual units exist right now. This is called the circulating supply. Different cryptocurrencies may adopt different issuance schedules, so it’s important to understand how the issuance works with each network.

The market capitalization (or market cap) is the price of an individual unit multiplied by the circulating supply.

Market Capitalization = Circulating Supply*Price

As you might imagine, the market capitalization of a cryptocurrency network is a more accurate representation of the value in the network than the price of an individual unit. A network with a lower-priced coin but a higher circulating supply might have a higher total valuation (market cap) than one with a higher-priced coin but a lower circulating supply. And the opposite could also be true in certain cases.

It’s worth noting, however, that market capitalization does not represent how much money entered a particular market. For instance, it’s a common misconception among newcomers that the Bitcoin market cap represents the total amount of money invested in Bitcoin. But that doesn’t make sense because the market cap depends on the price and supply.

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