What is Cryptocurrency (ULTIMATE GUIDE)

This is an ultimate guide to cryptocurrency for beginners. As many of you may already know, 2017 was a huge breakout year for cryptocurrencies. Bitcoin reached higher than $19,000 and many new currencies were launched. Some people believe that the current crypto market is akin to the internet bubble in the 1990s. But others think digital coins have a strong future.

Introduction

a funny photo collage of rainbows, dolphins, bitcoins, and doves with people jumping in joy.

Photo art by Kunstbild von Charise

Cryptocurrency is a means of exchange that is also known as digital currency. Cryptocurrencies are alternative currencies to traditional fiat money and are not currently regulated by governmental policies. Although Bitcoin is the most widely used and most famous cryptocurrency, there are many more altcoins. Moreover, each month more virtual currencies are created and put out on the market.

Traits of Cryptocurrency

proof of stake concept image with key cryptography

There are many unique aspects of cryptocurrencies that set them apart from fiat (government issued) currencies. Security, limited supply, and decentralization are just a few of attributes that makes cryptos so unique. Learning why these are important can help you understand the power of cryptocurrency investing, and why they are becoming more popular even in the mainstream population.

Coding and Security

Modern cryptocurrencies use advanced protocols which serve to encrypt data transfer. These help to secure the coins when they are being traded. The developers create these cryptographic protocols using highly developed mathematical formulas. They also integrate principles of computer engineering. This combination makes the codes almost impossible to decipher. That being the case, the currencies are not susceptible to counterfeiting. Another thing that is unique to cryptocurrency is that the users remain anonymous. It is not possible to connect a wallet with currency to a specific person or group.

There are two main blockchain protocols. One is Proof-of-Work, like what is used by Bitcoin. The other is Proof-of-Stake, based on Ethereum, which more recent altcoins use:

Proof of Work (POW)

This is where a computational puzzle is solved by powerful computers. Miners compete to solve these problems, or rather an algorithm.This is to ensure the coin (hash block) is verified. Miners make small fees each time they solve and add their block to the chain.

Proof of Stake (POS)

In a nutshell, Proof-of-Stake is when a block is determined to be valid based on randomized criteria such as age, amount of crypto coins held, or even masternodes (specialized servers that are maintained and decentralized).

Decentralization

One benefit that coin traders enjoy is that their currency is free from intervention. Cryptocurrencies are not regulated or overseen by any type of government. This makes it nearly impossible for a governmental body to freeze accounts or seize assets. This is one of the main appeals to decentralization.

drawing of people making exchange over decentralized web

Furthermore, cryptocurrencies are not controlled by a single group. This is unlike modern fiat currencies, which are regulated by governments. The value and supply of the coins are built into their complex coding. This and how much coins are being traded determines the value of the currency. A single entity does not control cryptocurrency, but rather the people who buy, sell and trade it, and the miners of the coin are the deciding factors in pricing. Miners use a high amount of computing power to ensure the currency is stable and trading goes smoothly, hence their fees.

Limited Supply

Many of the modern cryptocurrencies are limited in their supply. However, this does not characterize all of them. The number of units that can exist is written into their source code. Over the lifespan of cryptocurrency, it will become more and more difficult for miners to mint new coins. That is, until one day, the currency ceases to be produced altogether. In fact, only 21 million Bitcoins are set to be mined. This makes the coins quite like gold, or other valuable natural resources.

History of Cryptocurrencies

Long before any type of cryptocurrency, the idea of it sat in the minds of its future developers. The early supporters of cryptocurrency wanted to improve traditional fiat currency. They realized that currencies like the USD had political and practical problems. These were problems that could potentially be solved through computer science and mathematics.

The 80’s – Cryptocurrency beginnings

In the early 1980s, David Chaum, an American cryptographer, invented a new algorithm. This “blinding” formula became the foundation for all modern cryptocurrencies. The formula allowed for information exchange between two parties. It ensured that the information would be unalterable and secure. This “blinded money” algorithm was the first step in developing electronic money transfers.

Later that decade, Chaum formed a team of other cryptocurrency enthusiasts. Their goal was to commercialize blinded money transfers. He founded a company called, “DigiCash”. His company produced units of currency using his blinded money formula. Notably, the control of DigiCash was centralized. The company had a monopoly on the entire digital currency industry. They had complete control of supply, quite like how the central bank creates their own money. This is quite unlike modern cryptocurrencies such as Bitcoin.

Originally, DigiCash dealt with individuals. However, the central bank in the Netherlands, where DigiCash was located, didn’t like that concept. DigiCash opted instead to work only with businesses. This seriously reduced their market size. This company failed soon after.

There were more attempts at creating a sustainable cryptocurrency system. These included B-money, which promised identity protection and security. B-money was never launched as a cryptocurrency business. Another system created during this time was Bit Gold, which used a system that is like today’s popular currencies. The Bit Gold currency never became popular and due to this, it failed. After the failure of DigiCash, much of the investment money being offered to more online money transaction systems went to PayPal.

The 90’s – “e-Gold” ponzi scheme?

The company reached success during the mid-2000s. They had millions of active accounts and had done billions of dollars worth of transactions. However, the company’s security protocol made it an easy target for hackers and scammers. The company’s low-level compliance rules attracted Ponzi-schemes and money launderers. Due to this, the company went under due to legal pressure in 2009.

e-gold cryptocurrency ceo douglas jackon in room full court documentsSource: Wired

The 2000’s – The Emergence of Bitcoin

Bitcoin is known as the world’s first modern-day cryptocurrency. It combines concepts used by its predecessors. These include block-chain record keeping, user anonymity, decentralized control, and built-in scarcity. The idea for Bitcoin was first summarized in a white paper by Satoshi Nakamoto, which is a pseudonym.

In the year 2009, Nakamoto released Bitcoin to the public. Avid supporters of it began to use it to trade. They also began mining the coins. As early as 2010, more cryptocurrencies began to appear. During this time, the first Bitcoin exchanges opened their doors.

Later, in 2012, the online blogging platform WordPress began to accept Bitcoin as a form of payment. Other large companies, such as Expedia and Microsoft followed suit. Few companies accept other cryptocurrencies as payment, but they can be easily exchanged for Bitcoin or cash.

How Cryptocurrency Works

 

The mathematical formulas and coding involved with cryptocurrency are complex. But the average person can understand the underlying concepts. It is useful to know that most of the new cryptocurrencies are just like Bitcoin, with slight variations. So, the concepts outlined below hold true for all cryptocurrencies in use today.

The Blockchain

A blockchain is a master record that keeps all transactions in its history. This makes it easy to track the current owner of every single coin that is on the market. The blockchain has a finite length that gets longer each time there is a transaction.

a colorful diagram of blockchain
The blockchain is not that hard to understand once you know what it is.

The blockchain is stored within the currency’s software network. This network is decentralized and is run by people known as miners. The miners continually authenticate the block chain’s data.

When a cryptocurrency transaction takes place, it isn’t technically complete until it has been added to the blockchain ledger. This takes a few minutes. During this time, the funds are not available to either party. It also must be noted that unlike with credit cards or PayPal, there is no refund or chargeback feature.

The blockchain is useful because it prevents the same currency from being duplicated and manipulated.

Keys

The users of every type of cryptocurrency have their own keys to access their coins. These coins authenticate their identity and allow them to buy and trade. The keys and between 1 and 78 numerals long and the users can create their own, or have one generated for them at random. With the key, they can use their currency. Without it, they are not able to buy, sell, or trade.

Cryptocurrency Wallets

 

Wallets are used to verify the current owner of their cryptocurrency units. These wallets store the currency when the coins are not in use. They can be stored on an external or internal hard drive, or in the cloud. Backup of wallets is highly recommended. And although units may be stored on two or more devices, this does not duplicate the units.

A common misconception surrounding crypto wallets is that you can actually store your coins in your digital wallet. This is not true. The wallet will tell you how many coins you own, but the coins are not actually in there, in physical form. The only thing that exists to show the whereabouts of cryptocurrency is the record on the blockchain.

A cryptocurrency wallet that allows a cryptocurrency user to keep track of their coins. This is done through complex coding that communicates with the blockchain. Users can also use their wallet to conduct transactions. When an exchange takes place, the person on the paying end signs off their ownership of the coins. They send their coins over to another wallet, using a public address. The key they send their coins to must match the key on the wallet. No real coins are exchanged. There is only a history of the transaction on the blockchain ledger.

Although there are many different kinds of wallets, they all fit into only three categories. Paper, software, and hardware.

PAPER WALLETS

a beautifully created gold and white bitcoin wallet out paper
You can some beautiful cryptocurrency wallets out of paper.

Source: BitcoinPaperWallets

Paper wallets give coin users a lot of security. Plus, they are easy to use. A paper wallet can simply be a printout of your keys and current balance. But the term can also refer to software that is used to make the print-out. To exchange coins from a paper wallet to a digital wallet, you must transfer funds from the software wallet to a public address. In order to spend your money, you can enter your key or scan the QR code on your paper wallet.

SOFTWARE WALLETS

a screenshot of Exodus wallet with cryptocurrency views.
The Exodus wallet features the ability to store multiple cryptos.

Software wallets come in three types: desktop, mobile, and online. A desktop wallet is downloaded and stored on a personal computer. After the wallet is downloaded, it can only be accessed from that single device. Although this type of wallet is secure against digital attacks, it is possible that if your computer crashes you could lose all your funds. If you are using a software wallet, a good idea is to back it up with a USB, external hard drive, or a paper wallet.

  1. Online wallets run in the cloud.They are accessible from anywhere you can get internet service and can be accessed on many different devices. This type of wallet is very convenient but it comes with a downside. Because online wallets are run by a third party, they are more prone to cyber attacks.
  2. Mobile wallets are an app that you can download onto your phone. This type of wallet is convenient because you can take it with you when you are shopping. They are much like a desktop wallet but they will be simpler, with fewer features. This is because of the limited space available on mobile devices.

HARDWARE WALLETS

trezor's crypto hardware wallet website

Source: Trezor

The second type of wallet is a hardware wallet. These simply store a user’s key on a hardware device like an external hard drive or USB. You can use a hardware wallet to make transactions, but the actual keys are stored offline, making them very secure. There are many different types of hardware wallets, although you must choose one that is compatible with the type of coins you wish to trade. If the user of a hardware wallet wishes to make a transaction, they need to plug their device into a computer or cell phone with internet service. Then, they enter their pin, send the funds, and confirm. This type of wallet is easy to use and highly secure.

Bitcoin and Altcoin Mining

a small rack of graphics cards being used for bitcoin mining
Small rack of personal graphics cards being used for bitcoin mining

Miners keep track of every currency transaction using the blockchain. They also have authority over the value of each unit. Miners use tons of power in their mining farms to authenticate transactions for the blockchain. Miners create new data for the blockchain, data which before was unverified. This new data is called a block. Blocks include all new transactions that have occurred since the last copy of the blockchain was created.

The term “miners” relates to the fact that when miners do their work, they create a new currency, new wealth in the form of cryptocurrency. Every time a miner completes a transaction, they also create new units of currency. Plus, each transaction charges a small fee, which accrues in existing units. This is what makes mining a potentially money-making venture for those who wish to invest in some high-powered computers.

a picture of thousands of cryptocurrency mining rigs at a bitcoin mining farm
This is what a mining farm looks like.

However, with mining becoming too expensive in electricity cost for most people to mine Bitcoin, many have moved to mining pools, or using cloud mining for Bitcoin and other altcoins that are still affordable. Finding a reputable cloud mining is difficult, but they still exist. As a side not, I don’t personally recommend doing this. You may get a return, but it will be little compared to what you might have made if you invested your original money into the altcoin of your choice and waited for growth.

Miners can choose to prioritize fee-containing transactions over those with no fee. This gives merchants an incentive to charge transaction fees to buyers. Typically, this fee is less than 1% of the total charge.

The Consequences of Limited Supply

bitcoin cold coins beside a computer chip

Most modern cryptocurrencies are designed to have a finite supply, even though through mining, new units can be created. For miners, this translates to less and less currency they can earn was time goes one. Eventually, they only receive transaction fees as a reward for mining. Modern cryptocurrencies have yet to reach their finite supply. Experts believe that the last Bitcoin will be mined somewhere in the 22nd-century. Because of the concept of finite supply, cryptocurrencies are very much like natural resources such as gold.

So, what is going to happen when all the coins are mined? Well, The limited supply of coins will cause the price of the coins to increase. There are stockpiles of inactive coins around the world. One of which is owned by the mysterious Satoshi Nakamoto. Perhaps the roughly 1 million coins are being held for when the world is in short supply.

An end to the creation of coins will have an effect on miners as well. For starters, criticizers of Bitcoin say that the miners won’t receive any more rewards once they can’t mine the coins anymore. Although they could still earn money from transaction fees. Perhaps this is when the mining process will become unsustainable. The miners will not be paid enough to keep up with the number of transactions on a daily basis. There will then be a reduction in the number of people willing to mine. Thus, the blockchain ledger will begin to have issues and the entire system might become more centralized.

That is one way to look at the effects on miners. But there is reason to believe that the transaction fees might be enough to support the digital coin system. This is because, in the foreseeable future, mining rigs are bound to become less cumbersome. Transaction fees might also increase, making mining profitable still.

Cryptocurrency & Exchanges

a picture of a hand holding a bitcoin as it rises on cryptocurrency market

Newer, lesser-known cryptocurrencies can be traded using the peer-to-peer system. But larger, more abundant currencies like Bitcoin and Ripple have exchanges where units of the currency are traded. These exchanges let currency owners trade their units for the USD or the Euro. The may even exchange it for lesser-known cryptocurrencies. These exchanges are important for maintaining the fluidity of the currency. They also help set the value of certain currencies in relation to fiat currencies like the USD.

Regular markets do not sell cryptocurrency (yet!), so anyone who is looking to buy digital coins must use an exchange. Although this may change in the future, for now, there are a few good options.

screenshot of Coinbase cryptocurrency exchange website

Coinbase is the most well-known and highly used cryptocurrency exchange. It has over 10 million registered users and has a $20 billion trading volume. Impressive, right? This exchange offers trading in the form of Bitcoin, Bitcoin Cash, Litecoin, and Ethereum. It is relatively simple to set up an account with Coinbase and make your first purchase using USD.

The Gemini exchange is like Coinbase, but it offers fewer digital currency options. The only coins that are traded on the site are Bitcoin and Ethereum. It does, however, have its benefits. It is FDIC insured for its customer’s cash balances. This is a huge plus, but keep in mind that once you use your cash to buy digital currency, this insurance no longer applies.

a screenshot of Kraken cryptocurrency exchange website

The Kraken exchange has the most currencies available. You can trade over 17 different digital coins on this site. There are three different membership levels in Kraken. Each one requires more identification on your part. One great thing about this site is that it offers Ripple. Also, you can get started by trading in some USD for your cryptocurrency of choice.

Presently, cryptocurrencies can be traded in online venues for fiat currencies including the USD and the Euro, and many more fiats. However, these online marketplaces are vulnerable to hacking and theft of the coins.

Legality of Cryptocurrency

a picture of the world showing which countries are legal and which are not legal for cryptocurrencies
Is cryptocurrency is legal or illegal where you live?

There is certainly a huge gray area when it comes to cryptocurrency and the legal system. Since these forms of exchange are relatively new, they are still, for the most part, unregulated. They are not yet a part of the legal framework in much of the world. Like fiat currency, digital currency comes with its own set of legal considerations for the governments of the world. Laws that Bitcoin has set a precedent for being used for other types of digital coins. Lawmakers used the term ‘virtual currency’ to describe all the cryptocurrencies in use today.

Countries have created their own classifications for virtual currency. Some of them have proclaimed it to be legal and others have not made statements on its legality. Still, some countries have deemed it outright illegal. These include China, Bangladesh, Iceland, Ecuador, Thailand, Russia, and Kyrgyzstan.

Is Virtual Currency Taxable?


Source: Ryan Berkness via YouTube

Using cryptocurrency and remain anonymous is not very difficult. For tax purposes, digital currency is classified as an asset. Many people know that transferring large sums of money from country to country can cause a large amount of taxes to accrue. Instead of doing the transaction using fiat currency, they exchange their cash for coin and bypass the fees.

For people who would like to stay on the lawful side of digital dealings, all forms of cryptocurrency income can be declared on taxes. This is done using the current exchange rate. You must keep a good record of your transactions and review the tax law in your area. In places where digital currency is banned, tax laws do not apply.

In general, it is illegal to avoid paying taxes. Although there are legal loopholes in the tax code, it is recommended that you pay the tax on your digital assets. Talk to a tax expert and research the tax laws in your area to ensure lawfulness.

Money Laundering

crypto coins hanging on a laundry line

Souce: ETHnews

Because it is so easy to move large amounts of money unchecked, digital currencies have become a go-to for criminals the world over. However, using the digital coins to launder money is precarious. This is because of the publicity of the blockchain ledger. Law enforcement is learning how to use the ledgers to track the whereabouts of money connected with illegal activities. Money laundering is widely illegal despite the way criminals go about it.

Using Your Cryptocurrency

funny bitcoin buy-power illustration
Some Bitcoin traders could probably buy a Lamborghini in 2017. 🙂

First, in order to use any cryptocurrency for exchange, you must have a wallet. You must also find an exchange where you can buy and sell your cryptocurrency units. After those steps are completed, there are some forms to fill out so you can get your first units.

Buying Goods With Cryptocurrency

A "Buy with Bitcoin," on Overstock's website
You can spend Bitcoin a lot of places, even Overstock.com

Once you have secured a wallet and have the funds, digital currency is simple to use. There are many things you can do with it. For starters, you can treat it as an investment and choose to let it build value in your wallet. Another way to use it is like regular money. Companies are increasingly allowing payment in the form of digital coins. As of 2017, some big companies like Dell, Overstock, and Microsoft are now accepting it from their customers.

As digital currency becomes more widespread, expect to see it gain popularity as a form of payment.

Investing in Cryptocurrencies

a bitcoin trading chart

If you are looking to invest or trade in cryptocurrency instead of buying, selling, and trading, you can choose from a few options. You can invest stock in the GBTC Trust, a company sold on the NYSE that is involved in buying and selling Bitcoin. You could also set up a cryptocurrency IRA. Or you can simply get a wallet and invest in buying some coins. There are also broker-wallet hybrids which allow investors to invest in coins, but also to buy, sell, and trade them. Two companies that provide this services are GDAX and Coinbase.

cartoon man poking a bitcoin with a stick
It’s so slowwwww.

Here are some things to consider before investing in cryptocurrency. The first is that cryptocurrency exchanges are separate from the stock market. If you are using GDAX or Coinbase, neither of these are entities of the NYSE.

Another thing you must consider is that if you are a beginner, it might be better to invest in the cryptocurrency stocks. This is because then, you will not have to buy and trade currency units. The stock for Bitcoin is called GBTC. Keep in mind that this stock costs much more per share than buying a single Bitcoin. In other words, you will pay a premium when you invest in a cryptocurrency stock.

Also, cryptocurrency trading happens around the clock. But traditional stocks trade only during business hours.

At the time of this writing, the Kraken exchange has the most currencies available. You can trade over 17 different digital coins on this site. There are three different membership levels in Kraken. Each one requires more identification on your part. One great thing about this site is that it offers Ripple. Also, you can get started by trading in some USD for your cryptocurrency of choice.

Conclusion and the Future of Cryptocurrency

A stack of gold Bticoins stacked on a United States One dollar bill

Bitcoin is expanding and new types of digital currencies are emerging. This equates to more people will be using digital coins for transactions. In return, more commodity markets will accommodate digital currency. For instance, when you have billionaires invest into the blockchain, then it could indicate wider acceptance in the financial sectors.

Cryptocurrencies are going to become a staple in the business world. Governments and military groups may seek to use the digital currency infrastructure as a weapon. These could come in many forms. There may be attacks on mining rigs could cause some hefty chaos. These groups might try to take down a single currency, like the possible government-issued ones. Secret backdoors could be built into the coding of certain currencies. As the value of cryptocurrencies increases so does the potential of coin combat.

Enjoy your newfound cryptocurrency journey!

Click Here to Learn Cryptocurrency from the Pros!

Sources for this guide

ETHnews
Investopedia
Nasdaq
Blockgeeks
Forbes
Money Crashers
Cryptocurrency Fact
Coin Market Cap
Steemit

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