Cryptocurrency Basics: A Beginner’s Guide To Digital Currency [2021 Guide]

Cryptocurrency has been the buzzword for the past few years. The debate is ongoing whether to invest in them or not. Some people call it the future of money and investment, while for others, it is the riskiest investment option, and they suggest staying away from it. If you are also in the same dilemma, the best way to get to one side of the debate is by increasing your understanding of cryptocurrencies. If you invest in a stock market, you know what exactly you are doing – you are buying shares of a company whose balance sheet you have studied. You know when the company grows, your investment will grow along with it. Traders work with technical analysis. Based on their analysis they take trading calls.

Now, if you plan to invest in cryptocurrencies, you should know the cryptocurrency basics. Unlike equity, cryptocurrency is a very new concept for investors. So let us start from the basics, and we hope you will enjoy learning this exciting topic.

 

What is a Digital Currency?

At a very broad level, anything that digitally represents value comes under digital currency. A digital currency is non-tangible, unlike the Dollar and Rupee. Digital currency also includes virtual currency that is not considered legal tender. 

When you deal with physical currency, you have to work with a bank. To transfer money to your friend, you need an intermediary party in between (bank). This is a major difference between physical and digital currency – with digital currency a transaction can happen between you and your friend without any third party.

What are Cryptocurrencies?

Now that you know the digital currency, let us get started with cryptocurrency basics. Cryptocurrency is a digital currency, and hence there are no bills or coins tied to it. If you track news around cryptocurrencies, you would know the value of it fluctuates very drastically. For example, a couple of months back, the price of one of the most popular cryptocurrencies, Bitcoin, fell around 50 percent in a week. The reason for it lies in the cryptocurrency basics – since it is not tied to anything of value in the real world.

If it is not tied to any physical thing, the obvious question is – how does the price change? Cryptocurrency only has value because someone else has it and wants to give it to you for money (high-level understanding).

 

Cryptocurrency Basics:

There are few concepts you should know to understand cryptocurrencies. We will talk about these concepts in detail in future articles. For now, let us have an overview – 

Cryptography

Cryptography is a process that converts ordinary plain text into unintelligible text. This ensures only those for whom the message is can read and process it. Cryptocurrency uses this technology for safety and security purposes.

Blockchain

It is a Distributed Ledger Technology. You can think of it as a database spread over multiple operators – computer devices, nodes, etc. It is perhaps the most important technology around cryptocurrencies. The digital ledgers in blockchain verifies accounts, transactions, and balances. Other than financial purposes, blockchains are used in industries like supply chain management. One term related to the blockchain you should know is a node. It is the individual part of the larger structure and is part of the blockchain. The blockchain is created using these nodes, and without them, the entire system will collapse.

Decentralization

Decentralization is linked with Blockchain technology. It refers to the transfer of control and decision-making from a centralized entity like an individual, organization, or group to a distributed network.

Peer-to-Peer

There is no need of a broker to send or receive cryptocurrencies. It can directly change hands between two people. Since there is no broker, the processing fee is very minimal. It goes towards compensating the network.

Different Types of Cryptocurrency:

There are two different types of cryptocurrencies available. You must know the difference between the below two:

Coins –

A coin is a cryptocurrency that has its own blockchain. Example – Litecoin, Ripple, Ethereum, and Bitcoin. When you hear someone saying – I bought a cryptocurrency – it means they have bought coins.

Token –

It is a cryptocurrency that is built on another blockchain. For example, dApp runs on Ethereum’s blockchain. These represent an asset for a specific project and are sold during the first public sale of a project known as – Initial Coin Offering (ICO). It is similar to an IPO in a stock market. 

Tokens are subdivided into two parts:

Utility Token –

It is intended to be used to buy products and services from the platform or company that issues them.

Security Token

It is a digital version of financial security that acts as a share of the value of an enterprise. They pay you dividends, interest, share profits or invest in other tokens to generate profits for the token holders.

You can consider a digital asset as a security token if it meets three criteria:

  • It has a monetary investment.
  • The fund collected goes to a single enterprise.
  • If investors are investing intending to gain income derived from the work of the third party.

 

Different Form of Cryptocurrencies:

When we talk of cryptocurrencies, most people think of Bitcoin. However, there are more than 2500 different types of cryptocurrencies one can buy or sell. The good part is you don’t have to know all of them. But lets us see the top three so when you decide to invest in cryptocurrencies, you know the starting point:

Bitcoin

It is the first and the most popular cryptocurrency that started in 2008. It is also known as Digital Gold.

Litecoin

It is referred to as Silver to Bitcoin’s gold. It is a split of Bitcoin and started in 2011 as a competition. It was created to make a cheaper and faster transaction when compared to Bitcoin.

Ethereum

Bitcoin is a peer-to-peer payment system, but Ethereum is different – it is a decentralized software platform that powers distributed platforms and smart contracts.

How Does Cryptocurrency Work?

It is a wide topic to cover, and since we are only dealing with basics, we will see the process at a very high level. For now, we will understand how the transaction happens in cryptocurrencies.

Assume Mr. X wants to send Mr. Y Bitcoin worth $5. The process will be as below:

  • Mr. Y will send his Bitcoin address to Mr. X (also known as hashed public key). The address depends on the exchange or cryptocurrency wallet Mr. Y is using. 
  • It will look something like – 545fsefsefeuVG8JFBfdgfdFFFS7gwj614yG4CPg.
  • Mr. X will enter the address received in his cryptocurrency wallet along with the Bitcoin amount. Let us assume he enters a Bitcoin amount that corresponds to $25 and presses send.
  • Mr. Y will receive the Bitcoin minus a small fee. The fee ranges between $0.05 and $0.58. The important part concerning the fee – it remains the same whether you transfer $10 or $10,000.

We will check later what happens behind the scene.

 

What Are The Benefits Of Digital Currency?

The benefits will make a lot more sense now that you understand cryptocurrencies a bit –

High-speed Payments –

Using digital currency, you can transfer money much faster. Though now there are a lot of other mediums that do the same, it still has an edge.

Minimum Transfer Fee –

International transfers are very costly when you do them via traditional methods. There is a high fee associated with them. With digital currency, the cost is minimum and fixed. It does not matter from which part of the world you are sending from and to.

24*7 Access

You can transfer money using cryptocurrencies any time of the day, seven days a week.

 

Rules and Regulation Around Cryptocurrencies:

There are different ways to look at cryptocurrencies. The basics are the same, but how one understands and views cryptocurrencies can vary from person to person. For example, everyone knows fixed deposits in a bank are a safe way to invest. When it comes to cryptocurrencies, there is no consensus around it.

One thing you need to understand is that unlike other financial markets (stock and banks) which are regulated to ensure investors don’t have massive losses, cryptocurrencies are not regulated.

You need to understand the regulatory climate around cryptocurrency is in a constant state of flux. It means what you know today can change tomorrow.

Some Points To Know  – The Other Side

There Are Too Many Cryptocurrencies –

At the moment, there are too many cryptocurrencies, and it may take time for a new person to research and know which one is good for investment. There is still a big question mark around some of the cryptocurrencies.

Fluctuation In Price –

Since it is not regulated, the cryptocurrency price and value can change suddenly and drastically. Hence they are not being used too much for a transaction. For example, a business would never use a medium for a transaction since it is volatile. If they buy a cryptocurrency at 100 to pay their vendor, the next day it could go to 80 and hence not ideal for business transactions.

We have pretty much covered everything you need to know to start your cryptocurrency investment journey. There is still a lot to learn, and we will cover everything around cryptocurrency in the coming articles.

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