Cryptocurrency can be very baffling and it’s no wonder a lot of people are trying to find out what is cryptocurrency, what they can do with it – and even whether cryptocurrencies are legal. This article will tell you everything you need to know about cryptocurrency.
But first, let’s explain what a cryptocurrency is. In short, like any other currency cryptocurrency is a medium of exchange but cryptocurrencies differ from normal (or fiat) money in that cryptocurrencies are digital, or “virtual”.
Also, cryptocurrencies use technology called cryptography to ensure that transactions are verified and to put a limit on the production of new cryptocurrency units. This is because cryptocurrencies are each individual database entries, and these entries can never change unless very specific circumstances are present.
History of Cryptocurrency
Many people have tried to create a digital currency throughout the 1990s and beyond, one example is DigiCash but even Flooz failed to really make it to market in a big away. These projects failed for a variety of reasons which range from financial issues through to outright fraud and also a degree of conflict between the people who worked on these projects, and the leaders of the projects.
What was particularly frustrating at the time was that as much as these projects often used a safety approach called Trusted Third Party they still managed to fail. This safety approach requires that the company behind the currency verifies and facilitates all transactions. So, because these companies failed despite the use of a safe approach many people thought for a long time that a digital cash system is not a viable project.
Bitcoin: the First Viable Digital Currency
However, this changed when Bitcoin was introduced by a group of computer geeks that operated under the name of Satoshi Nakamoto. Today nobody knows who Satoshi is but this “person” operating as the front of Bitcoin described the currency as a cash system that is electronic, as well as P2P, or peer-to-peer.
As a result Bitcoin is completely decentralized, not operating with a central command the way that fiat currencies do – which has a central bank. Nor are there any servers involved in the use of Bitcoin. You can think of Bitcoin and many other cryptocurrencies as operating in a way similar to file sharing P2P networks.
Of course, any payment network has some central challenges to resolve. One of these is spending money twice, also called double-spending, which counts as fraud. So, the typical approach is a controlling authority with a central server that ensures records of transactions are kept alongside balances. However, the drawback is that this central authority exercises a high level of control and also holds personally identifiable information for people using the currency.
Blockchain – the Power Behind Bitcoin
With cryptocurrencies like Bitcoin this job of controlling spending and holding record of transactions and balances is done by everyone who participates with the network. In understanding what is cryptocurrency you must understand that the tool that makes this happen is Blockchain, which is a public record of all the transactions ever made on a network. So everyone on this network can see the account balance of everyone else.
Furthermore, every transaction made with a cryptocurrency is in fact a file which includes the public keys (like an account number) of both the person who sent money and the person who received it – alongside the amount of coins sent in the transaction. To ensure security, transactions are also signed off by the sender using their private key – it’s really just elementary cryptography in action. Once the transaction is confirmed it is then broadcast across the network.
Transactions are confirmed by miners, and these miners can only confirm a transaction using a cryptographic puzzle. These miners mark transactions as legitimate and then spread transactions around the crypto network. In turn, every node operating on the network takes this transaction data and then adds it to its database. Confirmed transactions cannot be reversed and cannot be forged, the miner gets a reward for confirming a transaction alongside the fees for a transaction.
Note that cryptocurrency networks are all based on the agreement (known as consensus) of all of the parties to that network as this consensus confirms that transactions and balances are legitimate and correct. Where a node does not agree about a single balance it would in theory mean that the network will completely break. There are, however, set rules built into the operations of a network which ensures that this will never happen.
In essence, the reason why cryptocurrencies are called by the name cryptocurrency is because of the fact that this consensus process is basically enforced and safeguarded using very strong cryptography techniques. So there is no need to engage with what is basically blind trust in a third party, the crypto network enforces this trust.
Cryptocurrency in Real World
There is a surprisingly versatile quality to cryptocurrencies: you can not only use cryptos to buy stuff but also to speculate and invest, while you can also make money by generating a bigger pool of cryptocurrency. What are cryptocurrencies good for? Let’s take a look.
A key element of making cryptos work is the mining of cryptocurrencies. Like buying, holding and selling coins mining can also be seen as a way to invest in cryptocurrencies. Miners are basically like the accountants for cryptocurrencies, ensuring that records are kept. They are compensated for the computing power they use in order to solve the difficult cryptography mathematics that make cryptocurrencies work. Solving these mathematical equations are computer-intensive but are required to ensure that every transaction on a blockchain is confirmed and that these transactions are recorded.
The way many cryptocurrencies are designed means that mining becomes more computationally intensive over time – the difficulty of the cryptography puzzles being mined increases over time, alongside the numbers of people participating in mining. Effectively, as a cryptocurrency gets more popular more and more people will try to mine it which means that mining it becomes really difficult over time.
When Bitcoin was just launched it was really easy to mine Bitcoin – you could do it with a basic computer or just your laptop. The result is that a lot of people become very rich, very easily, over a short period of time. This has changed however – right now you need very powerful infrastructure to mine Bitcoin efficiently. Another affordable approach here is to utilize the cloud mining approach.
Beginners can still cost-effectively mine some cryptocurrencies, think Dogecoins and Litecoins for example. However, the earnings are not quite as big as it used to be with Bitcoin – you might earn something along the lines of a few dollars a day for your mining efforts. Of course, those profits can become much higher if you can put together sufficient computing power to solve more crypto puzzles – you get a reward in the shape of a transaction fee for every puzzle you solve.
Nonetheless because cryptocurrencies have become more popular mining cryptocurrencies have become more difficult. One reason for this is the fact that there is a limited amount of coins that can be mined. Bitcoin for example has a maximum circulation of 21 million, and by the end of 2019 over 18 million Bitcoin has already been mined – which means mining the remaining 3 million will be rather complicated experience: computationally expensive and also expensive in terms of electricity usage. That said, in theory at least, as mining becomes tougher Bitcoin value will also go up.
This increase in mining difficulty that correlates with an increase in coin value has the effect of making cryptocurrency mining effectively an arms race where people that jump in early are the ones that win the most profits. Mining profits may entail taxes – while special regulations under money transmission rules could also apply. In the USA FinCEN has said that it considers the mining of cryptocurrency and the exchange of coins for normal money the equivalent of the transmission of money. So people who mine must submit to special regulation and laws that governs money transmission. If you are mining at a large scale it is worth getting to know these laws.
Purchase with cryptocurrency
There used to be a time when it was difficult to use cryptocurrencies to buy things as most online merchants simply wouldn’t accept cryptocurrencies. However things are different now because you can buy goods and services using cryptocurrencies via a number of retailers. Both online stores and bricks and mortar stores now let you buy with Bitcoin and other cryptos. Even large retailers such as Overstock now let you buy from them with Bitcoin, while you could also find local bars and smaller shops that can accept cryptocurrency.
You can pay for a range of products by using cryptos including everything from computer parts, to education all the way to flights and hotels. You can even buy apps with your Bitcoin or other cryptocurrency – Apple has recently authorised a range of cryptocurrencies as an accepted form of payment on the App store, and it includes not only Bitcoin but also Ripple and Ethereum as well as Litecoin.
However, these currencies are not as broadly accepted as Bitcoin, once you start looking at other retailers. That said, you can always exchange other cryptocurrencies into Bitcoin, so you can swap your Ethereum for Bitcoin so that you can shop at a store that accepts Bitcoin only. You can also choose to buy gift cards from a website such as Gift Off – they accept more than 20 different cryptocurrencies so in reality you can buy basically anything with any one of the popular cryptocurrencies.
And don’t forget, some places will only let you buy with cryptocurrencies, websites such as OpenBazaar do not except fiat money at all.
Accept cryptocurrencies as a payment option
Every business wants to grow quickly and acquire new customers. Businesses who accept cryptocurrencies open up new markets for their products and services. Arguably cryptocurrencies will become more and more popular so any company that wants to expand its market should think about accepting cryptocurrencies. It’s not just stores business that works with cryptocurrencies: there are now thousands of Bitcoin ATMs across the world – in over 50 countries.
Putting up a sign that says that your business accepts Bitcoin should be the first step you take. You can then take Bitcoin for payment using a physical terminal – just like you would take a credit card – or you could use one of the many apps. You could also try using a simple wallet address which you can print out in the shape of a QR code. To accept cryptocurrency for payment you need to contract with a third party vendor, but you have plenty of options. CoinGate, BitPay and CoinPayments are all popular options – the latter accepts more than 75 digital currencies. Your payment processor can charge as little as 0.5% of the value of a transaction.
From a legal perspective, at least in the USA, accepting cryptocurrencies is basically the same as taking a gift card or cash – cryptocurrencies are seen as a convertible currency. Again, from a tax perspective, accepting cryptocurrencies does not mean you can skip reporting your profits on your tax return. You record it just the same way you’d accept a dollar payment – recording the currency, the date of the transaction and the amount accepted. Sales tax will also be payable in some states and the amount of the sales tax is based on whatever the exchange rate was when you made the sale.
Investing in cryptocurrency
Bitcoin investors has seen big gains in the past, consider the “atomic” rise of price in Bitcoin within just a single year, for example. In fact there are plenty of people who have become dollar millionaires just because they invested in Bitcoin. So, certainly in the past at least, Bitcoin has been one of the hottest investment opportunities around. It’s not Bitcoin that has shown the biggest rises though, but Ethereum which has seen incredibly large gains occurring very rapidly. As a whole cryptocurrencies have seen a growth in market capitalization of more than 10000% since around 2013. These are very large gains.
That said, as always with investment, with the opportunity for big gains comes the potential for big risks and this is the case for cryptocurrencies too. Cryptocurrency value can fluctuate really rapidly and there is no regulation that enforces stability in cryptocurrency values. Cryptocurrencies have unique risks too, for example there is a chance that some countries might completely outlaw the use or trading of a cryptocurrency. Security is a concern as well as many episodes of hacked cryptocurrency exchanges have been reported over the years, with cryptocurrency owners often losing all their coins.
Bitcoin: still important, but a smaller share of the crypto pie
In terms of investment Bitcoin remains the biggest player in crypto but since 2017 the share of cryptocurrency market cap belonging to Bitcoin has dipped as alternative cryptocurrencies with unique features have come online. Each of these coins have different useful features, with some cryptocurrencies focusing on points like privacy while other coins are focused on things like decentralization – other coins are basically carbon copies of Bitcoin.
Bitcoin is one of the easiest currencies to get a hold of in the crypto space, but other cryptocurrencies can be tougher to buy from an exchange, with some obscure currencies very difficult to buy or trade. Big cryptocurrency exchanges including BitFinex and Kraken makes it easy buy the lesser known cryptocurrencies such as Ripple and Monero. Cryptocurrencies can be purchased in other ways too, you even get Bitcoin ATMs and of course you can also exchange directly with someone who wants to buy Bitcoin.
Just like fiat money, Bitcoin needs to be stored somewhere safe. In the case of cryptocurrencies you need a crypto wallet, most exchanges of cryptocurrencies offer wallet services. It is a convenient way to store your coin it is in fact better if you store your coin outside of an exchange – for example, on your computer hard drive. You also get dedicated hardware wallets which you plug into your PC and which are known as the most secure way of storing cryptocurrencies.
Always monitor the cryptocurrency markets
Anyone who invests need to keep an eye on markets. In the case of cryptocurrencies a good place to monitor the performance of your investment is Coinmarketcap, the website covers all important market info ranging from prices through to the volume traded as well as the total number of coins in circulation.
Don’t forget – just because cryptocurrencies are unregulated does not mean that you can skip declaring your investment gains on your tax return. Interestingly, some countries take a unique view on how cryptocurrencies are treated for tax. In the USA the IRS considers cryptocurrencies just the same way as it does property – so it’s not seen as a currency for taxation purposes. As a result US investors pay capital gains tax on their cryptocurrencies based on whatever their personal capital gains tax rate is.
The most popular cryptocurrencies
Bitcoin is no longer the only important cryptocurrency around. Several other cryptos are gaining the importance. Let’s take a look at the dominating cryptocurrencies today.
Bitcoin. As we know, Bitcoin is the crypto that kicked off cryptocurrencies and it is still the most valuable cryptocurrency on the market by capitalization, the most widely accepted and also the one cryptocurrency that most members of the public known about.
Bitcoin Cash. Relatively new, Bitcoin Cash rapidly became very popular in part because it is support by the biggest player in Bitcoin mining and also because a major manufacturer of ASIC chips used for mining supports it. It has one of the top cryptocurrency market caps and uses a fork of the Bitcoin code for its blockchain codebase.
Ripple. Ripple is faster than Bitcoin in part because of the way it builds consensus for a transaction does not use typical blockchain ledger technology. The iterative approach of Ripple means that transactions are faster, but in turn Ripple is also easier to hack.
Ethereum. Possibly the second most important cryptocurrency out there because it is not just a cryptocurrency – it is also a platform which lets developers build unique applications that work using distributed ledger technology. It is not possible to build applications like this using Bitcoin.
Litecoin. Like Bitcoin Cash, Litecoin is also a Bitcoin fork and the creators say they wanted to make a coin that is the “silver” to Bitcoin “gold”. The major difference is that there is a maximum number of Litecoin of 84 million, compared to Bitcoin’s 21 million. At the same time Litecoin’s design means that blocks can be generated four times quicker than it happens on Bitcoin.
NEM. Most coins use a proof of work algorithm but NEM is different – it uses a proof of importance algorithm. This means that only users who already have a certain amount of coins will be able to get new ones through work. The design of NEM is also such that it encourages people to spend the coins they have, tracking the number of transactions in order to determine how important one given user is to the global network of NEM users.
Monero. With a very active community Monero is known to be very open and also very privacy focused compared to other coins. It features the ability to conduct transactions privately between Monero members.
Dash. Interestingly, the Dash network has two tiers. First miners secure the network and make transaction records on the first tier, while the second tier effectively relays transactions including instant and private transactions. As a result Dash can be faster than Bitcoin, and it also offers more privacy when compared to Bitcoin.
As you can see there are plenty of Bitcoin alternatives each with their own advantages – and indeed disadvantages. It’s worth exploring the different coins to try and find out what type of coin suits your investment or transactional needs the best.
The best way to buy cryptocurrency
You can start by using a crypto ATM, but there are many other ways to buy cryptocurrency including popular exchanges as well as gift cards. You can even buy into cryptocurrency using investment companies who specialise in cryptocurrency investment. However the less common cryptocurrencies will not be available through all of these channels. If you want to buy a less common cryptocurrency you need to look at an exchange which supports that currency. You could also choose to trade that currency face to face. It really just depends on the exact coin you want to buy, and it also matters where exactly you live – your options can differ depending on the jurisdiction you live under.
Storing your crypto
You might have realized by now that storing cryptocurrency works differently to fiat currencies. You can’t use a bank, and you can’t put your Bitcoin under the mattress. In fact, you do not “store” cryptocurrency the way you would a physical item or another asset. Instead, you “store” the private key which is required to sign for every transaction you make.
Cryptocurrency is stored using a cryptocurrency wallet and these wallets all have different characteristics – it really depends on your needs at the time. For example, if convenience is the primary concern you could use an online wallet that is hosted by a crypto exchange or an independent party. However, storing your funds offline is the most secure way, these are also called cold wallets – or hardware wallets. You can even store your private key by printing it out.
Are cryptocurrencies legal to use?
There’s little questions that countries are struggling to decide how they want to legislate cryptocurrencies but the increasing popularity of cryptocurrency is forcing tax authorities, courts and governments to find a way to apply regulation. Yet understanding the concept of cryptocurrencies has eluded many regulatory institutions, and it can be difficult to see how cryptocurrency fits into existing regulatory and legal structures. In essence regulators was taken aback with cryptos because of the unique way cryptocurrencies are constructed: cryptocurrencies are not controlled by anyone in particular and are completely decentralised and independently sustained, cryptocurrencies do not exist in a physical form either.
To be frank, regulators are still in essence wondering what are cryptocurrencies all about. This brings along many problems for regulators who do not like the fact that cryptocurrencies can be used without trace: you can buy, trade and pay with cryptocurrencies anonymously. As you can imagine the anonymity is something that really attracts criminal activity because criminals can use cryptocurrencies to hide their illegal activity – and of course some ordinary people might want to try and use cryptocurrencies to evade tax.
As a result a few countries have decided to ban the use of cryptocurrencies, but these are relatively limited – think Kyrgyzstan, Vietnam and Bangladesh as examples. However, it has been said that both China and Russia may completely outlaw the use of cryptocurrencies in future. Other countries has not made the use of crypto against the law but there are a range of regulations coming in place that affect how cryptocurrencies can be used in practice – and how users of cryptocurrencies must report their cryptocurrency holdings and trades to the government.
Market insight always matters when you hold or invest in an asset like cryptocurrencies. Thankfully there are plenty of market commentators that are worth following to keep tabs on the crypto trade. One of these is Vitalik Buterin, the man who created Ethereum – you can follow him on Twitter. If you have a real interest in Bitcoin you could follow Andreas M. Antonopoulos who is a leading Bitcoin supporter, and the writer behind the book “Mastering Bitcoin”. He’s on Twitter too. Two other people worth checking out is Charlie Lee, the person behind Litecoin and of course Coinbase founder Brian Armstrong. Also consider following Roger K. Ver as well as Adam Back.
Some of the best inside tips about cryptocurrency can be found on discussion forums. You can also use these to help you better understand how cryptocurrencies work and how to buy, invest and trade cc. Check out CryptoCompare, Bitcoin Talk and BTC Warriors.
What is the future of cryptocurrency?
Cryptocurrencies are hotly debated and depending on who you ask the future of cryptocurrency is either bright and life-changing in scope, or perhaps a bit less so. For example, the founder of PayPal, Peter Thiel, said that his company tried to create a new currency but that PayPal couldn’t – and instead ended up creating a system for payments. According to him, Bitcoin’s success is that it is a new currency, but he suggested Bitcoin is too hard to use for payments, at the moment.
Google’s chairman Eric Schmidt said that the way Bitcoin makes use of cryptography is highly remarkable, and that it is unique in that Bitcoin has found a way to make something that is digital yet at the same time impossible to duplicate – Schmidt thinks that for this reason businesses will be very interested in cryptocurrencies. Richard Branson of course is always on point and honest about investments.
According to him, cryptocurrency seems to be working and he suggested that it is clear that many people have made a lot of money from Bitcoin while others have been less fortunate – he pointed out that, while Bitcoin changes in value quickly, many people who understand this volatility are therefore uniquely placed to make money out of these rapid changes in Bitcoin value.