There is a buzz about online investments. People are talking about online trading. How cryptocurrencies are the next big investment vehicle. And how bitcoin is bound to increase in value.
What are cryptocurrencies? How are they made available? Which technology is used? How can you buy bitcoins? And is it secure?
The above and many more questions will be answered in this comprehensive post. Stay close and be in the know.
What are Cryptocurrencies?
The word cryptocurrency comes from two separate words- crypto and currency. Crypto is a prefix stemming from the word; cryptography. Crypto means ‘hidden’.
Generally, cryptography is a method used to protect information and data by using certain codes. This ensures that third parties cannot access the information. It’s only the intended recipient who can decrypt the message and understand it.
In the ancient world, manual techniques were used to encrypt information. It could be as simple as shifting each letter of the alphabet forward or representing each letter of the alphabet using a specific number.
The sender and the recipient had the decryption key. And for the above case, it could be a prior communication on how to rearrange the characters to get the original message.
In olden times, manual encryption of data was mostly used in war. This ensured that even if the enemy got hold of the communication, they were not able to decipher the original message.
So what are cryptocurrencies?
Cryptocurrencies are digital assets or if you love it, digital currencies, that are secured using cryptography techniques.
Since they are secured, it becomes difficult to counterfeit them or even double spend.
Unlike fiat currency, cryptocurrencies are not owned by any government in the world. They are controlled by a decentralized system that is built on blockchain technology.
A decentralized system ensures that no single entity has control over the network. Instead, all the nodes connected to the network work on a consensus method. Before a transaction is approved, more than 50% of the CPU power of the computers connected to the system has to accept the transaction.
This makes it difficult for hackers to compromise the network and steal these digital currencies.
What Led to the Creation of Cryptocurrencies?
There are several reasons which led to the creation of cryptocurrencies. I will identify the core ones.
1. Control Inflation
In the year 2008, the world experienced a global financial crisis. Those who had stored their wealth in form of paper assets (money, stocks, etc.) nearly lost half of their wealth due to inflation. Paper assets increasingly lost their value.
As a result of this, people were upset by banks, their governments, and the whole financial system. They wished to have a decentralized system. A system that was immune to the manipulations of the government, the Federal Reserve, and the banking system. And sure to their wishes, the first cryptocurrency, the Bitcoin, was created by an unknown person(s) with the pseudonym Satoshi Nakamoto.
2. Create Finite Currency
The Dollar and other world currencies continually lose their value. You can verify this by checking what 100 dollar bill would have bought 30 years ago and what it could buy today. This implies that the fiat currencies of the world cannot entirely be trusted as valuable assets. The value of such currencies drops every time the government authorizes more printing of paper money.
At the end of the day, the fiat currency is just a mere paper. What makes it have value is simple; it is backed by the government.
If we had a currency whose supply was not constantly increasing over the years, then the demand for such a currency will continually rise. The value of such currency will thus increase proportionally over time.
The creators of Bitcoin envisioned this. The Bitcoin software is programmed such that the coins mined by the nodes continually become less as more blocks are added to the blockchain.
It will reach a time when no more bitcoins can be mined. At this point in time, the bitcoin’s total market supply will be finite. Thus those who own Bitcoins will not fear a constant and heavy dip in the value of the currency. Of course, the normal day to day inflations will occur but averagely, the value of the coin will continue to rise due to its limited supply.
3. Decentralize Control
Power and wealth belong to the people. To ensure that the new currency was not controlled from a single point, a decentralized system was picked. This way, it’s not possible for any government to seize your investments and freeze them, either for a good or malicious reason.
And better still is that any person can participate. This can be done by downloading the Bitcoin software and installing it on your computer. The exact specifics on how to do this is beyond the scope of this article.
The software, once connected to the internet, will download the previous transaction blocks, and then join the network as a node. This node (The computer connected) alongside other nodes in the network will communicate and approve transactions occurring within the network.
As you can see, the network is quite decentralized. You don’t need to depend on a specific banking entity to allow you to transact.
4. Avoid Double Spending
Double spending occurs when someone sends money to you. Then on delivering the agreed product/service, that person reverses the transaction. You end up losing. Cryptocurrency transactions are irreversible. They are thus a guaranteed way of avoiding double-spending.
5. Privacy and Security
Cryptocurrencies are quite private. Though all your transactions will be publicly transparent in the blockchain network, it’s only the public address that will be visible. The details of the person who owns such a cryptocurrency address will not be visible. Thus you can keep your transactions anonymous.
The network architecture of most cryptocurrencies is quite secure. The decentralized processing of transactions makes it difficult for the system to be hacked.
Blockchain Technology: How Does It Work?
Cryptocurrency networks are built on blockchain technology. So how does blockchain technology work?
Blockchain, as the name implies, is basically blocks of data connected in a chain such that each block references to the previous one. Let’s take the explanation further:
A blockchain is a form of a database. Unlike the normal database where data is stored in tables, a blockchain database stores data in blocks. Each block has a specific amount of space. Once this space is filled, a new block is created and chained to this filled block. The subsequent blocks form the blockchain.
This system is quite secure and has been adopted by different private and public entities to store its data. The bitcoin and other cryptocurrencies are built on the same technology, the only difference being that they are decentralized.
Here is how the Bitcoin Blockchain works:
1. New transactions are initiated. Different nodes pick these transactions and broadcast them to the rest of the nodes.
2. The miner nodes collect the broadcasted transactions into a block. Usually, miner nodes give preference to transactions with high transaction fees. Consideration of how old the transaction is is also taken into account. This implies that transactions with low transaction fees might delay more before being confirmed as compared to those with a higher fee.
3. Once a block is filled, the nodes work to find proof-of-work. This usually involves solving a computational puzzle. The node which solves this puzzle broadcasts the solution to the rest of the nodes.
4. The rest of the nodes connected to the network validates the transaction. If more than 50% of the CPU power connected to the network validates the transactions as true, the new block is added to the blockchain with a unique timestamp. The minor node which solved the puzzle is awarded miner bitcoins and the total transaction fee in that block.
5. After the new block is added to the blockchain, the nodes start working on the next block.
Bitcoin: The First Commercial Cryptocurrency
Bitcoin is the leading cryptocurrency. It was the first cryptocurrency to attract commercial interest. It was created in 2008 by a person or a group of unknown persons going by the name Satoshi Nakamoto. This currency was first availed in 2009. The bitcoin software was released as Open-source thus sparking the creation of new cryptocurrencies.
The first block of Bitcoin (Genesis block) was mined on 3rd January 2009. After this, the bitcoin network grew and attracted speculators, investors, and also criminals who wanted to cover their financial tracks. Throughout the years, Bitcoin has increased in value amidst the normal fluctuations.
How to Buy Bitcoin
You will need a bitcoin wallet to buy and sell bitcoins. A cryptocurrency wallet contains a Public and Private Key. The Public Key is used to generate the bitcoin address which you share with the person who wants to send bitcoins to you.
To help you understand, a public key is like your bank account number. You can share it with anyone without risking losing your money. A private key, on the other hand, is like your bank account PIN or signature.
Anybody with your PIN and account number can transfer money from your account. The same applies to bitcoins. Anybody with your Public key and Private Key to your Bitcoins can transfer bitcoins to another Bitcoin address.
You can get a bitcoin wallet online. There are myriad of companies which offer this service. You need to be careful to select a company that has a good reputation to avoid losing your investment. You can as well create your own bitcoin Wallet using free online Software. The key is to ensure that such software doesn’t keep your bitcoin credentials with them.
Once you have gotten your bitcoin wallet, the next thing is to buy bitcoins. You can buy Bitcoins from exchanges or from P2P deals. If you go with the exchange option, ensure that the exchange allows you to send bitcoins to an address outside the Exchange accounts.
P2P deal is where you know someone who has bitcoins and you make an arrangement to buy from them. Be careful not to be conned if you go with this option. An escrow can help you avoid this. One P2P exchange that has escrow integrated is Paxful.
Hot and Cold Wallets: Which One is Better?
Unlike normal money wallets, a cryptocurrency wallet does not hold actual cash. What it stores is your Public Key and a Private Key which you will need to authenticate your identity and sign transactions.
A hot wallet is a wallet that is connected to the internet. It could be an app on your smartphone, a desktop app, or even an online account protected with a username-password combination. Hot wallets can be set quickly, it’s easy to perform transactions, but can be compromised by hackers.
Offline wallets are those which are not connected to the internet. It could be a piece of paper having your public and private address, a flash disc with firmware having your public and private keys, or even a PDF file.
How to Trade Bitcoin and Other Cryptocurrencies
You can trade Bitcoins and other cryptocurrencies online. There are a wide array of exchanges that allow you to trade cryptocurrencies.
The first step is doing your homework to ensure that you choose a reliable and secure cryptocurrency exchange. You will then create an account, deposit cash to buy your first trading volume, and start trading.
Like any other exchange, trading cryptocurrencies is risky and requires solid analytical and trading skills. If you have never done it before, it is recommended that you start with virtual cash and seek training before trading with real currencies.
How to Evaluate the Legitimacy of an Exchange
So many crypto exchanges have popped up online. Differentiating a genuine one from fake ones has become an uphill task. Here are the key pointers which you can use to determine a legitimate exchange:
1. Year it was established – The older an exchange, the longer it has been in business. If it were a scandalous exchange, a simple Google search would show it. This does not however mean that newer entrees into the exchange business are not genuine. But the older, the higher the probability of it being genuine.
2. Country registered – I’m not discriminating against countries but it is a well-known fact that some countries have stricter financial regulations than others. You better go for an exchange that is based in a country with clear and tight financial services regulations.
3. Certificate of registration – Some exchanges are not registered with any financial services regulatory body. This should sound a warning signal. Crawl around the website looking for this information before opening an account with such an exchange. Some online ‘companies’ operate from the blues. Meaning if something happens to the exchange, your money will go under without anybody being answerable.
4. The C.EO and top management – Check the website’s “About Us” to see if you will get the details of the top management. If it’s not possible, do a search on Google. Once you get the CEO’s name, do a further search to check whether they are legit or it is just a pseudonym.
5. Liquidity – Liquidity is very key in exchanges. You don’t want to get into an exchange that is not liquid.
6. Reputation and scandals – Keep off any company that has been in the limelight for the wrong reasons. Make some online search to get reviews, opinions, and information about the exchange.
7. Ability to withdraw your investment: How complicated? – There are certain exchanges that make it quite complicated for you to withdraw your funds. Ensure that you go with an exchange that has a clear and seamless withdrawal process.
8. Support– An awesome customer support is always a plus.
9. Trading and transaction fees – You must be keen to check the transaction fees charged while depositing and withdrawing cash. Are these charges reasonable? Or they are too high? What about the trading fees?
10. Security – Be sure to check the security of the exchange platform. There are software analytical tools that can help you gauge the security level of their system. You can as well search to see if there are customers complaining of compromised accounts, loss of money, or such related security glitches.
If you Lose Private Keys Can You Recover Your Bitcoins?
If you lose your private keys, it’s difficult to recover your bitcoins. That is the reason why it is advisable to keep your Public and private keys in a secure place. You can print the keys and keep them safely, maintain a software backup, and also have a third-party repository where you keep the keys.
You should also note that any person accessing your Public and Private Keys can transfer the cryptos to their own address. For big investments, it’s recommended that you distribute your investment in different addresses instead of keeping them in one address.
How to Avoid Crypto Scams
Cryptocurrency scams have filled the internet. So many people have been dragged into these scams. Most of these scams thrive on a referral system. While referral marketing is legitimate, if an exchange basically gets its money from bringing in new customers but not from fees from the trade, then it is a scheme. Never invest in what you don’t thoroughly understand. And keep in mind that nobody is giving out free money online.
Understanding what you want to invest in is crucial. You have learned what cryptocurrencies are, how the blockchain works, and the intricacies surrounding cryptocurrencies. With this information, you can compare your known investments and cryptocurrencies and make an informed investment decision.