Cryptocurrency in simple terms

Cryptocurrency in simple terms

What is a cryptocurrency

The term “cryptocurrency” first appeared on the pages of Forbes magazine in 2011. This name hides a special type of electronic payment instrument created on the basis of a complex mathematical code. Each such currency contains special cryptographic elements that act as a digital signature and protect the asset from any outside influence, thereby minimizing the risks of hacking electronic wallets and stealing money. This principle of operation of cryptocurrencies becomes possible thanks to blockchain technology.

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Cryptocoins are not identical to real currencies (the so-called fiat currencies) and exist exclusively in the digital world, while real money is issued in the form of coins or banknotes. Due to this, virtual coins differ from fiat money also in that they implement the principle of decentralization, that is, they are not issued by one body (for example, the ruble is issued by the Central Bank of Russia). The movement of cryptocurrencies and transactions with them are not regulated by third parties or banks, which means that financial institutions (except through trading on the exchange) cannot influence the value of virtual money.

Cryptocurrency principles

For an example that allows you to clearly show the principles of how virtual money works, you can take Bitcoin, since this coin appeared earlier than the others and still remains the most popular.

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Each operation (transaction) carried out using Bitcoin is recorded in a separate block, which in turn is connected to other blocks, and together they form a sequential chain that forms a kind of registry with data in the public domain:

This system operates on the basis of complex cryptographic calculations that ensure the integrity and chronological order of the blocks in the chain. Changes to it can be made only when a consensus is reached between all network participants.

Each transaction or transfer of BTC from one cryptocurrency wallet to another is recorded in a separate block, which is built into the chain and remains unchanged throughout the history of the system. Thanks to this feature of the blockchain, it ensures the legitimacy of all transactions and protects the network from third-party interference (hacking, rewriting data in the block, and so on).

Bitcoin also has other principles of operation:

BTC is a decentralized asset that is not managed by a single administrator (supervisory authority or other structure);
all information about the transactions carried out is stored on the computers of all network participants at the same time;
each block contains information about the new and all previous transactions;
for each block found, a reward is paid in the form of cryptocurrency.
An important detail of this system is that all blocks have a special digital signature, without which they cannot be built into the chain, and in order to hack such a system, attackers need to gain access to more than half of the computers connected to the network, which is absolutely impossible, since it Millions of computers are involved.

What are cryptocurrencies backed by?

Fiat money was backed by gold for a long time, but now the American dollar is the measure of their value. That is, the global financial market has a centralized control that ensures the activities of various banks and other similar institutions. Despite this, at the moment there is a trend of gradual abandonment of the dollar, which is facilitated by the gradual introduction of cryptocurrencies, the value of which is not determined by precious metals, the banking system or other factors. In addition, the following factors influence the value of cryptocurrencies:

reliability of the system, which is based on blockchain technology;
recognition of cryptocurrency as one of the means of payment;
the inability to uncontrollably create new crypto-coins.

Unlike the dollar and other currencies that are printed by order of the Central Banks, cryptocurrencies are mined (mined) by solving complex mathematical problems and the number of digital coins directly depends on the resources spent on their development, or, in other words, the volume of emission is determined by end users .

Emission of cryptocurrencies

Unlike ordinary money, the size of the emission of cryptocurrencies is artificially limited and, speaking of Bitcoin, regardless of consumer requests, no more than 21 million BTC will be mined.

However, not all cryptocurrencies have such an artificial limitation, and the second most popular cryptocurrency, Ethereum, can be mined in any quantity, but even in this case, certain restrictions are provided. In particular, the number of issued Ethereum coins directly depends on the total value of the network, which is used to develop this coin.

Capitalization of cryptocurrencies

Capitalization is one of the important indicators that investors are guided by when making decisions. This parameter is calculated as the total value of all crypto coins that are currently in circulation. Also, capitalization shows the level of demand for digital money and reflects the nature of the market development.

The rate of cryptocurrencies directly depends on the demand for the asset among traders. This parameter is determined by the same principles as the exchange value of the euro, dollar and other fiat money, so the rate depends on the following factors:

news bulletins;
financial policy (in this case, the creators of crypto coins);
rumors;
activity of large investors;
general behavior of market participants.
A distinctive feature of cryptocurrencies is that their rate often changes rapidly, and this digital coins stand out against the background of fiat money, whose price remains within a certain level for many years.

What is a fork

The essence of the concept of “fork” clearly demonstrates the features of the blockchain technology. As indicated, changes to the block chain can be made subject to consensus among the network participants and such a process is referred to as a “fork”. That is, this concept is used when there are branches from the standard chain. So, for example, Bitcoin Cash was created, and this cryptocoin is an offshoot of the Bitcoin block chain.

There are two types of forks:

1. Hard fork occurs when significant changes are made to the system, or a new network is created based on the previous one (an example of a hard fork is the appearance of Bitcoin Cash). Such processes occur in the event of a large-scale conflict among users, after which a completely new chain of blocks is created, which does not correlate (does not interact) with the old one.

2. Softwork (Soft work) occurs when it is necessary to make minor changes to the network. Unlike the first case, the new block chain recognizes all transactions that were written to the old one. This procedure is resorted to when there is a danger of cryptocurrency centralization or in case of other threats during the development of the project.

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At first, it was possible to acquire cryptocurrency only through mining. This term refers to the process of calculating complex mathematical problems on a computer, as a result of which a new block of the chain is opened, for which miners are paid a reward in the form of cryptocurrency. And if at first it was possible to mine the same Bitcoin using a video card, now special devices are used for this. Therefore, an easier way to get cryptocurrency is to buy it on a cryptocurrency exchange.

Despite the foregoing, cryptocurrency mining is still relatively in demand, but the process has become more complicated. For the extraction of cryptocurrencies, mining pools are more often used, that is, development is carried out using the capacities of many computers combined into one pool.

There is also a certain demand for “cloud” mining. In this case, users buy a part of the capacities on the basis of which cryptocoins are mined.

How to use cryptocurrency

All cryptocurrencies are stored in electronic wallets, which are divided into several types:

multicurrency (contain several types of currencies);
online wallets;
local;
hardware.
To choose the right wallet for storing cryptocurrencies, you need to decide what the cryptocurrencies will be used for.

If you plan to buy a large amount of cryptocurrency, then hardware wallets (cold storage) are considered the safest, since information about them is recorded on external media, but this storage method is not the most convenient, since each operation with digital money requires connecting an electronic wallet to network, which is inconvenient if the data about it is recorded on a “flash drive”.

If you plan to conduct frequent trading in cryptocurrencies, then it is worth storing funds on the exchange, and this will be the most convenient way.

Small amounts, which do not make up all possible capital, can be stored in hot wallets that provide online services on the network.