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What Is Cryptocurrency? Simple Explain for Beginners

This article will explain what cryptocurrency is in the simplest way and give you information about crypto like how it works, history and examples.
cryptocurrency

Cryptocurrency is a new type of money that exists only online and uses special technology to keep transactions secure. Since Bitcoin was created in 2009, cryptocurrencies have changed how we think about money, offering a system that isn’t controlled by any government or bank.

Key Takeaways

  • Cryptocurrency is a digital or virtual currency that uses cryptography for security.
  • It operates on decentralized networks based on blockchain technology, immune to government interference or manipulation.
  • Examples of crypto: Bitcoin (BTC), Ethereum (ETH), and Tether (USDT).
  • The legal status of cryptocurrency varies by country and usage, with ongoing regulatory developments.

What Is Cryptocurrency?

Cryptocurrency is a form of digital or virtual currency that uses cryptography for security. Unlike traditional currencies issued by governments and central banks, cryptocurrencies operate on decentralized networks based on blockchain technology. This decentralized nature means that no single entity has control over the entire network, making cryptocurrencies theoretically immune to government interference or manipulation.

How Does Crypto Work?

Cryptocurrency uses advanced mathematical algorithms to secure transactions and protect data from unauthorized access or tampering. These algorithms serve two main functions: maintaining user privacy and verifying transaction authenticity.

Blockchain transactions are public, and addresses (public keys) act as pseudonyms, though not entirely anonymous. In other words, while transactions are visible on the blockchain, identifying the users behind them is not straightforward. Cryptocurrency achieves this through encryption techniques like cryptographic hashing and digital signatures.

Cryptocurrency operates autonomously through a distributed network of computers called a blockchain, essentially a distributed ledger technology that stores transaction data across many specialized computers on the network.

Each computer, known as a node, maintains a copy of the ledger. A consensus algorithm protects the blockchain by rejecting tampered or inconsistent copies. This distributed architecture enhances network security since there is no single point of failure, like a bank vault, for malicious actors to exploit.

Cryptocurrency allows individuals to transfer funds directly to each other. In a typical cryptocurrency transaction, the sender initiates the transfer by creating a digital signature with their private key. The transaction is then broadcast to the network, where nodes validate it by verifying the digital signature and ensuring the sender has sufficient funds.

Once verified, the transaction is added to a new block, which is then appended to the existing blockchain. Although this process may seem complex, miners handle these steps so users don’t have to worry about them.

History and Evolution of Cryptocurrency

2008: Satoshi Nakamoto publishes the Bitcoin whitepaper, outlining the concept of a decentralized digital currency.

2009: The Bitcoin network is created with the mining of the first block, known as the “genesis block.”

2010:

  • The first real-world transaction involving Bitcoin occurs when Laszlo Hanyecz pays 10,000 BTC for two pizzas.
  • In this year the first cryptocurrency exchange, Mt. Gox, is established, paving the way for the trading of Bitcoin and other digital assets.

2011: Litecoin, one of the earliest altcoins, was released by Charlie Lee. It offered faster transaction times and a different hashing algorithm (Scrypt), making it easier to mine with consumer-grade hardware.

2012: Ripple, launched in 2012, focused on facilitating real-time, cross-border payment systems for banks and financial institutions. Ripple’s consensus ledger and its native token, XRP, aimed to provide faster and more cost-effective transactions compared to traditional banking systems.

2013:

  • The cryptocurrency market capitalization surpasses $1 billion for the first time.
  • The United States Senate holds its first hearings on Bitcoin, acknowledging its potential as a legitimate form of currency.

2014:

  • Mt. Gox files for bankruptcy protection after losing 850,000 Bitcoins in a hack.
  • The IRS issues guidance on the taxation of cryptocurrencies, treating them as property for tax purposes.
  • Tether (USDT), the first stablecoin, is launched, providing a digital currency pegged to the US Dollar.

2015: Vitalik Buterin launched Ethereum, a groundbreaking platform that extended the blockchain concept by introducing smart contracts—self-executing contracts with the terms directly written into code. This innovation enabled the creation of decentralized applications (dApps) and gave rise to decentralized finance (DeFi). Ethereum’s versatility and robust development community have made it the second-largest cryptocurrency by market capitalization.

2016:

  •  Ethereum undergoes a hard fork to reverse the DAO hack, resulting in the creation of Ethereum (ETH) and Ethereum Classic (ETC).
  • Bitfinex, a major cryptocurrency exchange, is hacked, losing approximately 120,000 BTC.

2017:

  • The Bitcoin network undergoes a hard fork, resulting in the creation of Bitcoin Cash.
  • At the end of the year, Bitcoin reached its all-time high price of nearly $20,000 per coin.
  • Initial Coin Offerings (ICOs) become a popular fundraising method, with numerous projects raising significant capital.

2018: Decentralized Finance (DeFi) begins to gain traction, with platforms like MakerDAO and Compound enabling decentralized lending and borrowing.

2020:

  • DeFi experiences explosive growth, with the total value locked in DeFi projects surpassing $10 billion.
  • Major institutions, including MicroStrategy and Tesla, began investing in Bitcoin, signaling increased institutional adoption. Bitcoin’s price surged to over $30,000, attracting renewed interest from institutional investors.

2021:

  • Non-fungible tokens (NFTs) have gained massive popularity, with digital art and collectibles being sold for millions of dollars.
  • El Salvador becomes the first country to adopt Bitcoin as legal tender, alongside the US dollar. Bitcoin reaches an all-time high of around $69,000 amid growing mainstream acceptance and institutional investment.

2022:

  • The European Union introduces the Markets in Crypto-Assets (MiCA) regulation, aiming to provide a comprehensive framework for regulating cryptocurrencies and digital assets across member states.
  • The Ethereum network undergoes a major upgrade, transitioning from a proof-of-work to a proof-of-stake consensus mechanism with the London hard fork.

2023: The United States Securities and Exchange Commission (SEC) approved the first Bitcoin exchange-traded fund (ETF), enabling investors to gain exposure to Bitcoin through traditional brokerage accounts.

Now:

  • The price of Bitcoin rebounds, reaching new highs above $70,000, fueled by increasing institutional adoption and mainstream acceptance.
  • Continued growth in the adoption of central bank digital currencies (CBDCs) as more countries pilot and launch their digital currencies.

Examples of Cryptocurrency

Among the many cryptocurrencies, four notable examples include Bitcoin (BTC) and popular altcoins like Ether (ETH), Binance Coin (BNB), and Tether (USDT).

Bitcoin (BTC)

Bitcoin (BTC) is a cryptocurrency created in 2009 by a group of programmers under the pseudonym Satoshi Nakamoto. Bitcoin was designed to function as a payment method outside the control of any individual, group, or organization, eliminating the need for third-party involvement in financial transactions. Bitcoin has a fixed supply, with only 21 million bitcoins ever created.

Ether (ETH)

ETH is the second most popular cryptocurrency, launched by Vitalik Buterin and his team in 2015. In addition to transferring value, ETH enables programming through smart contracts. Initially, ETH used a proof-of-work (PoW) mechanism but has transitioned to a more environmentally friendly and energy-efficient proof-of-stake (PoS) model. This change allows users to validate transactions and secure the network by staking their ETH instead of using computational power.

Binance Coin (BNB)

BNB (short for Build and Build) was introduced by the cryptocurrency exchange Binance in 2017 as an ERC-20 token on the Ethereum blockchain. In 2019, it moved to its blockchain, the BNB Chain, as a BEP-2 token.

Tether (USDT)

USDT is a stablecoin pegged to the USD, launched by Tether Limited Inc. in 2014. Stablecoins are cryptocurrencies that maintain a consistent value relative to reserve assets, such as fiat currency. In the case of USDT, each token is backed by an equivalent amount of assets held in the company’s reserves. This provides the benefits of cryptocurrency while minimizing price volatility.

Cryptocurrency Pros and Cons

Pros of Cryptocurrency

  • Easy, fast, and unlimited global transactions: Crypto allows users anywhere to easily transfer money directly, eliminating the need for third-party involvement.
  • Low transaction fees: The cost of making transactions with cryptocurrency is almost zero.
  • Fast transaction processing: Some of the fastest cryptocurrencies can complete transactions in under a minute. Generally, most transactions are processed within 2 to 10 minutes, thanks to peer-to-peer protocols and innovative blockchain technologies like DAG and Tangle.
  • Security and safety: Developed on blockchain technology, crypto ensures anonymity and high levels of information security through cryptography.
  • Decentralized, immutable, and transparent: The entire system operates transparently and in a decentralized manner, with data shared among all network participants.
  • Not controlled by any organization: Crypto transactions are conducted through peer-to-peer protocols without intermediaries. This means that investor transactions are free from control or influence.
  • Not subject to inflation or counterfeiting: Cryptocurrencies have a finite supply and cannot be increased or decreased arbitrarily (e.g., Bitcoin is limited to 21 million coins). Therefore, crypto is not susceptible to inflation like fiat money. Additionally, cryptocurrencies are issued using blockchain technology, where coins are mined by solving cryptographic algorithms. Each crypto has a unique and singular code, making counterfeiting impossible.

Cons of Cryptocurrency

  • Price volatility: Cryptocurrencies can experience significant price fluctuations, posing a high risk to investors. This is one of the biggest disadvantages compared to other forms of investment. For instance, Bitcoin’s price was around $1,000 in early 2017, surged to $63,000 in April 2021, then dropped to over $40,000 by July 2021. Late 2021 saw Bitcoin’s monthly price fluctuations ranging from 13% to 40%.
  • Lack of widespread recognition: The nature of cryptocurrency transactions is still debatable. As a result, cryptocurrencies, including Bitcoin, are not widely recognized in many countries and regions. This creates difficulties for cross-border transactions and reduces the liquidity of these assets.
  • Challenges for non-tech-savvy individuals: Since cryptocurrencies are created and operate on blockchain technology, managing and investing in them requires a certain level of technological understanding. This can be a significant barrier for traditional investors unfamiliar with new and advanced technologies.
  • Projects with no inherent value: Only a small portion of cryptocurrencies in the market hold intrinsic value from their projects. Many projects exist temporarily, appearing during market booms and disappearing during downturns.

Is Crypto Legal?

The legal status of cryptocurrencies depends on who you are, where you live, and how you use them. Regulations surrounding cryptocurrencies are still unclear, with some governments trying to classify them as securities, currencies, or both. This lack of clarity in regulations creates an environment where there’s not enough protection against fraudulent or unethical practices. Many investors have suffered significant losses because management teams didn’t fulfill their promises.

Do You Have to Pay Taxes on Crypto?

Yes, you have to pay taxes on cryptocurrency transactions, just like you do with other forms of income or investment gains. The specific tax treatment of cryptocurrencies varies depending on the country you’re in, but in many places, they are treated as property for tax purposes.

This means that when you sell or exchange cryptocurrency for fiat currency (like dollars or euros) or for another cryptocurrency, you may incur capital gains taxes if the value of the cryptocurrency has increased since you acquired it. Similarly, if you receive cryptocurrency as payment for goods or services, it may be subject to income tax.

It’s important to keep detailed records of your cryptocurrency transactions, including dates, amounts, and values, to accurately report them on your tax returns. Failure to do so could result in penalties or fines from tax authorities.

However, tax laws and regulations surrounding cryptocurrencies are still evolving and can be complex, so it’s a good idea to consult with a tax professional or accountant who has experience with cryptocurrency taxation to ensure compliance with relevant laws and regulations.

The Bottom Line

Cryptocurrency is reshaping the financial world by providing a secure, transparent, and decentralized alternative to traditional money. As it becomes more popular, it’s important to understand how it works, its benefits, and the potential risks.

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