What is cryptocurrency?
The beginner's guide to cryptocurrency
Cryptocurrency is a type of virtual currency built around transparency and inclusion.
Unlike traditional currencies, cryptocurrencies exist as a digital form of payment that is not issued or backed by any government. Instead, they are secured by cryptography, computer science and mathematics.
Some dismiss crypto as a scam. Others praise it as a revolution.
Some think the energy they use will destroy the planet. Others think they will power a new age of financial freedom.
The one thing everyone seems to agree on is that crypto is complicated.
Regardless of what you may have heard, there are still some shared truths about what cryptocurrencies are — and just as importantly — what they are not.
Cryptocurrencies are not:
- Only used for criminal activities.
- Completely anonymous (though there are some exceptions).
- Emitting more greenhouse gasses than traditional payment systems.
- Backed by nothing.
- Run by banks or governments.
- All an exact copy of Bitcoin.
- The same thing as blockchain.
Few things in the world are more misunderstood, yet fiercely debated, than cryptocurrency. So, let's eliminate the cryptic parts of cryptocurrency together as we separate the facts from the opinions.
Cryptocurrencies use concepts from cryptography, computer science, and economics. It is the combination of these three disciplines that allows cryptocurrencies to operate in a decentralized way.
- Cryptographic techniques keep crypto transaction information secure.
- Computer science keeps this information consistent across all participants.
- Economic incentives encourage everyone to follow the rules for the benefit of the network.
Cryptocurrency transactions share similarities to email messages. We no longer need a postal service to hand-deliver messages around the world. We can just send emails directly over the internet.
Cryptocurrency is the same. We no longer need a bank to hold and ferry our money around. We can hold cryptocurrency ourselves and send it directly to whoever we want.
A brief history of cryptocurrency
Attempts at producing a working cryptocurrency date back to the early 1980's.
However, it wasn't until the global financial crisis of 2008 that the world's first workable cryptocurrency was proposed. As countries around the world went bankrupt and people’s financial freedom was taken away, Bitcoin (BTC) offered an alternative.
Governments around the world frantically created trillions worth of national currencies from nothing to prop up failed institutions. This caused inflation rates to soar, business to close, and the purchasing power of government-issued currencies to plummet. In return for the damage they inflicted on the global economy, governments bailed out banks using taxpayers' money and allowed them to continue running.
The Bitcoin white paper written by pseudonymous author(s) Satoshi Nakamoto outlined what an alternative might look like.
Satoshi envisioned a true "peer-to-peer electronic cash system" system that did not rely on central banks or intermediaries. The proposal allowed "online payments to be sent directly from one party to another without going through a financial institution."
On the day Satoshi Nakamoto mined the first ever Bitcoin block in 2009, they famously embedded the day’s London Times headline to illustrate the role fiat currency played in this generation defining financial crisis:
"The Times 03/Jan/2009 Chancellor on brink of second bailout for banks."
Bitcoin's use of blockchain ledger technology laid the foundation for a new age of decentralization. Later projects like Ethereum (ETH), sought to build on the innovations of Bitcoin and decentralize the sharing of information altogether, not just digital currency.
Today, developers all over the world are using distributed ledgers to address the friction caused by middlemen. Their developments have given rise to smart contracts, non-fungible tokens (NFTs), decentralized finance (DeFi), and many other exciting innovations.
How do you use cryptocurrency?
Just as you don't need to understand mechanical engineering to drive a car, you don't need to study cryptography or economics to use crypto assets.
All you need is an internet connection and a device. Devices can be a smartphone, a laptop, a tablet, or a desktop computer.
Once you have those, you have several options to choose from when deciding to buy cryptocurrency. After you have bought your cryptocurrency, it is important to take some basic steps to keep your funds safe. Once you have bought your crypto and are keeping it safe using the method right for you, there are several ways to use cryptocurrency for different purposes.
How to buy cryptocurrency
Many feel the safest and easiest way to purchase popular cryptocurrencies is by using a crypto exchange like Kraken.
Cryptocurrency exchanges make buying crypto nearly as easy as any other online transaction. They automatically set up a digital wallet when you create an account and secure your funds on your behalf.
After you create and fund your account with your bank account, debit or credit card, you can buy any of the assets listed for trading. Many starting their crypto portfolio choose to eliminate the challenges of timing the market by dollar-cost-average. This strategy, also known as recurring buys, allows you to automatically purchase an asset on a regular basis, regardless of its market price.
How to secure cryptocurrency
Most cryptocurrencies are incredibly secure and resilient in the face of attacks. However, the ways people choose to take custody of their cryptocurrency are often full of risky practices.
While the Bitcoin protocol is highly secure, attackers regularly steal billions of dollars worth of crypto each year because of ineffective custody practices.
There are several different options to choose from when determining how to secure your cryptocurrency. Each comes with their own unique advantages and tradeoffs, but all are known as a cryptocurrency wallet. Unlike the wallet in your pocket that protects physical bills and coins, crypto wallets protect your cryptographic private keys, which serve as proof of ownership over the cryptocurrency you own.
Crypto wallets come in both digital and physical forms, known as software wallets and hardware wallets, respectively. Some are "cold wallets" and not connected to the internet, while others are "hot wallets" and maintain a connection to the web. Some are custodial, meaning an intermediary secures your crypto on your behalf, while others are non-custodial, meaning this responsibility falls entirely on you.
Finding the right type of wallet for you depends on whether you're looking for maximum security or something that's convenient to use. There are a series of tradeoffs for every option so it is important to do your research when determining how to keep your crypto safe.
What can you do with cryptocurrency?
Not all cryptocurrencies work in the same way, nor are they all meant to do the same thing. Here are some different things you can do with some of the most popular cryptocurrencies in the market today.
- Send value across borders - fast and cheap
- Own a self-sovereign store-of-value asset
- Buy goods and services in a peer-to-peer way
- Fund people and charitable causes in need
- Create and use decentralized applications
- Vote on proposals shaping the future of the cryptocurrency
- Earn rewards for securing the protocol via staking
- Join a cryptocurrency mining pool
- Support your favorite content creators
- Prove ownership of digital assets
Types of cryptocurrency
Since Bitcoin set out to be a "peer-to-peer electronic cash system," thousands of other types of cryptocurrencies have emerged. Some are taking on the same problem Bitcoin aims to address in their own unique way. Others are creating entirely new services and ways to transact altogether.
Many alternative cryptocurrencies copied the original Bitcoin source code. Cryptocurrencies like Litecoin and Bitcoin Cash are evolutions of Bitcoin aimed at addressing specific tradeoffs with how Bitcoin operates.
But not every cryptocurrency is simply a copy of Bitcoin.
Many cryptocurrencies serve as the native currency of a decentralized application (dApp) and allow users to pay for different transaction fees (often called gas fees) within these platforms. Others serve as governance tokens within different decentralized platforms, allowing token holders themselves to have a say in the strategic management and future direction of the protocol.
Some cryptocurrencies are revolutionizing the world of finance, IT, and entertainment. Others are challenging the concept of "currency" altogether. The different types of virtual currencies in the cryptocurrency market are just as diverse as their global networks of users.
Why is crypto important?
Cryptocurrencies are digital assets that can serve as a peer-to-peer medium of exchange or store of value.
Peer-to-peer refers to the sharing of information directly between individuals — not through a central intermediary. Medium of exchange and store of value refer to two characteristics of money. Ultimately, cryptocurrencies can eliminate the need for centralized intermediaries to be involved in money.
Banks and governments are examples of centralized intermediaries. Over the years, these entities quietly gained control over many aspects of our lives. This loss of power has often come at a cost to our personal finances, information, and freedom.
With crypto assets, there is no need for central banks, governments, or middlemen to stand between those who wish to send and receive value between one another.
How does cryptocurrency work?
One of the key characteristics of the crypto market is decentralization. However, when there is no one "in-charge" of something as important as transferring value between individuals, how can a system operate without some sort of oversight?
The solution is a public ledger system called a blockchain and a globally distributed network of computers.
Blockchains can track all sorts of information.
They accomplish this through highly secure and censorship-resistant rules. These rules are coded directly into the protocols and typically available for anyone in the world to inspect for themselves.
Each participant in the peer network maintains their own unique copy of the blockchain database. Each of these nodes plays a part in helping the whole network reach agreement on new data before it is added to the blockchain.
Because any attempts at submitting fraudulent information to the chain would need to be accepted by the majority of the network, blockchains essentially crowdsource the responsibility of verifying information.
Here is another way to think of it. Rather than trusting one single individual with determining if a piece of information is true or false, blockchains put that question to a community vote. The community is able to assess the facts for themselves and collectively agree on a yes or no answer.
By linking each new block to the previous block, any attempts at tampering with historic information are immediately apparent to all participants on the network.
Tampering with one block of information would require an attacker to not just change that one block of information, but all blocks after that as well. They would also need the majority of the network control (more than 50% of all nodes) to cooperate with this change too.
Because of the amount of coordination, money and processing power this would require, such an attack has proven to be practically impossible to carry out on widely adopted blockchains like Bitcoin or Ethereum.
Ready to get started with Kraken?
Kraken offers a secure and easy way to get started in the cryptocurrency market.
With hundreds of different cryptocurrencies available to buy, sell and trade, millions choose Kraken as they start their journey to financial freedom.
Create your account to get started with Kraken today.