Start off with a Few Basic but Key Crypto Concepts.
You’ve heard of cryptocurrencies like Bitcoin, Ethereum and Doge. Maybe even Solana.
DeFi, NFTs and CBDCs are going to sound familiar to a lot of people by now too. It’s hard to ignore crypto and Web3 as this industry grows in adoption and media coverage increases.
As is the case with almost everything new, this technology tends to be polarizing — loved by some, hated by others, and confusing to just about everyone.
This is the 1st of 4 BEGINNER 101 GUIDES
It explains exactly what “crypto” is, some of the advantages over traditional fiat currencies, and outlines the risks you’ll need to be aware of before buying, trading or using crypto.
READ TIME: 6 MIN
What Exactly is a Cryptocurrency?
According comedian John Oliver (and many other reasonable people), it’s something along these lines:
A cryptocurrency– is everything you don’t understand about money, combined with everything you don’t understand about computers.
Crypto + Currency = Cryptocurrency
A more practical definition is Crypto + Currency. Using this breakdown, the word crypto comes from “cryptography”.
Cryptography uses a technique called encryption to conceal messages using algorithms. Encryption is nothing new. The first recorded use of cryptography is in the year 1900 BC. (We’ve been hiding messages from each other for at least 4 thousand years.)
Today encryption is defined as “the process of encoding a message so that it can only be read by the sender and the intended recipient”. In other words, as secret as possible. Whether an encrypted message is kept a secret is up to the owner.
An encrypted message can only be decrypted by using the right key.
We all use encryption many times a day. It’s used to keep internet interactions secure. Using a particular type of encryption technology called SSL allows you to interact safely and securely with your bank online and other websites. We’re using encryption right now.
Let’s also agree that a currency is “a form of money”. Like the Dollar, the Pound and the Yen.
And all currencies must have these characteristics:
- A Medium of Exchange (buy things with it)
- Fungible and Divisible (break it into smaller interchangeable units)
- A Unit of Account (keep track of it)
In short, cryptocurrencies are a new type of digital currency. They use encryption in order to keep them safe and secure.
All cryptocurrencies have a value (cost per unit) and can be bought, sold and traded.
Some cryptocurrencies like Bitcoin function as digital money or gold. Others were developed to secure data, distribute video, provide storage and to prove ownership.
Bitcoin ($BTC) is the biggest and best known cryptocurrency, but there are thousands more.
You’ll hear cryptocurrencies referred to as cryptos, coins, or tokens.
The Advantages of Cryptocurrency
Crypto represents a technological improvement over today’s fiat currencies (government issued money) and this new asset class holds enormous potential as a result.
These are the main advantages:
Cryptocurrencies don’t depend on a middleman, bank, company or government to process and validate transactions. Crypto is independent from this. This is advantageous for the people who use them, because central authorities get into trouble occasionally by manipulating markets, committing fraud, going bankrupt or even freezing accounts of people they don’t like for political reasons.
Because of decentralization, cryptocurrencies also avoid manipulation, editing and censorship.
Transactions are able to be processed 24×7, 365 days a year, so you won’t have to wait 24 hours for a deposit to clear or 2 to 3 days for a wire transfer to hit your account.
It all happens in real time with cryptocurrencies.
Crypto (blockchains) can process transactions very quickly, some at speeds similar to credit cards networks like Visa or Mastercard. Although not all cryptos are equal in this way (some are still fairly slow), they’re all working on improving their transaction speed.
Solana ($SOL) now has block times of 400 milliseconds or over 2,700 transactions per second (TPS) according to their official site.
Crypto is more efficient since they’re peer-to-peer transactions. They don’t need to go through a bank or middle man in order to process. There are fees required to verify and process transactions, but with the exception of Ethereum fees (Gas), crypto tends to cost much less than the traditional banking system.
Many cryptocurrencies restrict the amount of coins that they will ever produce. This is the exact opposite of traditional (fiat) currencies.
As we’re seeing today, when countries print a lot of new money, it tends to decrease the buying power of their currencies and leads to higher rates of inflation. We’re seeing this today in higher prices for things like houses, cars, and food. The value of non-cash investments tend to increase as well, just look at the rising prices of gold, silver, collectibles, and artworks.
Bitcoin and many other cryptos are actually deflationary.
Bitcoin‘s supply is so tightly controlled that the total amount that will ever exist is limited to 21 million. The result is very likely to be that BTC and other deflationary cryptos will go up in value compared to fiat currencies where supply is constantly expanding.
Here’s an observation:
There will only ever be 21 million Bitcoin (BTC) mined. Over 19 million are already mined.
That’s the total. It’s a finite number and a fixed supply.
Only the demand can increase.
However, many of the early BTC were lost by people who forgot their passwords (lost their keys). The exact number doesn’t matter but it’s considerable (up to 20% by some estimates).
Now also consider that there are close to 60 million millionaires in 2021 according to this article.
The point here is, there is no possible way that every millionaire will be able to own a whole entire BTC.
Maybe this isn’t a big deal. Or maybe it will factor in somehow and the price will go up… it’s hard to predict.
Crypto is a Platform for Building Other Things
Cryptocurrencies are not just digital money, they’re often platforms for building new technologies on top of. This is a larger topic for another post, but for now just understand that cryptos can be used to build all kinds of new things like a fully decentralized versions of YouTube (video streaming), Dropbox (file storage), or financial services (loans and other banking functions).
One common example is NFTs. An NFT is a Non-Fungible Token meaning each one is unique and can’t be divided or copied. Because of this, NFTs are able to represent digital assets like art, collectibles, and other rare one-of-a-kind items. This has far-reaching implications in visual art, music, and gaming, with more use cases emerging by the day.
Why should we care?
Because the use of a platform also drives the demand for the crypto. In other words the Network Effect— essentially, the value of a network increasing with as the number of people using it grows.
People buying NFTs drive up usage of the Ethereum network because most NFT projects are built on Ethereum (using the ERC-721 Standard). This in turn drives up demand for ETH.
Cryptos are Built on Fundamental Concepts.
There are thousands of cryptocurrencies, but all of them are share these common concepts:
There’s no such thing as an actual physical Bitcoin or any other cryptocurrency.
It’s all just code running on a blockchain.
Cryptocurrencies do not exist in any physical sense. Unlike dollar bills or gold bullion, these are exclusively digital assets that exist solely on the blockchain.
Cryptocurrencies are essentially online digital ledgers that can be accessed through a web browser and by using an app (crypto wallet).
Thousands of “nodes” located around the world maintain and sync copies of the Bitcoin blockchain.
More nodes means more decentralization and that in turn means greater network security.
One of the key technologies behind crypto technology is decentralization. A record of every single transaction is stored and visible on a decentralized or distributed ledger. Unlike a central bank, a copy of the public ledger exists across thousands of computers around the world simultaneously.
Decentralization makes censorship and manipulation almost impossible because no one can influence or update enough of the ledger copies at the same time.
Decentralized ledger technology is built on a software protocol known as a blockchain. Because a blockchain is a software protocol that follows specific predefined rules, it replaces the need for trust in a 3rd party or central authority. This in turn reduces any risk that they may be corrupt.
Note: Almost all cryptocurrencies use decentralization to provide a secure and permissionless user experience. However, some blockchains are much more centralized than others. Being more centralized typically allows decisions to be made more quickly, but it comes as a cost to the end users who relinquish their control.
Ripple (XRP) for example uses something called gateways, a series of private blockchains, to improve the speed of traditional banking.
Also known as Peer-to-peer.
With crypto, only an owner has the ability to spend or transfer their coins or tokens to another crypto wallet, no matter where on the planet the recipient is.
You or I can directly transfer to or receive crypto from any other person. There’s no central authority to go through because the blockchain replaces the need for it. No middlemen to grant or deny approval or charge an extra fee. Only the parties involved have control over what happens.
Transactions are considered “trust-less” because they are secured by the blockchain, not other people you have to trust.
Some cryptocurrencies like Bitcoin function mainly as digital money or digital gold. Others (like Ethereum) exist to do all kinds of different things, like securing data, providing storage and proving ownership and authenticity of digital assets.
It’s the combination of technology + currency, which opens up so many possibilities.
How crypto works is what makes it so valuable.
We’ve covered these core concepts:
- Cryptocurrencies exist as digital ledgers built on blockchain technology.
- Blockchains keep permanent and immutable records of ownership for each coin or token.
- Ownership of crypto means having the permission to send a specific amount of it to someone else.
- Anyone with an internet connection and a smartphone / computer can participate.
- Blockchains are publicly visible (with the exception of centralized or privacy-focussed blockchains).
- Decentralized blockchains can’t be censored or edited. (It’s extremely difficult)
- More centralized blockchains can increase speed and efficiency and maintain control, but this comes at the expense of security and user control.
Increasing adoption is promising – for investors and users.
Sometimes it might seem like it’s all happening overnight but there is a steady progression that has been happening for a years.
Bitcoin was introduced at the end of 2008 (as a whitepaper) and launched officially in 2009.
Crypto and Web3 will continue to grow as the internet, blockchains and people evolve regardless of the current price and market conditions.
More and more companies are getting on board.
A Bitcoin ETF seems to be just over the horizon for US citizens (depending on the stance of the almighty SEC).
Paypal allows its customers to buy, and hold cryptocurrencies and has launched its own stablecoin.
Trading platforms like Robinhood, Gemini, and Coinbase have gone all in.
Central banks and governments are working on releasing their own digital cryptocurrencies (CBDCs).
Web 3.0 promises to allow creators to earn from their work directly and wrestle our personal data from the stranglehold of big tech.
What actually happens when Bitcoin is sent from one person to another?
Remember that Bitcoin (BTC) never leaves its blockchain. Only the permissions to who can send/spend it are ever moved around.
As a result, Bitcoin transactions involve some very unique attributes that make them secure and trustworthy.
Here’s a visual explanation of how a Bitcoin transaction might look.
Cryptocurrencies work because all transactions are verified on the blockchain – a decentralized public ledger.
That means a cryptocurrency can only be spent one at a time, eliminating any chance of corruption or a “double-spend”. Crypto can’t be copied or duplicated like an MP3 or JPEG.
Because of how blockchain technology works, (Peer-to-peer) you can send cryptocurrency directly to anyone else, without artificial barriers.
This all sounds great and wonderful, but a lot of new people get scared of messing it up.
In other words, you’re probably thinking…
Is all of this a gigantic and incalculable risk?
We hear this a lot. We’ve felt it ourselves.
There’s a good chance you’re worried about this very thing. And that’s perfectly reasonable.
Up next we’ll help you put things into perspective.