Cryptocurrencies like bitcoin, litecoin and peercoin are growing in popularity. Here’s how they work.
The value of bitcoin is reaching all-time highs in 2017, boosting interest in all cryptocurrencies — more than 700 out there at any given time. But just what is cryptocurrency, and how you can save, earn and spend it?
What is cryptocurrency?
Cryptocurrency is a digital currency for which encryption techniques are used to regulate its use and generate its release. Unlike fiat currency — like US dollars, euros and yen — cryptocurrency is not regulated or controlled by any bank, government or centralized financial authorities.
Instead, it relies on the power of the Internet to guarantee its value and confirm transactions. Users on a network verify every transaction, and those transactions then become a matter of public record. This prevents the same digital currency or coin from being spent twice by the same person.
How are cryptocurrency records kept?
That digital public ledger on which all transactions are recorded is called the blockchain. Data is stored across a network, so it’s not susceptible to exploitation by hackers or central failure.
Each record or series of records on the blockchain is known as a block. A block is sent to the network and added to the blockchain after it’s accepted by the network as a valid transfer. Once verified, the blocks cannot be changed.
What does it mean to mine cryptocurrency?
Cryptocurrencies are released to the world through a process called “mining.” For you to mine this currency, you must attempt to solve a computational puzzle known as a hash, which allows you to add the next block. These transactions are then recorded in the blockchain for all to see.
People around the world compete to be the first to solve a hash. Those “miners” who succeed in solving the hash receive a block reward — or an amount of the cryptocurrency they mined.
Unlike mining for gold, you’ll need a few more tools than a pan and a magnifying glass. Invest in these basics to get started:
- Mining hardware. You’ll need a ASIC chip for your computer designed specifically to mine cryptocurrency.
- Mining software. Look for free software with easy-to-follow instructions that explain how these programs work with your ASIC.
- Bitcoin wallet. If you complete a block, you’ll need to store your bitcoin in a wallet.
How can I buy and use cryptocurrency?
Cryptocurrency is a volatile market, with exchange rates that can wildly fluctuate by day, and sometimes by hour. Bitcoin is the better-known and most valuable cryptocurrency out there, but there are many others to explore, including litecoin, peercoin, dogecoin, monero and ripple.
When you buy or receive cryptocurrency, you are given a digital key to the address of that currency. You can use this key to access and validate or approve transactions.
You need a place to keep your key safe, which is where a cryptocurrency wallet comes in.
You have a variety of cryptocurrency wallets to choose from:
- Desktop wallets. Software like Cryptonator allows you to send and store cryptocurrency addresses and also connects to the network to track transactions.
- Online wallets. Cryptocurrency keys are stored online by exchange platforms like Coinbase or Circle and can be accessed from anywhere.
- Mobile wallets. Apps like Blockchain store and encrypt your bitcoin keys so that you can make payments using your mobile device.
- Paper wallets. Some websites offer paper wallet services, generating a piece of paper with two QR codes on it. One code is the public address at which you receive cryptocurrency, and the other is your private address you can use for spending.
- Hardware wallets. You can use a USB device created specifically to store bitcoin electronically and your private address keys.
Compare cryptocurrency marketplaces
Why should I use cryptocurrency?
You already use debit cards and credit cards — two tools that “digitize” your dollars, pounds or euros. But there are a few advantages to using cryptocurrency over your standard government-issued currency.
- Low transaction fees. Because miners are simply rewarded cryptocurrency from the network itself, there are typically little to no fees for core transactions.
- Ownership. With your digital key, access to your currency is yours alone. Unlike money you store at a bank, your use of your cryptocurrency cannot be frozen or limited by any entity.
- Identity protection. Paying with credit or debit cards requires submitting sensitive banking information that could be stolen or compromised. Cryptocurrency can be sent directly to a recipient without any information other than total amount you want to send.
- Accessibility. Billions of people can access the Internet, but not everyone has access to banks or money exchange systems. Cryptocurrency requires no bank or line of credit to make or receive payments electronically.
- Risk-free for sellers. Payments using cryptocurrency can’t be reversed, which means merchants don’t have to worry about stopped payments. The blockchain makes it difficult for you to be defrauded.
Are there drawbacks to using cryptocurrency?
Aside from the difficulty of understanding the concept of cryptocurrency itself, there are a few drawbacks to using it:
- General awareness. More people and businesses are starting to accept cryptocurrency, but it’s a small number compared to those accepting debit and credit cards.
- Volatility. Cryptocurrency exchange rates can vary greatly. Which means the amount you pay or receive one day could be wildly different the next. The market should eventually settle down, but it’s hard to predict where the rates will be.
- Newness. Even popular bitcoin is new and growing. It could take time before the various cryptocurrencies reach their potential. Similarly, some may fall by the wayside, while others come to dominate the market.
What’s the most popular cryptocurrency?
Among the burgeoning 700 cryptocurrencies in use at a time are the heavy hitters of the market. These popular ones are those you’ll be able to spend more easily.
- Bitcoin. The original cryptocurrency, bitcoin is also the most valuable. Its good reputation and large user base have cemented it as the leader for now. It’s entering the mainstream and can even be spent at retailers like Amazon and Victoria’s Secret.
- Blackcoin. A proof-of stake verification system requires users to stake coins from their own wallet for the right to verify a Blackcoin block. If the block isn’t verified, the coins are spent. This makes for a quicker mining process that consumes less power.
- Dash. This cryptocurrency prioritizes anonymity by using “Masternodes” to complete multiple transactions at once. There is no public ledger, which makes it harder for others to observe your savings and transactions.
- Litecoin. Started by a former Google employee, litecoin caught on quickly and is accepted by more retailers than some other cryptocurrency. Litecoin plans on releasing a total 84 million coins — far more than bitcoin’s 21 million.
- Dogecoin. This cryptocurrency created the hash algorithm Scrypt, which was supposed to prevent large companies from monopolizing its mining. That didn’t work, but it still has a large following.
- Peercoin. Its hybrid proof-of-stake/proof-of-work system sets this cryptocurrency apart. There’s also no hard limit on the possible number of coins minted, though it’s designed to eventually attain a 1% inflation rate.
51% attack. An attack on the blockchain, whereby a group of miners controls more than half of a network’s computing power and can refuse to verify transactions and pay users. It hasn’t happened, but it’s a possibility discussed in the market.
Block. Each record or series of records on the blockchain.
Block reward. An amount of bitcoin given to the person who adds a new block to the blockchain.
Blockchain. A digital public ledger on which the entire history of a cryptocurrency is recorded.
Proof of stake. A system that replaces the concept of “mining” with a consensus algorithm, whereby miners put up a stake of their currency to verify a block of transactions.
Proof of work. A hash that is so difficult, it could only have been solved through significant work or power.
Cryptocurrencies offer a new way of storing and spending money anonymously and without the use of a centralized bank or financial institution. The technology is relatively new, and so it’s not yet widely understood or accepted as a means of payment. But it’s growing quickly and could be an important method of financial transactions in the future.
Frequently asked questions
Is cryptocurrency legal in the US?
Yes, owning and spending cryptocurrency is legal in most of the world outside of India and China.
Can I make money mining cryptocurrency?
Yes, but you are more likely to make money by joining a mining pool. Due to the cost of mining for some of the most popular cryptocurrency, like bitcoin, many miners join mining pools that combine resources and split the block reward.
If it’s not regulated by a government, what decides a cryptocurrency’s value?
Supply and demand: As demand increases, so does the value of that cryptocurrency. Most cryptocurrencies have a finite amount distribution, so the value fluctuates sometimes wildly based on demand or lack of demand.