With cryptocurrencies becoming more and more popular, an increasing amount of people want to get their hands on a share of the cryptocoin pie. But before you dive into investing or mining cryptocurrency, it’s good to know all the facts. Here are 11 things everyone should know about cryptocurrencies.
1. The Number of Cryptocurrencies
When cryptocurrencies are mentioned, there’s generally one main name that comes to mind: Bitcoin. However, while Bitcoin is the largest cryptocurrency (accounting for around 50% of the market at the time of this article), it’s not the only one. There are currently over 2,000 cryptocurrencies in circulation. With the barrier to market entry so low, that number is only expected to grow. Alongside Bitcoin, the other cryptocurrencies with the highest market capitalisation are Ethereum, XRP, Litecoin, and EOS.
2. The Technology Behind Cryptocurrencies
For many beginners, one of the most confusing things about cryptocurrency is the technology behind it: blockchain. To put things simply, this technology records cryptocurrency transactions in the form of ‘blocks’ which are automatically added to the blockchain. Each block contains both the transaction information and a hash (64-character distillment) of the previous block. As such, this technology is used because it makes cryptocurrency transactions virtually tamper-proof. To tamper with one transaction, you have to change the hash in the following block too. Of course, by the time you’ve done that, there will be another block in the chain—and another, and another. This makes it nearly impossible to ‘hack’ cryptocurrency.
While it is mainly used for the cryptocurrency, blockchain technology does have other applications. Alongside cryptocoin developers, there are several big companies who are testing and using the technology, including IBM and multiple financial firms.
3. The Decentralization of Cryptocurrencies
One reason why blockchain technology has become such a big deal for both cryptocoin developers and big business alike is that it’s so secure. That’s because, alongside the tamper-proof process, blockchain technology is decentralized. As the term suggests, this means there’s no one central source of blockchain information. Instead, small fragments of each blockchain network’s information are stored on servers across the world. As a result, it’s very, very difficult for hackers to manipulate a cryptocurrency, because there’s no specific data centre for them to attack.
4. How Cryptocurrency Transactions are Made
As outlined above, cryptocurrency transactions are made using blockchain technology. Every cryptocoin user has two 34-character keys—their public key (also known as the address) and their private key (which is used to sign off on transactions and must be kept secret). To initiate the process of sending cryptocurrency to another person, you must input your private key, the recipient’s public key, and the amount you want to send into the cryptocoin software. After you’ve done so, the network nodes verify that you currently have ownership of that crypto coin. Once this is validated, the transaction becomes one of the blocks in the blockchain, and ownership of the amount you sent is transferred to the recipient.
5. How Cryptocurrencies are ‘Mined’
One term you’ll hear often in cryptocurrency discussions is ‘cryptomining’, the process through which crypto coins are acquired. Cryptomining is also the process by which cryptocurrency transactions are verified, as mentioned above. During this process, your cryptomining software competes with the software of other users to solve highly complex equations. The first software to solve the equation verifies the cryptocurrency, and in return for their computing power, the software’s owner is rewarded with a small amount of cryptocurrency. Thus, by cryptomining, people can earn money without working for it themselves. However, these days competitive cryptomining requires powerful computer hardware and can quickly run up electricity bills, making it less lucrative than it used to be.
6. How Cryptocurrencies are Stored
While traditional currency is usually stored in a bank, cryptocurrencies technically aren’t stored at all. That’s because they don’t exist physically, instead ‘existing’ only in the form of blockchain transaction records. Of course, there is software that acts as a bank for the cryptocurrency, allowing you to monitor your balance as well as send and receive money. This software is called a ‘wallet’, and it stores the cryptocoin address that keeps a record of your transactions. Wallets can be run from a desktop, online website, mobile app, or even USB-like hardware.
7. How Cryptocurrencies Have Value
One aspect of cryptocurrency that many people struggle to wrap their heads around is how it can hold any value. Since cryptocurrencies aren’t backed by anything physical, who decides what they’re worth if anything at all? To understand how cryptocurrencies have value, it’s important to note that today’s modern currencies are no longer backed by physical precious commodities like gold either. Instead, they are ‘fiat’ currencies—currencies which governments simply declare to be legal tender. While governments and banks do not back cryptocurrencies, they are still valued in a similar way: by public perception. Just like traditional money, cryptocoin has value because we believe it does. Determining its precise value at any given time depends on a number of factors, including the slowing supply and growing demand, the competing currencies, and exchanges like Coinbase.
8. The Legality of Cryptocurrencies
Cryptocurrency is currently illegal in the following countries:
• Saudi Arabia
In all other countries, mining, sending, and receiving cryptocurrency is either legal or only partially regulated. Of course, it’s still not recognised as legal tender by any government, which means the parties involved in a transaction are the only ones who can attest to the cryptocurrency’s value.
Technically, even in countries where Bitcoin and other cryptocurrencies are illegal, it’s very difficult to enforce the ban. As long as you have access to the right equipment, anyone can use these currencies. Of course, if you do intend to do so from a country where it’s illegal, you’ll need to reroute your internet connection through a remote server via a VPN. Using a free VPN in China, for example, will ensure the Chinese government can’t see what you’re doing online, allowing you to mine and trade cryptocurrencies without getting caught.
9. Staying Anonymous with Cryptocurrencies
Many people who are new to cryptocurrencies mistakenly think they’re anonymous. However, a better descriptor is pseudonymous. Every transaction you make with a cryptocurrency is linked to your cryptocoin address. As a result, if ownership of that address is ever attributed to you, so are all the transactions. This is a concern if you’re using cryptocoin to purchase items you wouldn’t want the authorities to know about. Thankfully, there are ways to increase your anonymity. Using a VPN is one possibility, even if you’re not in a country where cryptocurrencies are illegal. You could also use the Tor browser, use a bitcoin mixer, or generate a new public address for every transaction you make.
10. Taxes on Cryptocurrencies
Just because the cryptocurrencies aren’t considered legal tender by the government, doesn’t mean they’re exempt from tax. In most countries, “taxable” income includes any money you’ve received, including via cryptocurrency trading and mining. In the United States, for example, cryptocoin earned by mining is taxable, and the expenses involved (such as hardware and electricity) are deductible. If you sell your coins for more than they were worth when you mined them, you’ll also be taxed on the difference between those values.
11. The Volatility of Cryptocurrencies
As you may have noted after learning about how cryptocurrencies are valued, the cryptocurrency market is inherently volatile. Since they’re traded across various exchanges and easily impacted by factors like media fearmongering, their values can change very rapidly. In fact, Bitcoin has been known to change 10 times as much in price as the US dollar in the same time period. As a result, cryptocurrency trading is not a decision to be taken lightly. It’s important to understand it as well as you can before choosing to invest in it, and never be afraid to ask experts for more advice.