A beginner’s guide to understanding cryptocurrency
TL;DR: To understand cryptocurrency, we explore the basics in this blog. We go over how a transaction takes place, how people use cryptocurrency, and some of the most common misconceptions around this new financial phenomenon.
Much is said about cryptocurrency. Even after several years of working in several crypto projects, I find the topic incredibly interesting, enriching, and complex. It’s sort of a rabbit hole with endless possibilities and applications. What I want to do in this post is go over some of the basic concepts behind cryptocurrency and why this technology has so much potential.
The basics of understanding cryptocurrency
In short, cryptocurrency is digital money. It still works as a value exchange, but it doesn’t need to be issued or maintained by any central authority or bank. Cryptocurrency is a more specific version of a distributed ledger, which is also an important concept on the topic.
A ledger is a list or database. I want to note that a ledger for crypto isn’t radically different from a ledger in the traditional sense. It’s used to record items. However, a user can no longer change a record once it is inserted into the list.
A distributed ledger means that no central authority maintains that list or can add records to it. Distributed ledgers are consensually shared across multiple sites, whereas centralized ledgers require a single point of entry. It’s helpful to think of distributed ledgers as records that allow people to build many items.
How does a transaction work
The transaction process depends on the type of cryptocurrency you’re using. And this, at the same time, depends on the type of ledger. However, most popular cryptocurrencies work through a Proof of Work, which is a consensus mechanism used to record transactions. The word “consensus” is key because there are no overarching entities overlooking the transactions.
In a transaction flow, a person first submits a specific amount of money to another entity. This sum transfers to different nodes or computers that add to the ledger. Nodes can submit transactions to the ledger in large chunks called blocks. Each of these blocks is bundled together, forming a chain. Hence “blockchain”.
To find out the order in which we need to process these blocks, nodes will identify each block using a cryptographic hash function. The system will continually compute hashes until the block fulfills certain arbitrary criteria. Such a criterion is also variable and depends on how many nodes are attempting to insert a block.
Let’s say a node wants to notify a new block that is on the chain. If your first node meets all necessary criteria, it may alert other existing nodes. These nodes, in turn, will load the required information and notify other nodes along the chain. A simple notification spiderwebs until it’s out on the chain for everybody.
How do people use cryptocurrency?
If you’re not going to mine cryptocurrency yourself, which is a concept we’ll explore later on, and you want to purchase it just as you would use fiat currency (or government-issued currency), you need an on-ramp. An on-ramp is an exchange that allows you to trade fiat currency for cryptocurrency.
This system works just like a stock exchange. You have a market of folks who want to sell crypto and another market wanting to buy it. If a bid matches a buyer to a seller, the set value will be transferred just like an in-person transaction.
When trading cryptocurrency, monetary policy, inflation rates, or economic growth do not apply. Therefore, a number of factors determine the price point. These include supply and demand, the cost of mining, the number of competing cryptocurrencies, and regulations regarding their sale.
What about mining?
Mining is the action of putting blocks on the chain. When creating a new block, the node that validates the transaction will receive a bounty for adding it successfully. That’s their incentive. Depending on the type of blockchain, you’ll get a certain amount of cryptocurrency every time you find a hash that works.
Most people ask themselves if this works like generating money does. The answer depends on the currency. With Bitcoin, any new value goes to a wallet as soon as you have a new block. In Ethereum, however, the transaction initiator pays a type of tax called “gas”. Once validated, a percentage of the transaction goes to the miner.
Common misconceptions about cryptocurrency
The number one misconception about cryptocurrency is its secrecy. A lot of people think that cryptocurrency fosters illegal activity because of its decentralized nature. However, it’s not as private and untraceable as people think.
Also, the world doesn’t run on cryptocurrency (yet). People who want fiat money need to go to exchanges, which are genuine businesses that follow the laws of the countries in which they operate. In the United States, for example, legislation rules cryptocurrency exchanges in US dollars.
The above is why anyone interested in opening a Coinbase account (a digital wallet) has to provide their personal information. Any entity trading US dollars in the United States will follow what the law indicates. So, to remain truly anonymous, you wouldn’t be able to trade at all. Most countries are already starting to implement laws to regulate cryptocurrency trade.
Understanding cryptocurrency use at Blankfactor
At Blankfactor, we’ve built a wallet application that incorporates cryptocurrency. One of our latest projects is Prontomás, a payment gateway that allows users to pay merchants, get paid from their employers, transfer funds, and exchange for fiat currency – all in a single place.
Imagine wanting to pay with cryptocurrency using your phone and you live or work in a country with a more volatile flat currency than the US dollar. If desired, the platform we created would allow an employer to pay a percentage of a wage in cryptocurrency pinned to the US dollar. Therefore, users may be able to pay for items or transfer money in that specific cryptocurrency.
Great business opportunities exist to implement cryptocurrencies for small and medium enterprises (SMEs) as well as remittances. Using cryptocurrency and digital wallet applications is just one of the many solutions we’ve worked on to provide financial inclusion to different populations.