If you feel like you haven’t quite been able to wrap your head around the enigma that is cryptocurrency, this blog is the one for you
What is Cryptocurrency?
Cryptocurrency is any form of currency that exists virtually, using cryptography to secure its transactions.
Rather than using ‘real’ money in the ‘real’ world, cryptocurrency exists entirely within the digital sphere… it is not tangible.
What is cryptography?
Whilst its name makes it seem complicated, cryptography is just a way of encrypting transactions to keep them secure
An Inversion of Traditional Banking
Cryptocurrencies are entirely self-governing, with most being supported by a technology called a blockchain. Every transaction made is automatically logged onto a database referred to as the Blockchain. This Blockchain acts as a kind of digital accounts book, shared amongst numerous computer systems.
This is very different to traditional banking systems which favour a single ledger that only a central authority can access. In short, with traditional banks, you can’t always see what they’re getting up to!
The complete transparency of cryptocurrency is deliberate, made in reaction to the 2008 Financial Crisis.
The Financial Crisis in a Nutshell
Banks and other lenders recycled enormous levels of debt into subprime financial products that were far too complicated for most people to understand. Very few people had access to the books, as access is of course restricted to a central authority.
When the products defaulted, the world economy was hugely affected, which led to massive amounts of money being given to banks to bail them out for the same problems they had caused.
People using cryptocurrencies make direct online payments to one another, cutting out the middle-man of banks and traditional financial agencies.
Now the complicated bit… how does it work?
Today, there are thousands of different cryptocurrencies being traded, so let’s just stick with one. We will use Bitcoin as an example, as this was the first modern cryptocurrency.
Every ten minutes or so, bitcoin transactions are batched into a block, which is then added to the blockchain we discussed earlier.
Adding the new blocks into this shared ledger is called mining, which is the way that new bitcoin are released into its virtual system.
Whoever wins the competition of solving the cryptographic problem can then add the new transactions block to the larger blockchain. They are also rewarded by gaining new bitcoin.
What’s the Catch?
This all sounds good, right? Avoid the banks and take matters into your own hands! But you may want to rethink that, as cryptocurrency is incredibly volatile. It is entirely driven by demand and supply, with no outside regulation from institutions like the Financial Conduct Authority, meaning it has huge fluctuations.
The reason you might have heard stories where people have made their millions off Bitcoin, is because the rewards of cryptocurrencies can be incredibly high. Those who make their millions do so by trading currencies as the rates rise and fall in order to take advantage of the peaks and troughs of the market.
As Isaac Newton said, every action has an equal and opposite reaction. Therefore, the chance of high reward also brings the chance of high losses. In fact, Bitcoin is down more than 50% this year, and is worth just 70% of its highest recorded price. These are not fluctuations to be taken lightly.
Read the Guardian’s interview of former primary school teacher, Duncan, who has faced losses worth £36,000 from investing in cryptocurrencies. If you still want to invest in cryptocurrency after this read, it might be a good idea to avoid putting all your life savings into it at least.
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