The idea behind cryptocurrency is to provide a decentralized platform that operates independently of any one entity, offering its users a way to control their money without interference from banks and other regulatory bodies.
How Does Cryptocurrency Work?
Curious about cryptocurrency but afraid you don’t know enough to start taking it seriously? Don’t worry; it’s a relatively new technology that will change the way we transact with the world in the near-future in the same way that BitTorrent changed the way large files are downloaded on the internet. Cryptocurrencies operate with a public ledger that records all confirmed transactions created on the network and makes them available for everyone to see. This process keeps 100% accurate digital wallets with an accurate tally of the funds held to prevent double transactions from being registered.
A new currency is created through a process called mining, which is a process that confirms transactions on the network using the miner’s CPU or GPU to perform the calculation. As a reward for their effort and contribution to the network, these miners are awarded a cryptocurrency token according to the rules of the cryptocurrency they are mining. We’ve recently looked at how to go about making your own cryptocurrency, and we can say that anyone can understand the entire process.
But how are there differences between cryptocurrencies and how does cryptocurrency work globally? These rules are very different across multiple currencies, so it’s important to research each one before you get involved so you can understand the process and how the currency plans to support itself in the long run.
How Does Blockchain Work?
A very common term which few actually take the time to explain. Blockchain was developed as the backbone of Bitcoin, but it has far reaching uses that are still being discovered.
Basically, the blockchain is a decentralized ledger that allows digital information to be distributed but not copied. Think of files you download on the internet now. These files are copies that are deposited onto your computer that you can do whatever you like with them. In blockchain distribution, you would not be able to modify these files or share them with anyone else unless they had your authorization key.
The essence of blockchain makes it possible to distribute goods without making copies that can be manipulated. That’s the main idea behind forming a digital currency, but blockchain technology will revolutionize hundreds of industries like construction, healthcare, logistics, transport, shipping, and more.
How Does Cryptocurrency Mining Work?
Remember the mining I mentioned earlier? In your quest to understand how Bitcoin works, you should know that mining is the essential backbone of creating new cryptocurrency. Mining is the only way to create new cryptocurrency and some currencies have built-in rules that limit the number of coins that people can generate as time goes on.
There is a finite amount of time that you can mine Bitcoin. Plus, the rewards from doing so are exponentially halved according to the cryptocurrencies’ rules. As such, mining becomes much harder as time goes on. In the early days of Bitcoin, it was possible to mine coins on consumer hardware using one CPU and one graphics processing unit (GPU).
Bitcoin mining in 2018 requires dedicated machines consisting of hundreds of GPUs working in tandem on the cryptocurrency’s algorithm. This overhead cost of massive computational power means mining consumes tons of electricity and is, therefore, most profitable where electricity is cheapest.
Miners are the genesis of the cryptocurrency they mine. This gives them voting power over changes that come as a proposal for any cryptocurrency protocol. When you think about how cryptocurrency works, remember that miners control the direction of the cryptocurrency with their input.
How Do Cryptocurrency Transactions Work?
In short, when a user creates a transaction on the Bitcoin network, that tells the network they intend to send funds to another wallet on the network. But how do cryptocurrency transactions work, in fact?
The blockchain ledger goes through a scan to make sure the sender has the necessary amount of funds. Moreover, it checks that nobody distributed it to anyone else before the transaction comes to a block for miners to process it. Once the system processed a transaction you can’t undo it or tamper with it as the blockchain needs an accurate representation of asset transfer for future transfers to be accurate.
Transactions go to a cryptocurrency wallet that comes with two long strings of letters. One is the public key that people share with the world to allow the wallet to receive funds. You can’t remove any funds from the account using the public key, only transfer it in.
To transact on a cryptocurrency network, the sender must sign the transaction with their private key. This transaction that people sign joins then the blockchain ledger. Next, miners process it as they work to clear blocks on the network. These types of processes are also called chain transactions, a trending term for today’s investors.
What Do I Need to Do If I Want to Invest?
If this process sounds interesting to know now that you’ve learned how cryptocurrency works, then you might be considering “investing” in this new technology. Before you do that, here are a few key points that you need to know and understand:
Always do your research.
This burgeoning technology is attracting a lot of attention, and not all of it is with good intentions. There have been many cryptocurrency scams that took place over the years with millions of BTC in limbo because of these scams. Be careful with your investment opportunities.
Be responsible with your investing.
Cryptocurrencies by default are considered a high-risk investment because their volatility is through the roof. You should never have more than 10% of your total investments in cryptocurrency at any point in time to help mitigate risk. Think of it as never investing more than you’re willing to lose.
Understand crypto volatility.
Bitcoin volatility is going down right now but it’s highly improbable, based on its history, that it will stay the same forever. But that’s just the Wizard’s opinion, others say Bitcoin is still the most stable option if you want to invest. Still, you need a good heart if you want to survive the ups and downs of the cryptocurrency market. Lastly, we’ve tackled the most volatile cryptocurrencies on the market right now and we have to say – steer clear!
Cryptocurrencies are not a set-it-and-forget-it investment.
Always stay vigilant about the news and any price movements that may be happening with your cryptocurrency of choice. No one likes to be off guard, so understand how cryptocurrency works. Moreover, never share your private wallet key with ANYONE.
Be very afraid of cryptocurrency scams.
As with most of the internet, scams abound in the crypto market as well. From Twitter spambots to totally legit-sounding pump and dump groups, there are traps out there for every investor. Constant vigilance and in-depth analysis are the two main things to keep in mind so you don’t fall for Ponzi or pyramid schemes.
Always track your gains and losses in cryptocurrency so you can understand how you’re performing versus traditional investments. Most countries haven’t started the process of regulating cryptocurrencies. They didn’t set it as a form of digital asset, so capital gains aren’t a concern. However, you will want to keep track of this information for your peace of mind, so you don’t have to worry about dealing with the tax authorities in your country.
Other Things You Should Know
No two cryptocurrencies are alike, even if one cryptocurrency comes from a fork in the other. Bitcoin sets the current gold-standard for cryptocurrency. And this is because it was the first cryptocurrency to exist and established the rules of the blockchain.
Since then, various other software developers around the world have taken the idea of the blockchain. Then, they implemented it in several different ways to get new cryptocurrencies. Ethereum (ETH) appeared as a way to pay software developers for their continued efforts.
Litecoin (LTC) is a fork of Bitcoin that aimed to be more accessible by having larger blocks to mine. Whereas only 1,800 BTC appear per day at current mining rates, there are more than 14,400 LTC generated each day.
Because each cryptocurrency is so different, you will need to research the currencies that interest you. Thus, you can determine whether or not to invest in this new technology.
Cryptocurrency Legal Aspects
The legal aspects of cryptocurrency and its usage are in a very grey area right now. Certain countries are starting to introduce regulations surrounding digital asset ownership. Meanwhile, others seem complacent in letting this technology play out unregulated for now.
Legal Status of Cryptocurrencies in the United States
Inside the United States, cryptocurrency has no regulations. There are no concrete plans before Congress to introduce regulations to this new digital market. The Securities and Exchange Commission (SEC) has issued warnings to investors about the potential dangers of cryptocurrency investing and halted several fraudulent ICOs, but so far nothing has been presented in legislation.
Legal Status of Cryptocurrencies Outside of the US
The legality of cryptocurrency outside the United States varies greatly from country to country. Venezuela is notably attempting to adopt cryptocurrency as a way to avoid hyperinflation by tying the value of their national currency to its Petro cryptocurrency.
That example contrasts the approaches in China and South Korea. China has banned initial coin offerings (ICOs) from raising funds. Moreover, it has even frozen bank accounts associated with popular exchanges in the country. In fact, China is probably the most restrictive country in regards to their cryptocurrency regulations.
South Korean officials are following suit as Korean officials are pursuing regulatory actions to limit misinformation about digital currency exchange. A January report by Reuters even cited Justice minister Park Sang-ki planning to ban cryptocurrencies altogether. Even if he eventually rolled back his statement, advising a more cautious approach, it still sent the market plummeting for a few days.
Much of Europe is debating cryptocurrency regulation as the U.K. Treasury and the EU take aim at preventing anonymous cryptocurrency trading. This is due to fears the currency may help launder money and tax evasion.
As you can see, there are many facets to how cryptocurrency and digital assets operate in our modern world. Your position on cryptocurrency may change according to the country you reside in. However, there is no denying that cryptocurrency and blockchain technology will change the way we think about money going forward.
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