Things You Need to Know to Better Understand Cryptocurrency

Cryptocurrency.

Exactly what you know about it and how to better understand it is pretty much a non-negotiable. There are more than 900 cryptocurrencies available in the world, the most famous of which is Bitcoin.

Though there’s an illustrious amount of cryptocurrency, there are very specific types that lead the way in terms of worldwide use and value. Here’s a list of the world’s leading cryptocurrencies, per the April 2017 calculations of investment website Investopedia:

  • Bitcoin
  • Litecoin
  • Ehtereum
  • Zcash
  • Dash
  • Ripple
  • Monero

Each one of these cryptocurrencies has their own features that make them unique and each of them tend to have a slightly different focus.

What unites them is that they’re all decentralized – there’s no single company running the show – and they’re open source, which means users update and strengthen the currency’s networks and infrastructure.

All that could sound pretty confusing if you’ve never read about cryptocurrency before. The goal of this guide is to help you understand the things you should know about cryptocurrency, much of which we’ll explain through the story of Bitcoin:

  • When and why cryptocurrency started
  • How it works
  • Cryptocurrency security
  • How you can get it without mining
  • Can you insure it?
  • How safe are exchanges?

When and Why Cryptocurrency Started: Bitcoin Was the First High-Profile Digital Currency

While other forms of digital currency had existed up to that time, Bitcoin was the first cryptocurrency to take hold and gain significant national and international attention.

The founding of Bitcoin started in 2009 among developers and coders who were looking for a way to use currency without government or banking oversight, not unlike how/why other cryptocurrencies. One person, in particular, led the charge: someone with the alias “Satoshi Nakamoto.”

The group’s main beef with the way that money was set up was that the government could track you based on what you spent.

Meanwhile, banks were charging you significant premiums to transfer money internationally. These banks were inefficient, too: even transfers between U.S. bank accounts took at least one day between customers of the same bank.

This small group of forward-thinking developers and coders figured there had to be a better way to do money. So, they came up with Bitcoin as a solution for that. It was kind of like the Uber of money, with one key difference: There wasn’t one company controlling anything.

Bitcoin was a decentralized way to generate money, pay for things and build wealth. There wasn’t one government, bank or company overseeing and tracking transactions.

Rather, computers all across the world tapped into the Bitcoin network and, when new Bitcoin transactions happened, they verified the transaction and added it to the Bitcoin blockchain, which is basically like a massive running ledger of Bitcoin transactions.

Cryptocurrency like bitcoin has a limited number of currency units that will be released, unlike paper money, which can be printed at any time the government sees fit.

The idea here is that a limited amount of currency increases the currency’s value and guarantees that value won’t be watered down by government-controlled rollouts of more currency.

How Cryptocurrency Works: Mine It, Record It, Use It

Nakamoto and his colleagues devised and fine-tuned the process of finding Bitcoin, a process that is reflected, in one way or another, the way most cryptocurrency is initially introduced to the market: mining.

Bitcoin are buried online via complex math equations not unlike complex codes, which is where the “crypto” in “cryptocurrency” came from. The first computer on the network to solve a coin’s equation won that coin.

At first, it didn’t take a crazy amount of computing power to mine Bitcoin. There weren’t that many computers on the network, so there weren’t that many people competing for coins.

Over time, though, mining required high-powered machines that, instead of being designed to do a bunch of things, were designed specifically for mining Bitcoin. This specialization led to increased pricing on mining machines.

Once these Bitcoin are uncovered, the transaction is confirmed by other computers on the network.

When there is a majority decision among these computers that you are, in fact, the person who mined the cryptocurrency, the transaction is logged on the blockchain.

Pro tip: Various cryptocurrencies differ slightly in how some of the above concepts work but share the same overall concepts and methodology.

Cryptocurrency Security: Virtually Anonymous and Protected by a Unique Security Feature

Your Bitcoin or other cryptocurrency is stored in what basically amounts to an online wallet. Your currency is protected by a security feature only you have access too.

Bitcoin’s security feature is called a private key and is necessary for users to make Bitcoin transactions, while Monero uses something called a “ring signature.”

Because security measures like private keys and ring signatures are unique to you and don’t reveal your identity, you can freely use your cryptocurrency, in theory, without anyone finding out who you are, where you live or how much coin and cash you’re moving.

It’s pretty much like a super-complex form of your house key. If someone randomly found your house key in the wine aisle of Target, they’d have no way of knowing which house you live in just based on the key. Nor would the key reveal anything about your personal information.

However, remember that your private key and ring signature and other access methods are absolutely essential to accessing your cryptocurrency just like a key is essential to opening your front door.

If, for one reason or another, you don’t have a backup of your key, ring signature or other access method and something catastrophic happens to your account or computer, you could be out of luck.

How Cryptocurrency’s Value is Determined: Demand and Disaster

One of the issues that early adopters of Bitcoin encountered was value. How does the value of a currency increase if only a limited number of people know about it?

For example, the early users of Bitcoin experimented with the currency’s value by offering tens of thousands of Bitcoin in exchange for someone delivering them a pizza. Other users offered stickers and various sundries in exchange for Bitcoin.

Because the cryptocurrency stayed within the ranks of software-savvy users, there wasn’t much demand.

However, that demand increased a couple of different ways, each of which will give you insight into cryptocurrency’s value.

Nathaniel Popper, author of “Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires Trying to Reinvent Money” (a must-read, btw), pointed out that the rise of a black-market website named Silk Road as well as the presence of cryptocurrency exchanges are what brought Bitcoin its value.

Without getting into too much techie detail, a guy in Texas started Silk Road as a way to sell mushrooms – the kind that make you high, not the kind you use in chicken marsala.

The site could only be accessed through a secure web browser, making it a good way for people to buy and sell anything they wanted without being traced by law enforcement. And what better way to buy hard-to-trace items than with a virtually untraceable currency?

Soon, Bitcoin was the premier currency for buying items on Silk Road. This popularity increased Bitcoin’s value because it provided supply for Silk Road’s currency demand.

On top of that, several different people in the United States and abroad created exchanges, which were basically places where you could buy and sell Bitcoin. These exchanges provided an easy way to acquire Bitcoin.

The easier it was to get cryptocurrency through an exchange, the more demand that could be created. As the demand rose, so did Bitcoin’s price.

Here’s the downside to this, though. Cryptocurrency’s value is determined by this kind of crazy crowdsourced demand, which means if the crowd gets spooked by something, the value of a particular cryptocurrency could drop.

For example, if an exchange is hacked or crashes, cryptocurrency has a history of plummeting in value in a matter of hours. It has, as history shows, rebounded. But that type of volatility among cryptocurrencies is what can scare people off (more on this later).

It’s definitely a legitimate concern, as hacking will always be a possibility. Exactly how much a hack of your particular cryptocurrency’s exchanges or wallets affects the currency’s value is up in the air. A lot of that depends on the breadth of the hack, exactly how much is stolen and whether or not fake cryptocurrency was created to drive down the price.

How You Can Get It: Services, Sales, Exchanges and Faucets

Cryptocurrency is available through a variety of ways once someone has mined it.

Pro tip: Ripple is one cryptocurrency that doesn’t require high-powered mining machines.

Getting It for Services and Sales

Much like startups who offer stock to contractors and employees instead of salary, you could earn cryptocurrency for providing a person or a company with services.

Another way is to sell something and get paid with cryptocurrency. As we mentioned earlier, this principle at work in Silk Road is what many would argue gave Bitcoin the momentum it needed to lead the cryptocurrency charge.

Buying It Through an Exchange

Remember how we said exchanges are places where you can buy and sell cryptocurrency?

Exchanges were and remain to be the most popular ways to buy cryptocurrency. These exchanges work like those little booths in the airport that exchange currency for you. You give them dollars, for example, and they give you Bitcoin.

When you’re choosing an exchange, the site’s reputation (stability), fees (cost) and verification process (security) should be your priorities, according to the experts at Blockgeek.com:

“The best way to find out about an exchange is to search through reviews by individual users and well-known industry sites,” Blockgeek wrote. “Before joining, make sure you understand deposit, transaction and withdrawal fees. Fees can differ substantially depending on the exchange you use.”

Faucets

Faucets are websites that give you free cryptocurrency for doing simple things like entering the address of your wallet. These sites tend to have limits on how much free currency you can get within a certain amount of time.

In the case of Bitcoin, one coin is worth a lot of money – more than $4,000 at the time of publishing.

Faucets won’t give out full Bitcoin; they choose to use fractions of Bitcoin called satoshis. One satoshi is worth 0.00000001 Bitcoin.

How You Can Insure It: Depends on the Site

When you put cash in a bank, your money is most likely guaranteed by something called FDIC, which stands for Federal Deposit Insurance Corporation.

This means that, in the event that your bank goes under, you’ll be reimbursed for up to $250,000 of what was in your accounts.

Cryptocurrency is a different ballgame. There is no FDIC for your cryptocurrency wallet, mainly because the concept of government control or oversight goes against the founding principles of cryptocurrency.

However, even though you can’t get FDIC insurance on your wallet, the reputable exchanges tend to have insurance policies that cover you if something catastrophic happens to the site.

We’ll use the Coinbase exchange as an example. According to their website, unless someone compromises your individual account, your money is insured.

“If Coinbase were to suffer a breach of its online storage, the insurance policy would pay out to cover any customer funds lost as a result,” their site says. “The insurance policy covers any losses resulting from a breach of Coinbase’s physical security, cyber security, or by employee theft.”

As we mentioned a few seconds ago, Coinbase won’t reimburse you if, for example, someone hacks into your account and steals your money. The security of your account is on you, so make sure you’ve got a strong password.

How Safe Are Cryptocurrency Exchanges and Wallets?

This is a tough question to answer because some of the biggest Bitcoin hacks in history affected average people as well as big companies.

Our instinct would be to say that, if you’re a small-time bitcoin owner with one or two coins, you’re safer than, let’s say, someone who has hundreds of thousands of dollars of the stuff in your Coinbase accounts.

The first major Bitcoin hack scandal came about in 2011 when hackers snuck into Mt. Gox, an early Bitcoin exchange that, along with Silk Road, helped boost the currency’s value.

The hackers created fake Bitcoin; enough to dilute the value of Bitcoin. The hackers then bought a bunch of Bitcoin at the diluted value. The price of Bitcoin bounced back and the hackers made a considerable amount of money.

From there, several high-profile Bitcoin hacks took place, all of which are detailed pretty well in an article from Hacked.com.

Bitcoin hasn’t been the only victim, though. A pair of high-profile Ethereum hacks took place in 2016 and 2017, totaling more than $80 million in stolen cryptocurrency.

The Ethereum hacks, in particular, summarize the dangers and safety of digital currency. The 2017 hack resulted in the loss of more than $50 million in “ether,” the name of the cryptocurrency traded on the exchange.

Hackers exploited a weakness in ether wallets to steal the money. True to cryptocurrency’s open-source nature, though, a group of coders called the White Hat Group (WHG) used the same weakness the hackers did to take ether out of all vulnerable wallets and stored them in WHG’s wallet until the vulnerability was fixed.

Take a moment to consider the fact that the recent hacks related to American banks resulted in the theft of personal information, not money.

These types of attacks on American banks points to something that highlights the difference between cryptocurrency and cash stored in banks: information.

As we talked about earlier, the foundation of cryptocurrency is to provide people a way to freely move money anonymously, without government or banking oversight.

Those who hack cryptocurrency exchanges are more worried about money than they are about personal information because there really isn’t that much information to take in the first place and, certainly, there are no troves of addresses and social security numbers.

Our Conclusions About Things You Should Know About Cryptocurrency

Based on our research of cryptocurrency and Bitcoin’s history, we believe there are a few things you should know as you decide whether or not to invest in digital currency.

First, the cryptocurrency world is still growing. There are new types of currency emerging every year. Inevitably, some will be reliable and some will not. Likewise, some exchanges are reliable and others may not be.

If you’re just starting out in digital currency, stick with a reputable, well-known site like Coinbase. Yes, you’ll be charged fees – 4% for every buy and sell – but the site, according to experts, is an excellent place to start buying and selling Bitcoin and other currency.


J.R. Duren

J.R. Duren is a personal finance reporter who examines credit cards, credit scores and bank products. J.R. is a three-time winner at the Florida Press Club’s Excellence in Journalism contest and his advice has been featured in MSN and Fox’s money sections.


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