August 20, 2019
As the stock market becomes increasingly fickle, some investors are shifting their assets toward cryptocurrency to add diversity to their portfolio. Following crypto price trends can be confusing, and many people don't understand what it even is. Some supporters see cryptocurrency as the future of world trade, while others see it as a glorified Ponzi scheme designed to fleece the masses. This article is intended to provide a bias-free explanation of virtual money, allowing readers to decide for themselves whether digital investments make sense for them.
What Is Crypto?
A cryptocurrency may be defined as any digital medium of exchange that can be used to transfer value from one person to another. In essence, it works the same way as a traditional money system like the American dollar. Unlike major world currencies, however, digital monies generally have no regulatory authority dictating their value. As a result, market forces can drive significant price fluctuations on a day-to-day basis.
Most cryptocurrencies are measured in units such as BTC (Bitcoin) or ETH (Ethereum), with the terms "token" or "coin" used in more general discourse. Just like you can get change for a dollar, it is possible to spend fractions of a token if it is worth more than the product or service you're purchasing. Most crypto coins are associated with their own blockchain, the underlying technology that the entire system runs on.
What Is the Blockchain?
The blockchain is a decentralized public ledger that records every transaction a given token is involved with. Transaction data is stored on "blocks" that are "chained" together, allowing each individual token to be traced through every account it has ever been in without compromising any individual user's security. Here's how it works:
Every transaction on the blockchain includes three pieces of information: Output, Amount, and Input. The Output is simply the recipient of the funds. It is the wallet, or account, number that's listed, preserving the privacy of individual users. Every wallet consists of two random strings of characters: a public-facing "username" that identifies individuals on the blockchain and a private key (or password) used to authorize transactions.
The Amount is simply the amount of crypto exchanged. Every token has its own minimum amount. For example, the smallest amount of Bitcoin that can be exchanged is a "Satoshi" worth 0.00000001 BTC.
Finally, the Input is the source of the funds transferred to the Output address. This is NOT the wallet that the funds are coming out of, but instead the wallet or wallets that originally transferred the funds to the wallet that is now sending them elsewhere. For instance, if Leo gave Chris 50 BTC that the latter is now giving to Ben, Leo's wallet is the Input of the Chris-Ben transaction.
That might seem like convoluted record-keeping, but it's actually a security feature. Volunteer miners use powerful computers to ensure that every new transaction is performed using tokens that are coming out of the accounts they're supposed to be in, meaning that you would need to hack multiple points of the blockchain simultaneously in order to add new coins to the system. Suspicious coins can also be traced back to their origin point, allowing unscrupulous accounts to be flagged and monitored.
What Determines A Crypto Token's Price?
With no central regulation, market forces such as supply and demand are the sole determinants of a cryptocurrency's price. On the supply side, every token has a planned circulating supply. Tokens with smaller circulating supplies tend to support higher prices per token, while larger circulating supplies mean lower prices per token. This means that investors tend to like Bitcoin, as only 21 million BTC will ever be in circulation. In contrast, Ripple has a planned circulation of 100,000,000,000 XRP, meaning that the price of one XRP will never be that high no matter what demand might be.
It should be noted that while Ripple's high planned circulation does little for investors, it is useful for those who want to use crypto to complete everyday transactions. It's a lot easier to buy a gallon of milk with a currency worth $1.50 than $10,000, isn't it?
Demand is best analyzed using pricing trends from reliable sources such as CoinMarketCap. You might also want to follow the news, as a trade war or general economic fears can boost crypto prices quickly. Likewise, any talk of new cryptocurrency regulations tends to drive the value of all crypto tokens downward.
Are Cryptocurrencies Secure?
As noted above, the blockchain is extremely difficult to hack. However, exchanges that facilitate crypto transactions can be hacked and cost investors thousands of dollars in virtual assets. One of the most noteworthy examples of this occurred in 2014. Mt. Gox, the most popular exchange at the time, revealed that $473 million in virtual assets had been siphoned off over a period of a few years. The company didn't carry any insurance, and attempts to make their customers whole resulted in bankruptcy.
Today, some exchanges such as CoinBase carry insurance so that you wouldn't lose everything in the event of a similar attack. However, CoinBase also charges larger transaction fees than many other exchanges. It's up to the investor to determine how much risk they are willing to take on. Individual exchanges also offer different token selections, trading types, and funding options, so novice investors should be prepared to do some homework to find one that best suits their needs.
Shady "experts" may also take advantage of the populace's general lack of knowledge to hype up a cheap token and sell it at a substantial profit to the suckers who trust them. It is advisable to avoid potentially-biased information sources such as social media and private forums until you feel comfortable conducting analysis in the space.
The Final Word
There are many other topics that could be addressed, but the information above should prove sufficient to help you determine if crypto investments are right for you. If you're interested in further information, topics such as programmable blockchains, blockchain forks, and transaction processing times are good things to look into.