What are cryptocurrencies?
The beginner's guide
5 min read
Cryptocurrencies are the currencies of our current time. They are not controlled by a bank or country like traditional currency is. It's the money of the future!
Cryptocurrencies are rising in popularity every year! But you probably wonder why? In this post, I love to tell you what cryptocurrencies are.
I'm not a financial advisor, so I will tell you everything in a simple way so every non-financial-guru understands what cryptocurrencies are.
What is a cryptocurrency
You can split the word cryptocurrency into two parts. Crypto and currency. To understand what it is we have to check them both.
In order to be able to understand what cryptocurrencies are we have to understand a few terms: currency, cryptography, centralization, decentralization, and blockchain.
What is the definition of currency is basically money?
Currency is a medium of exchange for goods and services. In short, it's money, in the form of paper or coins, usually issued by a government and generally accepted at its face value as a method of payment. Source: Investopedia
There are so many currencies in the world, we can't count them on two hands. Dollars, euros, pounds, yen are all currencies that are used in different regions of the world to buy goods. They all have a different value and are issued by a government.
Our money is also called fiat currency, this is because it is backed by nothing. So money can be printed endlessly. (Learn more about this via this video by ENDEVR)
The simple definition of it is:
Cryptography is the science of protecting information by transforming it into a secure format. Source: TechTerms
What do cryptocurrencies have to do with cryptography? Well, cryptocurrencies don't have a central system where all transactions are handled. They have a decentralized system that runs on multiple computers around the world. This is called the blockchain, which is using cryptography.
Centralisation, decentralization, and the blockchain
To understand why cryptocurrencies are different we have to understand a bit how our current financial system works. So how does our money flow and what happens when you transfer money to the other side of the world?
In the world, we pay in different currencies. Each currency has its own value. Each currency is controlled by a central bank. If you pay in USD that system is controlled by the US government, if you pay in Euro's that's controlled by the European Central Bank.
This is what we call fiat money. But what do we mean by that?
- Fiat money is a government-issued currency that is not backed by a raw material (commodity) such as gold and silver.
- Fiat money gives central banks greater control over the economy because they can control how much money is printed.
- Most modern paper currencies, such as the U.S. dollar, Euro, are fiat currencies.
- One danger of fiat money is that governments will print too much of it, resulting in hyperinflation.
If we want to transfer money to the other side of the world, our money flows through several systems (currencies) and banks. It may take days or weeks that the other person receives his or her money. In the meantime, the value of your money can be increased or decreased because the value is changing. Next to that, if your money goes through some different banks, they will take the fee of the total amount.
So if you had sent 100$ to the other side of the world, and 100$ had a value of 10556,30￥, the person on the other end would not receive that amount. But received a lot less because of the fluctuation of the value and the fees.
That's a sad thing right!
For the financial professionals, yes that is a lot more details for this, but that's not the goal of this article.
Now we know that we understand how our current financial system works in general, we can see how a decentral financial system works.
A decentralized financial system doesn't control your money from a single point like a centralized system would do. The money is also not created from one single point but is created by the crowd (mining).
Basically, a decentralized financial system is more democratic than our current fiat system.
Also, transactions are not processed by a single system, it's processed by multiple computers in a huge network, this is what we call the blockchain.
All the transactions on the blockchain are verified by multiple computers. The computer that did the verification first gets a reward. This is how for example Bitcoin is created.
It is super important that you store your Bitcoin, Ethereum, Cardano, or other cryptocurrencies in a safe way! I use the Ledger Nano S myself.
Also, transactions are not processed by a single system; multiple computers in a huge network process it. This is what we call the blockchain.
Multiple computers verify all the transactions on the blockchain. The computer that did the verification first gets a reward. This is how for example, Bitcoin is created.
This financial system is not based on trust in a bank or government but based on proof. That’s why all transaction in the blockchain have their own id (a unique computer-generated string of characters), the previous transaction's id, and some more data in it.
So everyone who wants to validate a transaction can check it.
The video by Simply Explained has a great visualization of how it works.
The most exciting thing about cryptocurrencies is in my opinion that it's more democratic than our current fiat currencies. But there are a lot more things you can do with cryptocurrencies, in the next series of posts I want to dive into more of the specifics.
If you like to get started with buying cryptocurrencies, then I advise you to do more research and find an exchange that is reliable. I have a great experience with Bitvavo, so check them out if you like.
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