Crypto or cryptocurrencies are becoming more popular but if you cannot tell your Bitcoin from your Cardano or Dogecoin, it can be quite confusing. As more and more people look to invest in crypto, trying to navigate through the complex discussions on blockchains or avoiding outright scams is a challenge. Here in Crypto-Basics, we attempt to outline the core of what defines crypto, how to get involved and how to manage your assets. The first aspect of this is to understand, what is the core of crypto, how is it generated and what is their function and purpose?
The core of crypto
Crypto or cryptocurrencies are a digital form of currency that is by design, decentralised. That is, the information of who owns what, is stored in a Public Ledger, held by all people running the crypto protocol (typically miners or pool owners) and the currency itself is protected from counterfeiting through a very strong cryptographic encryption code. This combination means that Cryptocurrencies have strong systems in place to prevent theft and fraud as transactions within the system have to be consistent with the ledger. The ledger itself consists of the blockchain, which is a record of all the transactions undertaken with the currency. Any attempt to modify the blockchain without the relevant security keys will fail as the distributed ledger will recognise the mismatch in the blockchain.
For the average user, it is enough to know that the cryptography at the core of the currency is what gives it its strength and security. The volatility in the value of the currency is in part related to the fact that as a decentralised currency it is not backed by anything of value in the way that fiat money is backed by the wealth of a country. So the value it has is very strongly coupled to the perception of that value as held by the community.
As a decentralised system, it is the participants in that system who maintain the ledger and the integrity of the transactions. As an incentive to the participants, the cryptocurrency protocol provides rewards for safeguarding the ledger.
How is crypto generated?
The two main mechanisms for making more coins in crypto and generating the rewards described above, is to either demand a Proof-of-Work or a Proof-of-Stake.
- Proof-of-Work is the original mechanism and is the driving force behind all Bitcoin mining operations. Miners perform complex calculations where if successful, they can mint a new Bitcoin which gets added to the amount of available currency. As more Bitcoin is mined, the algorithm increases the difficulty of the calculations and so Miners need to continually improve their hardware to mine efficiently.
- Proof-of-Stake operators provide their own coins as collateral and in return, can earn the right to mint new coins for the currency. The likelihood of getting new coins to mint is roughly proportional the number of coins in a given pool. Once minted, these new coins are then rewarded to the pool of delegators with which the operators have formed a collective. Over time, all delegators in all pools will receive the same rewards although larger pools will receive rewards more consistently.
Cryptocurrency: Function and Purpose
Several thousand cryptocurrencies have been created since the development of the blockchain technology but despite this, there are perhaps only 10-30 main currencies in the Crypto Market, including Bitcoin (in terms of Market share). Bitcoin is clearly the dominant player in the Cryptocurrency Market, followed by Ethereum, and the rest (Cardano, Solana, Tether and others) being more or less equivalent in Market Share. What differentiates these cryptocurrencies is their function and purpose.
Cryptocurrencies can be grouped into different areas with each performing a different role in the crypto ecosystem. Some common groupings include: Store of Value which refers to how Bitcoin is considered a commodity like Gold. Digital Currencies that are designed for buying and selling. StableCoins provide a mechanism to link cryptocurrencies to fiat money by pegging their value to the US Dollar or South Korean Won, for example. Smart Contract Coins allow the blockchain to be programmable, enabling automatic triggers to be implemented directly through the coin network. Utility Coins are designed for a specific function (e.g. decentralised storage or identity confirmation). Exchange Tokens are coins used within a specific cryptocurrency exchange to pay for a variety of costs or transaction fees for example. And, the list goes on.
Many cryptocurrencies can fall under one or more of these categories.
Examples of coins and their functions are:
- Store of Value: Bitcoin
- Digital Currencies: e.g. Bitcoin Cash, Ripple, Stellar.
- StableCoins: e.g. Tether, Diem, USDCoin
- Smart Contracts: e.g. Ethereum, Cardano, DOT, Solana
- Utility Coins: e.g. FIL, CVC
- Exchange Tokens: e.g. BNB, UNI, SUSHI
As always, NeoCasbah is not offering financial advice, nor are we financial advisors. CryptoCurrencies are inherently volatile and your assets are at risk. At NeoCasbah, our intention is to help you navigate the Crypto world so that you know where to start looking for answers. Everyone is different, so find what works for you. Stay safe!