Breaking Down Cryptocurrencies
When you take your first look at cryptocurrencies like bitcoin, it can make your head swim. I know it did mine. But in this article, we’ll break down cryptocurrencies into bite-sized chunks so you can understand them just as well – or even better — as the cash in your wallet.
First off, if you didn’t get a chance to do a deep dive into my first article of this three-part series on blockchain and cryptocurrencies, no worries. This article will get you up and running on like a crypto pro in no time. (But do take a spin around that article when you get a sec – it’s a good blockchain primer without all the jargon.)
So, let’s get started!
Cryptocurrency is a type of currency category that you’re most likely comfortable with already: Digital currency. Pretty much without exception, most money these days is digital currency.
After all, when you check your bank balance online, you’re looking at a digital representation of your money. And that’s digital currency.
In fact, you could look at cryptocurrency as a distant cousin of your online bank account, digitally speaking.
But unlike your bank account, cryptocurrencies have some unique and exciting features that make them interesting. Here are two important ones.
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Crypto Doesn’t Need Or Want A Central Authority
Unlike your bank account, cryptocurrencies aren’t governed by a central authority, like a central bank. They simply exist on their own without the need of any authority or intermediary.
When I first heard about this, I must admit it was a little scary. No central bank? What is cryptocurrency be worth if it’s not part of a bank?
The answer is: A ton. In fact, the lack of a central authority is one of the features that make cryptocurrencies so attractive.
Why? Because most government-issued central bank money hasn’t been backed by anything of real value – such as gold or similar commodity – for years. That’s why most central bank money is called “fiat” money – money that has value because Big Brother declares it does. (Fiat means “let it be done” in Latin.)
So, the money that we have now only has value because a central authority says it has value. And when that central authority is poorly managed, that money can become worthless. You only need to look at cases of runaway hyperinflation to see how quickly central bank money can lose value.
Cryptocurrency avoids this risk by not needing or wanting a central authority.
In addition, many cryptocurrencies have a fixed supply. And that means they can’t be easily diluted in the future like some currencies can (via money printing or quantitative easing) or like some stocks can (through additional offerings.)
Cryptocurrency Is Built On A Secure “Trustless” Blockchain
The second feature that sets cryptocurrency apart from your bank account is that you don’t have to trust a central bank or any other intermediaries.
Here’s what I mean…
For the most part, central bank money here in the U.S. is safe. The government goes to great lengths to make sure that your money is protected and that you trust that it will remain so in the future.
But in the end, you are trusting that the central bank will take care of your money. You are trusting that it will be a good custodian, that it will account for your monies correctly, that it will protect the software and hardware that houses your digital currency, and that it will always allow you to access your money whenever and wherever you want it.
When you think about it, that’s a lot of trust.
But with cryptocurrencies, you don’t have to do so much trusting. In fact, you don’t have to trust anyone (for the most part) when you use cryptocurrency as an exchange of value (like buying and selling things) or as a way to conduct business (like executing smart contracts).
And that’s because (virtually) every cryptocurrency is built on a technology called blockchain.
In fact, blockchain makes cryptocurrencies virtually bullet-proof. Here’s why…
A cryptocurrency blockchain is a list of transactions that are stored on a network of computers using cryptography. When a transaction is executed, the instructions are written by a computer program to each of the computers in the network. Every computer verifies the transaction is correct and, if so, it is added to the end of the blockchain. Then every computer in the network updates its copy of the blockchain, and the process begins again.
As you can see, you don’t have to trust anyone to make the transaction. Plus, the transaction is verified and then copied on multiple computers using cryptography. With blockchain technology, it would be virtually impossible to steal or cheat. And even if you were able to, there are so many other people watching that you would be discovered immediately and thrown out of the network.
Plus, since the blockchain is stored and duplicated across a wide array of computers – and not centralized on one set of computers like in a bank — if one of the computers fails and the blockchain is lost, one of the other computers will simply step in with a duplicate copy.
No muss, no fuss.
Here’s what’s next…
Today, we took a look at just two of the features that make cryptocurrencies so attractive. There are lots more, and we’ll get to them down the road. In my next installment, let’s dive into what cryptocurrencies really mean to you and your investments.
In the meantime, don’t forget to check out my prior installment on blockchain.