Cryptocurrency

A cryptocurrency is a digital currency issued on a blockchain that can be exchanged for goods and services like a normal currency. Like normal currencies, cryptocurrencies are fungible, can act as a store of value, and are transferable.

Brief History of Cryptocurrencies

Cryptocurrencies existed long before Bitcoin, but they were not effective. Back then, they were just pieces of code that could be copied endlessly, triggering a superinflation that eventually led to a price crash.

However, Bitcoin was the first cryptocurrency that could be spent only once as the mysterious crypto grapher Satoshi Nakamoto had solved the Double Spending Problem.

This gave birth to millions of cryptocurrencies, including Ethereum, USDT, XRP, and Litecoin, which are currently traded in the markets.

Types

There are several types of cryptocurrencies. A few of them are mentioned below.

Coins

Coins are those cryptocurrencies that serve as the native token on a blockchain. A cryptocurrency is only called native if it can be used to pay transaction fees on the blockchain where it is present.

There are two exceptions to this.

• Base blockchain, which has no native token and uses ETH for gas fees.
• Account Abstraction, a feature that allows gas fees to be paid in any cryptocurrency.

Tokens

Tokens are those cryptocurrencies that cannot be used to pay gas fees in that chain. These are multi-chain cryptocurrencies and have been either bridged or minted on the blockchain they exist.

Fungible Asset Tokens

These are new asset classes where traditional assets like real estate, stocks, rights, bonds, and other assets have been tokenized (converted into a blockchain token) for ease of trading.

How Does it Work?

Cryptocurrencies work using blockchain, a decentralized ledger where every network member has access to see every transaction on the blockchain. The collective watch avoids problems like double spending and allows cryptocurrencies to be spent only once, like real currency.

Below is a stepwise explanation of how this works.

Each cryptocurrency network consists of two types of members: transaction verifiers and ordinary users.

1. An ordinary user generates a transaction on any blockchain, but only if they have sufficient balance in their account.
2. Once it is generated, it is sent to a transaction verifier (called a miner or validator).
3. Verifiers then see if the transaction is genuine by checking account balances and running computations to validate the transaction.
4. Once done, they then broadcast all transactions to the entire network in batches called blocks.
5. Multiple verifiers then verify this transaction individually, and it is considered valid only if all or most of them agree on its validity.
6. Once a transaction is found to be valid, it is added to the blockchain in batches (block by block) and the end user receives the cryptocurrency in their blockchain address.

Advantages and Disadvantages

Advantages of Cryptocurrencies:

• Fast and Low-Cost Transactions: Almost all cryptocurrencies allow for near-instant transfers at lower fees compared to traditional banking systems. Exceptions being Bitcoin and a few other slow cryptos.
• Efficient Cross-Border Payments: Sending money across borders is faster and more affordable, bypassing expensive intermediaries like remittance services. When I used to receive money from international clients, I had to pay PayPal a hefty fee and had to wait for 2 days for the money to arrive.
• Decentralization: There is no need for central authorities such as banks or governments to reduce the risk of censorship or manipulation.
• Anonymity: All cryptocurrencies offer some privacy features, allowing users to transact without revealing their identities. There are privacy-focused cryptos as well like Monero.
• Permanent Record of Transactions: All transactions are recorded on the blockchain, providing transparency and immutability, as once they are confirmed, they cannot be altered or deleted.

However, they also do have some downsides:

• Facilitation of Criminal Activities: The anonymity can be exploited by criminals for illegal activities, making it difficult to track and prevent on-chain fraud.
• Steep Learning Curve: Understanding how cryptocurrencies and blockchain technology work can be overwhelming for newcomers.
• Lack of Regulation: The difficulty in regulating cryptocurrencies means users may miss out on traditional protections, such as asset insurance.
• Limited Interoperability: Most blockchains are isolated, meaning assets cannot be transferred directly between different blockchain networks without third-party solutions.