Cryptocurrency can be simply described as an internet-based medium of exchange that utilizes cryptographic functions to carry out financial transactions. Cryptocurrencies use blockchain technology to gain decentralization and transparency. The most important characteristic of a cryptocurrency is that it is not controlled by any central authority, rather, its decentralized nature makes it theoretically immune to the conventional old ways of government interference.
How does cryptocurrency work?
Firstly, cryptocurrencies were invented as a result of the invention of Bitcoin, the first and still the foremost cryptocurrency. It was invented by Satoshi Nakamoto. Although he never intended to create a currency, he developed a “peer-to-peer electronic cash system that prevents double-spending” something many failed to create before the advent of digital cash. The most important part of this invention was that he found a way to build a decentralized digital cash system. Before Nakamoto’s invention, there have been many attempts to create digital money which have all failed. After seeing all the centralized attempts fail, Nakamoto tried building a digital cash system without a central entity, something that strictly involves peer-to-peer sharing. This birthed Cryptocurrency.
To acquire digital cash, you need a payment network with accounts, balances, and transactions, but one major problem every payment network has to deal with is preventing Double spending. To prevent double spending, usually, a central server that keeps records of accounts, balances, and the transactions involved is required. On the other hand, when making use of a decentralized network, you don’t have this server. Instead, every entity of the network does the job. Every member of the network possesses an up-to-date list of all transactions to check if future transactions are valid or a case of double-spending. These records are important because if any of the peers of the network disagree about only one minor balance, the transaction chain is broken. There is a need for an unwavering consensus.
In a centralized system, a central authority declares the current state of the balance, but how do you achieve consensus of transactions in a cryptocurrency blockchain. A transaction that involves cryptocurrencies is verified through a universal crypto consensus process called Mining. After verification, the details of the transaction are added to the blockchain. Confirmation is an important concept in cryptocurrencies. More so, as long as a transaction is unconfirmed, it can still be forged. But as soon as it is confirmed, it can neither be changed nor reversed. It is important to note that, only miners can confirm a transaction as this is their primary assignment in a cryptocurrency network. They accept transactions, confirm them as legit, and pass them through the network. For this job, miners are rewarded with a token of cryptocurrency.
What drives the Cryptocurrency Market?
Cryptocurrency markets move by supply and demand. However, due to their decentralized nature, they tend to remain free from the economic factors that affect the fiat currencies. The following factors can have a significant impact on the prices of cryptocurrencies
- Media efforts: the portrayed media image and the amount of coverage affects the stability and market surge of cryptocurrencies
- Events: Events such as economic setbacks, regulatory updates, and security breaches have a role to play in the market situation of the crypto
- Market capitalization and Initial Coin offering: the current value of all the coins in existence and how their users project the development over time dictates the rate of trade between peers.
- Supply: the number of coins and the rate of trading and losses affect the flow of crypto
Risks of Cryptocurrency Investments
- Hacks and Theft: It is a widely known fact that a considerable number of cryptocurrencies are stolen every year. For instance, in 2018, an overall amount of 1.7 billion dollars was stolen, and that is just a year. The has been the most significant problem that cryptocurrency hasn’t been able to avoid, the problem of security. Passwords can be stolen or hacked, hardware can be corrupted or taken. At times, the people you do business with could be loose in their security causing a loss in your assets during transactions.
- Fluctuations of value: The use of cryptocurrency to make payments for goods and services comes with some risks. For example, bitcoin, since its inception, has gone from zero to about $20,000 for 1 bitcoin in December 2017. However, the current value of bitcoin as at the time of this paper is around $7k. Although the extreme price changes are becoming normal, the problem remains that these changes increase the risks of using cryptocurrency.
Risk Minimization and Management
Don’t put all eggs in one basket: No matter how tempting and promising a particular trade opportunity looks, it is never a good idea to place all your worth on the line. The volatile nature of cryptocurrency means any trade, even if it seems very perfect
- Don’t put all eggs in one basket: No matter how tempting and promising a particular trade opportunity looks, it is never a good idea to place all your worth on the line. The volatile nature of cryptocurrency means any trade, even if it seems very perfect can collapse and result in a significant loss. Therefore, it is advisable to invest in 4 or more different coins.
- Hedging: Hedging in cryptocurrency plays the same role as in traditional finance which is offsetting potential losses against a companion investment. It is simply done to minimize the chance that your crypto assets will lose value. It is similar to insurance.
The Future of Cryptocurrencies
After a slightly sluggish start, which is becoming rapidly forgotten, cryptocurrencies have gained stability and acceleration. More tokens are being created, more than 1000 at the last count, and as of now, no one knows the exact figure of cryptocurrencies as more people are getting on board. It is now looking like an economic status quo disruptor to the extent that some countries such as Russia have considered banning bitcoins meanwhile Switzerland has become a Crypto Valley because of how it has embraced the crypto technology. Now that cryptocurrency assets are becoming more widely accepted, and payment cards are allowing crypto owners to use their funds for real-world purchases, and this is not restricted to online transactions only, we are fast approaching the state of general acceptance. More so, with the current trend, digital currencies could soon become interchangeable with fiat currencies and get to a point of total replacement. Economic analysts have projected that we are fast approaching a cashless society and if that becomes the case, today’s cryptocurrencies will provide the foundation for all other currencies to be formed. Therefore, the earlier the cryptocurrency investment, the better prepared one is for the cashless world that is to come.