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What is Cryptocurrency?

Robert Stevens is a journalist who covers cryptocurrency for Wealthsimple. He has also reported for a variety of international publications including the Associated Press, The Guardian, Vice, and Decrypt. Current areas of interest include the political economy of technology, cryptocurrencies, and privacy. Robert has a Bachelor of Science from UCL and a Master's degree from the University of Oxford's Internet Institute.

The world of crypto is a funny one. On the one hand, billionaires are made overnight, and companies raise billions without even launching a product. On the other, most projects fail, and you can lose your fortune in a matter of seconds. But what is it? How does it all work, and—more importantly—should you invest in it, and how? Bitcoin, Litecoin, Dogecoin…what does it all mean?

Let’s start simple: Bitcoin is a cryptocurrency that, like all cryptocurrencies, runs on a technology called blockchain, a publicly available, decentralized ledger. Basically, this is a big database that records transactions. It’s maintained by everyone who uses the network, can’t be tampered with, and all transactions are recorded on it are public, for anyone to see.

Cryptocurrencies are just one of many use cases for blockchain, a technology that’s used today in almost any industry you can think of, such as real estate, food supply chains, and retail. But when people talk about the cryptocurrency market, they’re talking about trading cryptocurrencies like Bitcoin, Ethereum, XRP, and thousands of others.

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The History of Cryptocurrency

The most famous cryptocurrency, Bitcoin, dominates the market, with over 70 percent of the market cap. Its origin story is vague: Its alleged creator is Satoshi Nakamoto, who released a whitepaper—an academic paper explaining the purpose of the coin—for Bitcoin back in 2008. Nakamoto envisioned a system for a virtual peer-to-peer cash system that was completely decentralized and self-sustaining, unable to be legislated upon by central banks (because there’s nobody running it to legislate against). Rather than a company, its ledger is maintained by a network of so-called “miners”—other users on the network who use their computers to solve computationally intensive problems that confirm the validity of transactions on the network. But following the whitepaper, Nakomoto—who still holds hundreds of millions of dollars worth of Bitcoin—was nowhere to be found. Plenty have claimed to be him, or know him, but his identity remains a mystery.

Despite his anonymity, Nakamoto’s legacy is profound. Bitcoins used to go for fractions of pennies, but Bitcoin massively spiked in price towards the end of 2017 to a value of almost $20,000 for a single Bitcoin—followed by a quick crash in January 2018. Anyone who bought Bitcoins early on got super rich. The Winklevoss Twins, the ultra-alpha brothers who sued Mark Zuckerberg for stealing the idea for Facebook, decided one day to buy almost 1 percent of the entire Bitcoin supply. A big gamble, but it paid off—they’re now billionaires. Others weren’t so lucky. In 2013, one man traded 10,000 Bitcoins, worth $30 at the time, for a single Papa John’s pizza. At today’s price, that’d be the most expensive Papa John’s pizza on the menu, even with its two for one deal.

What is Cryptocurrency Mining?

You can’t have been involved with cryptocurrency or with researching it without hearing about mining. But get rid of images of soot-covered men working in the dark with pickaxes and a canary. Cryptocurrency mining is the way blockchain’s ledgers are maintained.

A blockchain consists of, you guessed it, chains of blocks. Billions of dollars’ worth of transactions take place on the Bitcoin, Litecoin, Zcash, and Ethereum networks (and so on) each day, and every ten minutes or so, these transactions are grouped together and rolled into “blocks,” appended to a “chain” of blocks that go all the way back to the “Genesis Block.”

People running complex software—“miners”—race to validate the transactions in these blocks by completing complex algorithmic puzzles. That keeps the blockchain super secure, because miners have to reach the same conclusion about the transactions on a block for it to be recorded as valid, preventing ne’er-do-wells from fudging the numbers.

Solving these puzzles requires extraordinary amounts of computational power and electricity, and any attempts to game the network by running thousands of miners would be more costly than beneficial. This is why the Bitcoin mining formula is called “proof of work”—the integrity of the miners is established by their willingness to pay in electricity.

Validating a block generates a “reward” of newly minted coins, that the miners get to keep. It’s big business, according to Digiconomist.com, an industry watchdog, Bitcoin mining alone generates almost $6 billion a year. But watch out: The more miners mine for Bitcoin, the more computationally intensive the mining process is. These days, mining computers need them to be very powerful, and many are purpose built.

Mining is an incredibly energy intensive process. In fact, Bitcoin mining’s energy consumption is comparable to the power consumption of the whole of Austria. If you want to get into mining, think about investing in purpose-built computers, or buying cloud computing space in dedicated mining pools.

Legality of Crypto

Cryptocurrencies are legal in most places, but regulators are scrambling to deal with it. The United States’ Securities and Exchange Commission has repeatedly said Bitcoin—and other cryptocurrencies—are not securities.

What you really need to pay attention to, though, are the laws around exchanges—large platforms where you can buy and sell digital currencies. That’s because 99 percent of cryptocurrency trading happens on exchanges, and because you need an exchange if you want to withdraw significant amounts of crypto to fiat. Because of the stringent US securities laws, a lot of coins struggle to reach the American market. For instance, Binance, a major crypto-exchange for the world, based in Malta, lists around 550 coins, all trying to become bigger than Bitcoin. Binance.US, however, Binance’s American outpost, lists just 31 coins.

The cryptocurrency market explained

Most people know about Bitcoin, but it’s just one of many coins on the market. On CoinMarketCap, which lists the coins currently trading, there are 2,400 coins. In part, that’s because it’s relatively easy to create a coin, and there aren’t many regulations. But take that figure with a pinch of salt: Only 900 coins currently trade more than $1 million a day.

By market capitalization, Bitcoin leads the pack—by far—with a current market cap of $144 billion. Next best is Ethereum, with a market cap of about $18 billion. After that, XRP, with $12 billion. But by daily trading volume, it’s a completely different story. It was not Bitcoin, but Tether—a coin pegged to the US dollar—that traded the most. Tether traded almost $20 billion in the past 24 hours, Bitcoin traded almost $16 billion, and Ethereum traded close to $8 billion.

If those numbers don’t make much sense, here are some major coins to keep on your radar:

  1. Bitcoin

    . The boss of cryptocurrencies.

  2. Ethereum,

     

    which is popular with developers, who use the network to build blockchain projects. For instance, Santander recently issued a

     

     

    on the Ethereum blockchain.

  3. XRP

    . Otherwise known as Ripple, because of its creator, Ripple Labs, XPR is popular with banks and payment networks due to low transaction costs and high speeds. Many banks use it to power cross-border payment networks.

  4. Tether

    . Tether is a stablecoin network. If you want to trade crypto that’s worth the same amount of money as the US dollar, consider Tether.

  5. Bitcoin Cash,

     

    a currency that split off from Bitcoin back in 2018 to become its own thing.

Why are people buying these things with actual dollars? Why are they worth anything? Well, it’s mostly because people believe in the market. Most of these tokens aren’t actually backed by fiat-currencies; they have no intrinsic worth. But if people believe they’re worth something, then, they are.

What to do with crypto?

First, you can buy things with cryptocurrencies. Because cryptocurrencies are anonymous, they’re well-known for their use on illegal, ‘dark web’ markets, where people can trade cryptocurrencies for things like drugs or weapons. But the blockchain industry has become far more legitimate in recent years. Cryptocurrencies can be used at an increasing number of retail outlets; You can spend cryptocurrencies at Overstock, Microsoft, and Newegg. And WooCommerce, which handles payments for around 30 percent of online retailers, just added a plug-in that lets you pay with crypto. Some companies even pay salaries in crypto.

You can trade cryptocurrencies on the market. Most trading is done on exchanges—safe bets are industry giants Binance or Coinbase. Signing up for an account is about as easy as joining PayPal. Most accept transfers of cryptocurrencies, but you’ll have to use a credit card or wire transfer if you want to buy with fiat currencies. After this, your website of choice might ask you to verify your identity—usually asking for a passport or driving licence, and then you’re turned loose onto the cryptocurrency exchange, to sink or swim at your own risk. Don’t let pundits confuse you: Pay attention to wider market trends and put your money in the larger, established networks if you want to stay safe.

You can also invest in Initial Coin Offerings (ICOs), where you buy a company’s new coin before it launches on exchanges, in the hopes it’ll become the next Bitcoin. But ICOs are risky. Two hotly anticipated projects, Algorand and Hedera Hashgraph, were expected to become runaway successes this year, following backing by huge companies like Boeing and Deutsche Telekom. But they didn’t: The Algo, the native token of the Algorand network, lost 94 percent of its value in the first three months, and the HBAR, the native token for Hedera Hashgaph, which launched its beta back in September, lost over 90 percent of its value just a week after launch.

Cryptocurrency in Canada

According to a report by the Canadian Chamber of Digital Commerce, crypto is big business in Canada. In fact, workers in the blockchain salary on average make six-figure salaries, and Canada received about $220 million in investments last year. Cryptocurrency is technically not legal tender in Canada, but tax laws still apply to it.

Pros and Cons of Crypto Investing

The benefits of cryptocurrency include the relative ease of entry into the market, the fact that you can buy and sell online, and trade anonymously. Cryptocurrencies can soar in value, and, if you time your trades correctly, you could become as successful as one of the Winklevoss Twins. That’s probably wishful thinking though. For every person that wins big on crypto there are also many losers. Cryptocurrencies are incredibly volatile, and, because the market is based on speculation, it’s very difficult to work out how things will turn out. Most cryptocurrencies are not backed by fiat currencies, and lots of so-called “stablecoins”, which claim to be pegged to the US dollar, aren’t, because there’s no standard definition of what a stablecoin actually is.

Inits current state, the cryptocurrency market is largely unregulated and still finding its feet. One report, presented to the SEC in March, showed that around 95 percent of cryptocurrency trading volume reported by exchanges was faked; exchanges commonly sold coins and bought them back themselves. A lack of regulation can hurt investors: in one instance, the owner of what was Canada’s biggest currency exchange, QuadrigaCX, died—taking the keys to the funds with him—meaning that up to $190 million of investors’ money was stuck in exchanges. Yet regulators are starting to make progress. Exchanges like Binance and Coinbase are working with regulators, like the CFTC, the SEC, and the NYDFS, to regulate the market, and the SEC are considering cryptocurrencies seriously.

As always, only invest the amount of money into crypto that you can afford to lose. If you spend your whole life savings on crypto, and the market bottoms out, you will come to regret your gamble. Remember that you are part of a new technology that is still finding its feet, and be cautious about how you invest. Need some more help getting started? Take precautions to stay safe, such as keeping the keys to your wallet secret, holding your assets in non-custodial, cold-wallets, and only investing in exchanges backed by regulators.

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Last Updated January 29, 2018

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