We have a long history with financial transactions. Long before the invention of money, people used a system of exchange called the barter system.
With the passing of time, our transactions became more efficient. We went from the barter system to precious metal coins to traditional money to virtual money. Now, the next stage of this journey is cryptocurrency.
In this article, we try to explain cryptocurrency in simple words, how it works, and is it safe to invest in them.
What is a cryptocurrency?
Cryptocurrency is a virtual currency that we can use to buy goods online. The core concept behind cryptocurrency is exactly the same as traditional money. The only difference is that cryptocurrency is 100% virtual.
There are many different cryptocurrencies out there. According to Statista, there are more than 6000 cryptocurrencies as of August 2021. Some popular ones are Bitcoin, Ethereum, Dogecoin, Cardano, Solana.
How does cryptocurrency work?
Cryptocurrencies are called such because they are secured by cryptography. There are many different types but the most common one that popular cryptocurrencies use is blockchain. But before we explain that, we need to know a bit about how our digital transactions take place.
Today, our online transactions are just numbers on a spreadsheet with our banks. For example, if a person buys ₹100 worth of products from Amazon, the transaction would show that ₹100 is deducted from their bank account and added to Amazon’s bank account. All these are numbers on a spreadsheet, in simple terms.
Cryptocurrencies do a similar thing but in a decentralized manner. For a particular cryptocurrency, say Bitcoin, all of its transactions are recorded on a single ledger. But, there are many copies of that ledger.
So, if you go to a store and spend 5 Bitcoins, the store would verify from every copy of that ledger. After the transaction, every copy of the ledger would be updated to show that you now have 5 Bitcoins less.
Then what is a blockchain? It is not a cryptocurrency itself. Blockchain is a secure type of ledger. It is a way of organizing all those ‘spreadsheet transactions’ into ‘blocks’.
If you buy something with Bitcoin, that transaction is recorded as a block. It contains data such as ‘who paid’, ‘to whom’, and ‘what amount’. Additionally, it has a unique transaction ID and the unique ID of the previous transaction.
Is it a smart alternative to traditional investments?
Unlike traditional currency which is backed and controlled by governments, cryptocurrencies are completely unregulated.
There is no government backing them. It is people’s trust in cryptocurrencies that give them value. This is why we’ve seen the price of some cryptocurrencies like Dogecoin fluctuate so much with a tweet from Elon Musk.
Some governments like the Chinese government have banned cryptocurrencies. On the contrary, the El Salvadore government gave legal tender status to Bitcoin.
So the entire ‘crypto-space’ is in a constant state of change. Thus, when it comes to investing, you should only invest an amount that you are comfortable losing.