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Portfolio Management International Investing. Part of. Guide to Cryptocurrency What Is Cryptocurrency? Table of Contents Expand. Table of Contents. Understanding Cryptocurrencies. Global Appeal. Government Responses.
Impact on Global Investments. By Justin Kuepper Full Bio LinkedIn Twitter Justin Kuepper is a financial analyst, journalist, and private investor with over 15 years of experience in the domestic and international markets. Learn about our editorial policies. Reviewed by Michael J Boyle. Michael Boyle is an experienced financial professional with more than 10 years working with financial planning, derivatives, equities, fixed income, project management, and analytics.
Learn about our Financial Review Board. Fact checked by Emily Ernsberger. Emily Ernsberger is a fact-checker and award-winning former newspaper reporter with experience covering local government and court cases. She also served as an editor for a weekly print publication. Her stint as a legal assistant at a law firm equipped her to track down legal, policy and financial information.
Key Takeaways Cryptocurrencies have become extremely popular due to potentially huge gains, but their volatility also involves the risk of dramatic losses. The noncorrelated nature of the market makes cryptocurrencies a potential hedge against risk, similar to precious metals like gold. As of , the petro is still struggling to become a truly functioning currency.
Article Sources. Andrey Sergeenkov is a freelance writer whose work has appeared in many cryptocurrency publications, including CoinDesk, Coinmarketcap, Cointelegraph and Hackermoon. Cryptocurrency is a relatively new type of money that operates in a completely different way than the traditional currency we all use every day. Instead of being produced by a central bank or government, like U. It takes an entire network of volunteers from around the world to secure and validate transactions made with cryptocurrency.
It also solves a problem that used to make middlemen like banks indispensable — the double-spend issue: when a person attempts to spend the same balance twice with two different parties. Cryptocurrencies use cryptography to encrypt sensitive information, including the private keys — long alphanumeric strings of characters — of crypto holders.
Think of private keys as the passwords that determine the ownership of cryptocurrencies. Keep in mind that cryptocurrencies cannot be stored outside of the blockchain. They are permanently based on the blockchain. Hence, when someone says they own X amount of coins, what they really mean is that their password can legitimately claim X amount of coins on the blockchain. Cryptocurrency private key concept Getty Images.
These private keys are what crypto holders store on their wallets, which, as you must have guessed, are special kinds of software or devices designed specifically for this purpose. In instances where a crypto holder loses access to his or her private key , the cryptocurrencies associated with such keys could be lost permanently. With the help of a cryptographic technique, private keys are encrypted to create wallet addresses, which can be likened to bank account numbers.
In essence, you need your private key to digitally sign transactions. A blockchain is exactly what it sounds like — a virtual chain of blocks each containing a batch of transactions and other data. Once each block is added to the chain, it becomes immutable, meaning the data stored inside it cannot be changed or removed.
The nodes perform a variety of roles on the network, from storing a full archive of all historical transactions to validating new transaction data. By having a distributed group of people all maintaining their own copy of the ledger, blockchain technology has the following advantages over traditional finance where a master copy is maintained by a single institution:. Think of it as having a cluster of computers take up the roles of a bank by consistently updating the balance sheets of users.
Instead, there are multiple copies of the balance sheets distributed across several computers, with each node, or computer connected to the network, functioning as a separate server. This infrastructural design makes it possible for cryptocurrencies to evade the security mishaps that often plague fiat.
Depending on how big the network is, it can be prohibitively expensive to carry out a coordinated attack. Also, it is worth mentioning that the distributed nature of these digital assets establishes their censorship-resistant attributes. Unlike the case with banks, which governments regulate, cryptocurrencies have their databases spread across the globe. Therefore, when a government shuts down one of these computers or all the computers within its jurisdiction, the network will continue to function because there are potentially thousands of other nodes in other countries beyond the reach of one government.
Crowd of people on network connection lines. Getty Images. So far in this guide, we have explained why cryptocurrencies are secure and why they are censorship-resistant. Now, let us take a look at how crypto transactions are vetted. Recall that blockchains are distributed databases where all the transactions executed on a crypto network are recorded permanently. Every block of transactions is linked together chronologically in the order the transactions were validated.
Because it is impossible to set up a central authority or bank to manage blockchains, crypto transactions are validated by nodes computers connected to a blockchain. So the question is: How do these networks ensure that node operators are willing to partake in the validation process? With incentives, validators are encouraged to participate actively and honestly in the validation process to earn rewards in the form of newly minted created cryptocurrencies.
This incentive system sets the rules that govern the process of picking validators who would, in turn, verify the next batch of transactions. It also ensures that the activities of the validators align with the goal of the network as a whole. Validator nodes found to be involved in actions that undermine the validity of the crypto network can be barred from taking part in subsequent validation processes or punished accordingly.
These incentive infrastructures are also known as consensus protocols. There is a wide range of consensus protocols being used by existing blockchain networks. The two most common ones are:. Tokens are digital assets issued by decentralized applications based on blockchains. These are applications similar to the ones you might find on your smartphone, but instead of being operated by a single company, they run completely autonomously.
Think of it like a free Uber app where taxi drivers and customers can connect together without having to pay the middleman company a cut of profits. Because these applications depend on the infrastructure of blockchains, transactions involving tokens come with an added fee settled in the native cryptocurrency of the blockchain in question. The value of a cryptocurrency usually depends on the utility of its underlying blockchain — though there have been many instances where social media hype and other superficial factors have played a role in pumping up prices.
It all boils down, though, to the demand for the coin relative to its supply and whether the buyer is willing to pay more than the amount the seller initially acquired the coin for. Notably, cryptocurrencies tend to favor a deflationary system, whereby the number of new coins introduced to the market is predictable and gradually reduces over time. For many cryptocurrencies, another important element is the total number of coins that can ever exist is often fixed.
For instance, there will be only 21 million bitcoins created, of which more than 18 million are already in circulation. This deflationary-based system is the complete opposite of what we have in traditional finance, where governments have the license to print an infinite number of fiat notes and inadvertently devalue their currencies. Bitcoin was the first of the many cryptocurrencies that exist today. Following its introduction in , developers began to create other variants of cryptocurrencies based on the technology powering the Bitcoin network.
In most cases, the cryptocurrencies were designed to improve upon the standards set by Bitcoin. Initially, cryptocurrency was pushed as an alternative to fiat currency based on the premise that it is portable, censorship-resistant, available globally and an affordable means of executing cross-border transactions. As a result, most crypto holders have shifted their attention to the investment potential of cryptocurrencies, which has since birthed the speculative side of the crypto market.
Investors seem to be more concerned about the possibility that the price of a cryptocurrency may rise sometime in the future than whether they can use cryptocurrencies to purchase goods and services, and so crypto is now predominantly viewed as an investment. The leader in news and information on cryptocurrency, digital assets and the future of money, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies.
In exchange, the protocol produces a reward in the form of cryptocurrency tokens, in addition to any fees paid by the exchanging parties to the miners. Verifying the blockchain requires computing power. Participants invest in expensive equipment and electricity in order to mine cryptocurrency. In a proof-of-work system , like those used by Bitcoin and Ethereum, the more competition there is for mining a certain cryptocurrency, the more difficult it is to mine.
That's because miners essentially race each other to solve a complex math problem in order to verify a block. As such, the cost to mine increases as more powerful equipment is needed to successfully mine. As mining costs increase, it necessitates an increased value of the cryptocurrency. Miners won't mine if the value of the currency they're mining isn't high enough to offset their costs. And, since miners are essential to making the blockchain function, as long as there's demand for using the blockchain, the price will have to go up.
Mainstream cryptocurrencies such as Bitcoin and Ether trade on multiple exchanges. Just about any cryptocurrency exchange will list the most popular tokens. But some smaller tokens may only be available on select exchanges, thus limiting access for some investors. Some wallet providers will aggregate quotes for swapping any set of cryptocurrencies across several exchanges, but they'll take a fee for doing so, increasing the cost of investing.
Furthermore, if a cryptocurrency is thinly traded on a small exchange, the spread the exchange takes may be too big for some investors. If a cryptocurrency becomes listed on more exchanges, it can increase the number of investors willing and able to buy it, thus increasing demand.
And, all else being equal, as demand increases, the price goes up. There are thousands of different cryptocurrencies in existence, with new projects and tokens launching every day. The barrier to entry is relatively low for new competitors, but creating a viable cryptocurrency also relies on building a network of users of that cryptocurrency. A useful application on the blockchain can quickly build a network, especially if it improves upon a limitation of a competing application.
If a new competitor gains momentum, it takes value from the existing competition, thus sending the price of the incumbent down as the new competitor's token sees its price move higher. Cryptocurrency networks rarely abide by a static set of rules.
Developers adapt projects based on the community that uses them. Some tokens -- called governance tokens -- give their holders a say in the future of a project, including how a token is mined or used. In order to make any changes to the governance of a token, there needs to be consensus among stakeholders. For example, Ethereum is working to update its network from a proof-of-work system to a proof-of-stake system , effectively rendering much of the expensive mining equipment in data centers or people's basements useless.
That will undoubtedly have an impact on the value of Ether. Generally speaking, investors like stable governance. Even if there are flaws in the way a cryptocurrency operates, investors prefer the devil they know to the devil they don't. As such, stable governance where things are relatively hard to change can be of value by providing more stable pricing. On the other hand, the slow process of updating software to improve protocols can limit the upside of cryptocurrency values.
If an update would unlock value for cryptocurrency holders but takes months to execute, it hurts the current stakeholders. There's some confusion about who should regulate the exchange of cryptocurrencies. Both can't claim regulatory authority over cryptocurrency exchanges.
A determining ruling could provide greater clarity and improve cryptocurrency values while opening the door for more widely traded crypto-related financial products. Regulation is required to allow for easier ways to trade cryptocurrency.
Products such as ETFs or futures contracts provide more access to cryptocurrency for investors, increasing its value. Additionally, regulation could enable investors to take short positions or bet against the price of cryptocurrencies with futures contracts or options. That should produce better price discovery and reduce the volatility of cryptocurrency pricing.
Regulations could also negatively impact demand for cryptocurrency. If a governing body changes the rules to disfavor cryptocurrency investment or use, it could send the price of cryptocurrencies lower. If you understand the core principle of supply and demand behind what gives cryptocurrency value and the factors influencing them, you can make better cryptocurrency investment decisions.
If you believe demand is going to increase for reasons X, Y, and Z and don't think supply will keep up, that cryptocurrency could be a good investment. But be aware that governments still don't have best practices for regulating cryptocurrency, which makes it a particularly risky and volatile investment no matter what.
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Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services. The key feature of a coin is that of a currency, and the term may also be used to describe a cryptocurrency asset that is not a token.
Unlike cryptocurrency tokens, coins are not intended to serve utility functions - such as to represent votes within a community or to denote storage capacity on a decentralized cloud storage. Instead, a coin operates on its own independent blockchain and acts like a native currency within a specific financial system.
Accordingly, a coin is essentially used as a medium of exchange or store of value within a digital economic network. Most blockchains work as a decentralized, distributed ledger that tracks and verifies each transaction, and their native coins can only be transferred between participants of this particular network. A coin, as a single unit of currency, can be traded for an agreed upon value depending on current market conditions.
Occasionally it can be exchanged for a different coin or token that belongs to another blockchain, either through a cryptocurrency exchange or through private transfers like peer-to-peer and OTC trades. Decentralized exchanges and atomic swaps are also viable alternatives for coin and token trading. Many companies and startups in the blockchain industry choose to raise funds prior to building their own blockchain, and this is often done through an Initial Coin Offering ICO crowdsale.
This means that instead of issuing their native coin, these companies decided to create a digital token that is issued on top of an existing blockchain network. Usually, these ICO tokens are offered in exchange for Bitcoin or Ethereum, but some startups also accepted fiat currency or other cryptocurrencies as payment during their fundraising.
The value of cryptocurrency is independent of market conditions. The value of cryptocurrency is independent of market conditions. A) True B) False. Share this: Twitter · Facebook · WhatsApp · Pinterest. Like this. The value of cryptocurrency is independent of market conditions such as supply and demandThis is False statement.