What is a cryptocurrency? How does cryptocurrency work? What are the different types of cryptocurrency?
Getting started in cryptocurrencies raises many questions.
In this guide, youll learn everything you need to know about cryptocurrencies and how to invest in crypto assets.
In a lot of ways, cryptocurrencies have a bad name. The word cryptography often implies secret, hidden, or guarded. But in reality, cryptocurrencies are generally open, transparent, and verifiable.
The currency part of cryptocurrency is also somewhat problematic because while cryptocurrencies can act as a peer-to-peer form of payment, they also have a wide variety of other uses ranging from a programmable financial infrastructure layer to a digital store of value and a new form of computing.
But the reason that cryptocurrencies are called cryptocurrencies is that they all have the commonality of being a digital asset or decentralized system of exchange that uses public-key cryptography to create a system of wallets and private keys.
A cryptocurrencys main objectives are to secure financial transactions, control the creation of additional units, and verify the transfer of assets.
New kinds of cryptocurrencies are constantly being created to serve different purposes. Most of the cryptocurrencies that are described below fall into the category of permissionless blockchains.
A cryptocurrency is a unit of account on a blockchain, which is like a massive ledger.
Cryptocurrency wallets hold the cryptographic keys necessary to interact with the digital assets that are stored on the blockchains ledger.
Cryptocurrencies are digital assets that are also known as cryptoassets. Depending on the designed use case, cryptocurrencies have properties similar to traditional currencies they can be exchanged or used as a means of payment, for example while cryptoassets act more like an independent investable asset class, such as stocks, bonds, or real estate.
Cryptocurrencies dont depend on a central server or computer. Instead, cryptocurrencies are part of a decentralized network comprised of thousands of distributed computers.
The advantages of cryptocurrencies over more traditional fiat currencies:
Fraud-proofWhen new cryptocurrencies are created, the coins, their owners information, and the transaction details are stored in a public ledger. Although this ledger is public, the owners identities are encrypted and protected via the key system mentioned earlier.
Transaction Legitimacy (solving double spend)Before cryptocurrency can be sent, a wallet address is checked by the ledger to ensure adequate funds are owned by the sender. The digital ledger the blockchain, maintains a record of all the transactions that take place between digital wallets.
Instant settlementUnlike traditional money transfer services, cryptocurrencies work more like digital cash, and the final settlement happens within minutes (the exact times are subject to the mining process described below), which is a massive financial innovation. Rather than complex and proprietary infrastructure to complete transactions, all people need to send and receive cryptocurrencies is a smart device and an internet connection.
OwnershipPermissionless cryptocurrencies are not owned or controlled by any corporation or government, although cryptocurrency use is regulated in certain countries.
AccessibleCryptocurrencies have the potential to increase financial inclusion (check out the infographic section on this page for more background)by driving down the costs per transaction (especially for sending money across borders or around the world) since they do not require a bank or credit card account to use. Most times, all thats required to get started with cryptocurrencies is a smartphone and a trustworthy cryptocurrency wallet (like Abra).
The most popular cryptocurrencies to buy based on market cap:
Bitcoin (BTC) is the cryptocurrency market leader.
Bitcoin is the first massively adopted cryptocurrency getting most of the attention and dominating other cryptocurrencies.
Bitcoin was born in 2008 when an unknown person or group of people named Satoshi Nakamoto published the Bitcoin whitepaper.
Since then, many other cryptocurrency systems (including many in the rest of this list) have considered Bitcoin as a model and created other kinds of cryptocurrencies based on the same concept and open-source computer code (in fact, if you want to, you can also take Bitcoins code and build your own cryptocurrency, you can find all of the code on GitHub).
Looking for more about the history of Bitcoin? Check out this illustrated history called Code meets money.
On January 12, 2009, Satoshi Nakamoto performed the first Bitcoin (BTC) transaction by sending 10 BTC to a coder named Hal Finney.
By 2010, Nakamoto disappeared along with an estimated one million BTC. Bitcoins development and maintenance was taken over by the Bitcoin Foundation in 2012. Since then, and over the last ten years, the bitcoin price has continued to rise.
Watch: Abra founder and CEO in conversation with Bitcoin.com CEO Roger Ver.
Bitcoin Cash was created following a split (or a fork) of the original Bitcoin blockchain.
The split was the culmination of a long debate surrounding ideas about increasing Bitcoins block size, or the number of transactions that can be processed per 10-minute block cycle.
A hard fork is a tool that developers and communities of cryptocurrency use to make changes and modifications to the blockchains.
The main purpose of increasing the block size was to increase the ability of bitcoin to confirm more transactions per block, the speed of network times, and reduce the cost per transaction. Bitcoin Cash advocates thought that Bitcoin should act more like cash, which requires speed and low costs.
The Bitcoin Cash movement was largely spearheaded by Roger Ver, a well-known Bitcoin supporter since its early days.
Eventually, Ver thought that Bitcoin was losing its way as a better peer-to-peer digital payment system, mainly because the block sizes were too small and the transactions were becoming too expensive so he helped create Bitcoin Cash as an alternative.
Ethereum is the second-ranking cryptocurrency by market cap. It was created in 2015 by Vitalik Buterin.
Check out part two in our illustrated history of cryptocurrencies: Ethereum and the reinvented internet.
Ethereum is not just a digital currency, but a blockchain-based distributed computing platform and operating system that offers smart contract functionality.
What are smart contracts?
Smart contracts outline conditions that need to be fulfilled on the blockchain. A smart contract is basically a computer program that executes a transaction after a series of requirements are met.
Smart contracts have a wide variety of applications including traditional business operations, but they also enable new kinds of technologies and innovations, like micropayments, or machines interacting with other machines.
Ethereum is the oldest and so far the most popular smart contract-based cryptocurrency platform.
Ethereum at a glance
A computer programmer and contributor to Bitcoin Magazine, Vitalik Buterin, wanted to create a cryptocurrency that made it easier for blockchain developers to build decentralized applications.
Working with others interested in the idea of a smart contract platform, he developed the Ethereum framework. And then he published the Ethereum white paper.
Ethereums creation enabled digital decentralization using smart contracts, which created a new roadmap for the future of the internet.
Ripples XRP does not fit squarely with the definition of a decentralized, permissionless cryptocurrency system. Instead, its more accurately defined as a real-time gross settlement system (RTGS), currency exchange, and remittance network.
XRP at a glance
XRP was created by the company Ripple Labs Inc. with the purpose of speeding up international payment transfers and making them cheaper and more efficient.
XRP eliminates the challenges current banking and financial systems have in transferring money which is slow and expensive. The speed, efficiency, and cheaper costs for global payment transfers make it more acceptable for the banks and other financial institutions.
Unlike other cryptocurrencies, XRP is more like a gateway or bridge to transfer fiat currency, which makes it an interesting alternative for established banks and other financial institutions.
Litecoin was invented to improve on Bitcoin by decreasing the block generation time, increasing the maximum number of coins created by changing the hashing algorithm.
Litecoin at a glance
In 2011, Charlie Lee created Litecoin to speed up blockchain-based transactions at lower rates (similar to the idea that inspired Bitcoin Cash). The launch of the Litecoin network by Lee, an ex-Google employee, gained huge recognition and was adopted by a large number of Bitcoin enthusiasts.
In 2013, Litecoin reached $1 billion market capitalization.
Why do people invest in Litecoin?
One of Ethereums co-founders, Charles Hoskinson, created another very popular cryptocurrency, Cardano (ADA).
Like Ethereum, Cardano is used as a platform to build smart contracts and decentralized apps. Cardano was developed to improve on the technology part of Ethereums blockchain.
Monero was launched in 2014. This cryptocurrency is donation-based and has strong support from cryptocurrency enthusiasts.
Monero uses a security technique, ring signatures, that doubles the privacy of users and transactions, making it one of the top cryptocurrencies.
NEO was created in 2014 by Da Hongfei. Previously known as AntShares, NEO works in a similar way to Ethereum.
The NEO network is used for building smart contracts and launching initial coin offerings (ICOs). NEO has the advantage of being supported by the government of China.
After its launch in late 2016, cryptocurrency enthusiasts were attracted to Zcash because of its focus on security and privacy. Zcash reveals fewer identifying transaction details such as the sender, recipient, and other transactional information.
Created by Evan Duffield, Dash makes fast digital transactions untraceable using its decentralized master nodes network. Previously known as Darkcoin, Dash has been one of the most popular privacy-oriented cryptocurrencies since its launch in 2014. Today, Dash developers are working to make the currency more useful in retail environments by creating faster transactions.
One of the big mantras in the cryptocurrency investing space is do your own research. It makes a lot of sense to read up on and understand how different cryptocurrencies work before starting to invest in them. Here are a few key points about how cryptocurrency works (the following explanation is a high-level overview of blockchains that operate using proof-of-work, which is explained in greater depth below).
Cryptocurrencies rely on consensus algorithms in order to function in a distributed way without a centralized gatekeeper or controlling authority. There are a number of consensus algorithms that various cryptocurrency projects are using, but the two most popular are proof-of-work and proof-of-stake.
The most common process for creating a cryptocurrency is proof-of-work (POW).
During the proof-of-work process, miners have to solve a complex mathematical puzzle to gather transactions together on the blockchain. Its the same process as when you have a lock whose combination is difficult to crack. You try one combination after another to open the lock. The same is the case with the proof-of-work process for creating a cryptocurrency.
Every miner is trying various combinations on the same blockchain network. Once a miners software finds the solution, other miners can verify the block easily and see that the block is correct. The new blocks are added sequentially in the existing chain of blocks (which is where blockchain gets its name).
To mine, you need to use the computer processing power to solve the puzzle. The energy-intensive nature of POW is part of what helps secure the network because it would cost a lot in terms of time and resources for a bad actor or a group to coordinate and gain control of the blockchain.
Miners are compensated for their work in verifying transactions by solving complex computation in the form of a block reward, which is the issuance of new coins. As a blockchain network increases in value it because increasingly more difficult to mine, which makes it more secure. If you crack the puzzle, you are rewarded.
The proof-of-stake (POS) process for creating cryptocurrency means that participants in the network stake their coins as collateral to vouch for the legitimacy of transactions.
This process requires less computational power and reduced electricity costs and is viewed as an alternative form of consensus. However, there are concerns surrounding the overall security of the proof-of-stake method. Ethereum is scheduled to move from a POW method to a POS in the near future.
This chart shows the growth of the Bitcoin market cap between April 2013 and July 2019.
There are a few reasons why cryptocurrencies gain value, including the idea of digital scarcity, network effects, internet-native exchange of value, and speculation about future values.
Some cryptocurrencies, like Bitcoin, have a pre-programmed limit, which creates a scarcity pressure similar to gold.
A strong and loyal following
The leading cryptocurrencies have strong communities of developers, advocates, and promoters that help spread adoption and usage. In some ways, getting involved with cryptocurrency communities is a lot like following sports teams, complete with crazy fans who help spread the message around the world.
People use cryptocurrencies to pay for goods, quickly and cheaply send money across borders, as a digital store of value, and as a hedge against inflation in places where fiat currency is becoming less valuable. A lot of newer cryptocurrencies are trying to use the functionality of blockchain and smart contracts to solve problems such as better ways to monetize the internet or rent computer space, or even create a hybrid form of digital money by creating stablecoins.
Another big driver of increasing cryptocurrency prices is that early investors are speculating that cryptocurrency protocols like Bitcoin and Ethereum are going to be worth more in the future once more use cases and supporting technologies are developed. Right now the total market cap for cryptocurrencies is only a small fraction of other valuable markets such as gold, real estate, or global equities. If cryptocurrencies as a market can capture liquidity similar to some of those other valuable markets, then over time the overall value of the cryptocurrency market could increase dramatically.
Cryptocurrencies often get lumped together in one big category, but there are many different types of cryptocurrencies that developers are creating to try and solve a number of problems.
There are over 2,200 cryptocurrencies listed on publically traded markets. More cryptocurrencies are being launched every day, while other projects are fading away.
Cryptocurrency market observers and pundits often refer to altcoins. Altcoins are the alternative cryptocurrency to the market leader, Bitcoin.
The term comes from cryptocurrencys early days when Bitcoin was the first massively adopted cryptocurrency. As other coins followed, people started creating different types of cryptocurrencies in an attempt to become as successful as Bitcoin.
Many altcoins work in a very similar way to Bitcoin (in fact many altcoins are forks of Bitcoin), while others such as Ethereum, Zcash, and Monero, are building completely different kinds of protocols to solve different kinds of problems, such as privacy, security, and decentralized computing.
Namecoin was developed in 2011 and is considered the first altcoin. Namecoin is a fork of Bitcoin and uses the same proof-of-work algorithm.
After Namecoin, hundreds of altcoins came into existence to solve more specific problems or to have a different form of governance.
Today, there are thousands of different kinds of altcoins and it seems like new projects and companies are being announced regularly, signaling massive growth in the space.
A crypto token is a type of virtual tradeable asset that is developed for specific purposes on a blockchain.
An example is a new startup that issues tokens to represent a position in a new product or a software license.
Another example of crypto tokens can be of ERC20 tokens. An ERC20 token is a digital standard used on Ethereum blockchain for smart contracts and is used in the exchange of tokens and other forms of value.
The difference between a cryptocurrency coin and a crypto token is that cryptocurrency is a digital or virtual currency that is designed to act as a unit of exchange (or a peer-to-peer digital cash-like system), while tokens are designed to fulfill some kind of utility on a blockchain network.
Read more here:
How to invest in cryptocurrencies | Abra