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Monday, January 30, 2023

Absolute Beginner’s Guide to Cryptocurrency

This article is for noobs who want to get their hands dirty in crypto but are confused and want to get familiar with the basics of cryptocurrency before diving into it. I have tried to use as simple terms as possible to make you understand so as to avoid difficult crypto jargons which most of the readers find difficult to assimilate.

I remember the time when I heard of crypto for the first time and I thought crypto is nothing but a Bitcoin and that is all. But when I dived a little more into it then I realized that there was more to it. Cryptocurrency is not just a bitcoin rather there are thousands of other Coins, Tokens, and Decentralized Apps with their unique use cases, characteristics, and applications. When I first tried explaining to my family and friend about this vast ecosystem of crypto, it just flew right over their heads.

What the hell is Cryptocurreny?

What the hell is cryptocurrency?
What the hell is cryptocurrency?

There is a lot of crypto jargon you might listen and a few of them are Blockchain, Mining, and Staking. These terms are not only hard to understand but even harder to explain to someone. The first reaction you probably get when you try to explain crypto to your friends and family; What the hell is crypto? Simply put, cryptocurrencies are like regular currencies except they are completely digital. Each individual cryptocurrency coin is nothing but a collection of numbers and letters. Well, this may sound complicated at first but it is indeed not far off from the currencies that we see today.

Cryptocurrency coin is collection of Numbers and Letters
Cryptocurrency coin is a collection of Numbers and Letters

Physical Money and Cryptocurrency

physical-money-serial-number [Investopedia]
Physical Money Serial Number [Investopedia]

Almost every physical money bill has a unique serial number that corresponds to information like when and where it was printed and so on. Apparently, a record of all money bills that have ever been printed and where they are is kept by a Central Bank that shares this information with smaller banks and the government. If you have an account in any bank, then you will have a debit/credit card that requires a password or pin number to access the money in that account. Your bank branch knows your account number, address, and name because you need to provide your personal information to open an account and this info is also shared with the central bank and government.

Suppose you have a 1 billion with the serial number AAA and your bank account number is 123. When you deposit that bill into your bank account, your bank branch, the central bank, and the government will see and confirm that the 1 billion AAA has been moved into bank account number 123. The cryptocurrencies work the same way, each individual cryptocurrency coin is like the serial number you see on a physical bill.

btc-paper-note
BTC Paper Note

Satoshi

Just like any regular bill, almost every cryptocurrency can be divided into smaller pieces. In the case of bitcoin, each BTC can be divided into 100 million pieces called satoshis which is like cents to a dollar.

satoshi-in-bitcoin
Satoshi In Bitcoin

Crypto Wallet vs Bank Account

A cryptocurrency wallet address is like a bank account number except that there is no physical debit/credit card attached to it. Unlike conventional banks, you do not need to provide any personal information to create a cryptocurrency wallet that means your identity is not attached to your crypto wallet. Most importantly, any cryptocurrency held in your personal wallet is held directly by you and no bank is the custodian of your wallet. Now, nobody can freeze your cryptocurrency wallet or block your transactions because you have total control over that account at all times. But the trade-off here is that if you lose access to your cryptocurrency wallet or forget to write down the recovery phrase you get when you make one; well you will lose your cryptocurrency forever.

Crypto Wallet Address - Blockchain Explorer
Crypto Wallet Address – Blockchain Explorer

Cryptocurrency Transactions are Public

Unlike banks and the government who keep track of everyone’s bills and bank account balances, crypto transactions are stored across all the computers connected to a cryptocurrency network. These transactions and account balances are publically available and can be viewed by anyone using something called a Blockchain Explorer.

Crypto Public Transactions - Blockchain Explorer
Crypto Public Transactions – Blockchain Explorer

Decentralized Cryptocurrency Network

Computers that are participating in a crypto network can earn cryptocurrency for processing transactions. This incentivizes more computers to be part of the network to process transactions and earn cryptocurrency in return. Cryptocurrency network is secure because there is no single point of failure and this is called Decentralization and it is the polar opposite of the centralized setups of governments and banks. The digital currencies that banks around the world are creating are not cryptocurrencies; they are creating a seriously dystopian payment network.

Crypto Coin vs Crypto Tokens

There exist thousands of cryptocurrencies – every cryptocurrency is different and in fact, not all of them are designed to be a currency, you would actually use for everyday transactions.

In a broader view, there are two types of cryptocurrencies Coins and Tokens.

Coin vs Tokens
Coin vs Tokens

Crypto Coins belong to cryptocurrency networks that were built from the ground up which means that it takes a lot of time, a lot of money, and putting together the code required to create a safe and reliable cryptocurrency network. Cryptocurrency coins are also the cryptocurrencies given to computers as an incentive when they process transactions for a cryptocurrency network. For instance, BTC is a cryptocurrency coin that is given to the computers that process transactions for the bitcoin network. Because cryptocurrency networks are so difficult to make from scratch, only a few dozen cryptocurrencies are actually coins and the rest are cryptocurrency tokens. 

On the contrary, Crypto Tokens are comparatively easy to build and can often be created in a short time without much effort. For this reason, there exist tens of thousands of tokens while coins are few. The NFT you might be hearing about are actually cryptocurrency tokens that are similar to digital certificates of ownership for physical or digital art pieces. NFT are just the tip of the iceberg of what you can do with tokens as well.

Stable Coin

For example, there is a company called Circle that issues a cryptocurrency token called USDC which is fully backed by real US dollars. For every one USDC in circulation, the circle has one US dollar in the bank. USDC is also called a Stable Coin because its worth is originally intended to be $1.

USDC - Crypto Stable Coin
USDC – Crypto Stable Coin

Another company called Paxos issues a cryptocurrency token called PAXG. Each PAXG token is backed by one troy ounce of gold kept in a vault. You can redeem PAXG tokens for either real physical gold or US dollars.

PAX Gold Coin - Cryptocurrency
PAX Gold Coin – Cryptocurrency

Are cryptocurrencies safe?

It is true that a lot of cryptocurrencies are nothing more than scams and this is basically because cryptocurrency tokens are quite easy to create. All a scammer needs to do is create a token, build a fancy website, run a few paid ads on social media, pay a few news outlets to feature their shit coin, and they can get rich off crypto newbies overnight.

Crypto Scam NEWS
Crypto Scam NEWS

Do only Scammers or Criminal Use Crypto?

There have been many major cases of crypto hacks in the past and we keep reading about the hacks most of the time. It arises a very important question; are cryptocurrencies safe?

There are always hackers somewhere looking to crack the cryptocurrency network. So they can trick noobs by creating new coins and tokens out of thin air to sell for huge profits. That sounds scary and it is. On the other side, we have banks and other corporations, who are recipients of continuous attacks on a daily basis. When the attackers succeed in penetrating the security, then the affected company usually fortifies their security system – the same goes for cryptocurrencies. Despite being some severe cyber attacks by bad actors, most crypto has been around for years.

Scammer or Hacker
Scammer or Hacker

51% Attack – An invasion

As we have discussed earlier that some cryptocurrency networks are comprised of computers spread out around the world. These computers’ fundamental job is to double-check the transaction histories and account balances. If anyone wants to corrupt this cryptocurrency network, we will need to hack at least 51% of computers connected to the network simultaneously. As the matter of fact, it is near impossible to corrupt a network that has millions of computers connected like Bitcoin have.

51 Percent Attack - Blockchain Network
51 Percent Attack – Blockchain Network

Having said that, there exist some cryptocurrency networks that have fewer computers connected to process transactions. Hence, they are more vulnerable to attack.

On the other hand, we also have centralized cryptocurrencies services like exchanges where we have seen most crypto hacks and millions of dollars have been exploited. Therefore, it is quite secure to possess your own personal wallet wherever possible and keep all your funds there. Only keep the funds in exchanges that you trade or cashes out. Keeping your funds in a hardware wallet is safest for all.

Public vs Private Transactions 

Bitcoin and some other cryptos have publically viewable transactions and wallet balances. This makes bitcoin transactions quite easy to trace by the authorities – even easier than regular currencies. So the criminal would be reluctant to hold or use cryptocurrencies that are so easily traceable i.e Bitcoin.

Bitcoin Explorer
Bitcoin Explorer

On the other hand, we have Monero, a cryptocurrency that is completely private and even the authorities can not decrypt its encryption – which is quite impressive.

Reward to crack Monero by IRS
Reward to crack Monero by IRS

Why Cryptocurrencies are so volatile?

Bitcoin is worthless - JPMorgan
Bitcoin is worthless – JPMorgan

Once upon a time, any money in your wallet or in the bank was backed by Gold but later it was replaced with paper money. Since then all currencies issued by states around the world started losing their value. Because the only thing that backed the currencies is ultimately the trust we have in the government that issues those currencies.

The purchasing power of one US dollar (USD) in every year from 1635 to 2020* [Statista 2021]

The governments have been actively printing and manipulating the currencies to benefit themselves and corporations that fund them at the expense of the common person. This has caused the record level of inflation that incentivizes spending over saving which leads to overconsumption.

Supply and Demand

Cryptocurrencies are valuable because of what they do – the different cryptocurrencies have different rates of value changes. If we talk about Bitcoin, it has an economic profile similar to Gold. Bitcoin has maximum supply and only a small amount of BTC is created a day and that amount is cut in half every four years assuming the demand for bitcoin stays the same – called Bitcoin Halving. As basic economics tells us that when a commodity has limited supply but the demand for it continues to increase prices. So, many investors see bitcoin as a safe place to park their capital outside the current financial system.

Demand and Supply
Demand and Supply

It is worth notable that the price of most cryptocurrencies is highly dependent on bitcoin prices. If the price of bitcoin goes up, the price of correlated cryptocurrencies goes up and vice versa.

On the other hand, we have other cryptocurrencies like Ethereum that have insane value due to the utility it provides. You can create other cryptocurrency tokens, decentralized applications, and websites on the ethereum network. By decentralized apps and websites we mean that no one can censor or shutdown them.

The main reason why the value of cryptocurrency fluctuates each day is that basically nobody knows what these technologies are actually worth. The reason is the same for the fluctuation of stocks, gold, and other fiat currencies.

One more reason that makes cryptocurrencies much more volatile is the revolutionary cryptocurrency network makes it possible to lend, save and borrow. Also, unlike conventional banks, without revealing the identity, these crypto networks make it possible to do business directly with other people without a middleman taking a cut i.e service charges.

Pump and Dump

Lastly, the slightest possibility of a clampdown on crypto results in a market crash, and the most outlandish rumor can lead to a massive market pump.

pump-and-dump
Pump and Dump Analysis

Which Crytocurrency to buy?

In terms of timeline, the cryptocurrency market seems to follow a four-year cycle. The bull market phase is where prices gradually rise and it is likely that the crypto holder will sell their cryptocurrencies when they are at their highest prices.

HODLing vs Trading

There are two types of crypto compatriots, one who is holding crypto and the other who is trading. The fact is that buying and holding crypto may give you about the same amount of profit as active trader crypto may get. However, trading is not recommended unless you plan on making it a full-time job.

Crypto HODLing
Crypto HODLing

Cryptocurrencies are considered risky investments but there are varying degrees of risk even within the crypto market. Theoretically speaking, the more risk you are ready to take the greater reward you stand to gain.

Crypto Market Cap

Now the easiest way to mitigate the risk is to look at certain important crypto metrics before investment and the crypto market cap is one of them. The crypto market cap is measured by multiplying the current value of than coin or token with its circulating supply.

Top 10 cryptocurrency by Market Cap
Top 10 cryptocurrency by Market Cap

The reason why the Solana is ranked so high is that it has a circulating supply of $300 Million and when you multiply this value with its price i.e $196.42, you get a $59 Billion market cap. Now if you expect the price of Solana to get doubled get rich quickly – this is not going to be the case. Because doubling the Solana price means an additional $58 Billion active investment in Solana which is not likely to happen at once.

Price, market cap, and circulating supply of Solana
Price, market cap, and circulating supply of Solana

As a rule of thumb, cryptocurrency with a smaller market cap has more potential to grow regardless of its dollar value. 

For example, Yearn Finance is token which is worth 172 times greater but its market cap is 48 times smaller than Solana. It means YFI would take a lesser active investment to push up the price with the exception of Solana. On the contrary, the top 10 cryptocurrencies are considered to be low-risk investments.

Market cap of Yearn Finance token
Price, market cap, and circulating supply of Yearn Finance token

Cryptocurrencies like Bitcoin, Ethereum, and Cardano are likely to be around for many years and they will likely double if not triple in price. As you go down the list, the riskier the investment becomes and I would personally stay away from any crypto coin or token that comes after 200 ranks in the list.

Disclaimer

Investment in crypto involves a high amount of risk, this article does not serve the purpose of any financial advice. You must do your own fundamental or technical analysis before investing in crypto.

Gulraeez Gulshan
Gulraeez Gulshan
I am an engineer, programmer, tech-savvy professional, and very passionate about the latest technologies for the modern web, mobile, cloud-native, machine learning, and network automation. I have a bachelor's degree in Electronics Engineering and a Master's degree in Computer Science and Information Technology from a renowned university in Pakistan. I have not limited myself to a certain set of skills in this era where technology is in a state of flux; I have experience working with an extensive range of technologies and learning daily to update my skills and adapt to the latest technologies

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