Understanding Cryptocurrencies: A Hand Guide to Decentralized Digital Currencies

Cryptocurrencies have taken the world by storm, offering a decentralized alternative to traditional fiat currencies. We have seen in recent hours how Bitcoin has returned to its all-time high, thereby triggering a true bull market in which even the least experienced investor is able to make money.

But what exactly are cryptocurrencies and how do they work? This short guide aims to answer these questions without complexities. Learning about this technology will position you as an individual who knows the latest about finances, with all the advantages that brings.

Defining Cryptocurrencies

Cryptocurrencies are digital or virtual currencies secured by cryptography, allowing for secure financial transactions and decentralized systems free from central banks’ control. Bitcoin (BTC), the first cryptocurrency, introduced in 2009 by an anonymous entity named Satoshi Nakamoto, paved the way for this innovative concept.

The idea of digital money has always been striking because the advantages are endless. PayPal has been one of the pioneers in the digital money initiative but its lack of flexibility due to high commissions, geographical restrictions and other conditions make it far behind cryptocurrencies.

At the same time, there are hundreds of solutions similar to the above-mentioned but with different restrictions, making them inaccessible to the majority of the population who only want to share assets without borders or leonine conditions.

How Do Cryptocurrencies Work?

Cryptocurrencies operate using blockchain technology – a decentralized and distributed digital ledger where transactions are recorded. Each transaction is verified by multiple network participants (nodes), ensuring its authenticity. Once validated, these transactions get added to the permanent record known as a ‘block’ in the chain.

Within the previous procedure, the word consensus resonates strongly as it is the characteristic algorithm with which each crypto asset legitimizes user transactions: While some crypto assets reinforce their security through mining or Proof of Work, others prefer to stake their assets in verification nodes called Proof of Staking.

Key Features of Cryptocurrencies

Cryptocurrencies, a revolutionary form of digital currency, boast distinctive features that set them apart from traditional financial systems. Understanding these key features is crucial in navigating the complex landscape of cryptocurrency. Here’s a brief exploration of the fundamental attributes that define this innovative form of currency:

Decentralization: No central authority governs cryptocurrencies; instead, they rely on peer-to-peer networks for transaction processing and validation.
Transparency: All transactions are publicly recorded in a distributed ledger accessible to anyone with internet access, enhancing accountability.
Security: Cryptography secures each transaction, ensuring the privacy of users’ financial data while protecting against fraudulent activities.
Divisibility: Most cryptocurrencies allow for fractional transactions and can be divided into smaller units (called satoshis for Bitcoin).
Anonymity: Although not completely anonymous, some cryptocurrencies offer higher levels of privacy compared to traditional banking systems.

Types of Cryptocurrencies

There are several types of cryptocurrencies. Among the various classifications, we can divide cryptocurrencies into three categories: consumer, governance, and infrastructure. We’ve written a blog post about these categories, and we encourage you to read it to delve deeper into them

Advantages of Using Cryptocurrencies

Human beings seek, by nature, to optimize our processes to the point of making them practical. This is the reason why the old banking payment system, by which the world has been governed for the last 300 years, has become almost obsolete. With the proliferation of artificial intelligence and blockchain, it is preferred to “verify before trust” and with this premise, all those systems in which the direct hand of a decentralized entity is required to operate it are called into question.

Below we mention just some advantages of using cryptocurrencies compared to conventional currencies, which position them as the most modern asset exchange system today:

Speed & Cost-Effectiveness: Transactions involving cryptocurrencies are generally faster and cheaper than traditional banking methods, enabling near real-time value transfer across borders with minimal fees.
Financial Inclusion: Decentralized currencies provide access to financial services for those unbanked or underbanked populations worldwide.
Programmability: Advanced cryptocurrencies like Ethereum offer smart contract functionality, enabling automation and development of decentralized applications (dApps).
Inflation-Hedge: Some investors view cryptocurrencies as a hedge against inflation due to their limited supply (capped for most) in contrast with governments’ ability to print more money.

Disadvantages of Using Cryptocurrencies

As the cryptocurrency industry is still in its early stages, there are inherent risks associated with its use. While many of these risks may be readily apparent to inexperienced users, there are also risks that impact all users, including those with more advanced knowledge.

Below is a list of risks that users experience when using cryptocurrencies:

Sending money to the wrong wallets: this is very common since the complexity in the readability of the wallets makes it difficult to distinguish between the real recipient and a different one. There are already solutions for this risk, such as ENS (Ethereum Name Service) which allows the user to create a human-readable address associated with their wallet, dramatically reducing the incidence of this error.
Phishing: Let’s not deny it, we all like to be told nice things that are pleasant to read, and even more so when they promise profits in cryptocurrencies with just a few clicks. This is where the old adage “if it sounds great, it probably isn’t” operates. Hackers and social engineers swarm social networks creating fake projects in which they attract unsuspecting users to click on poisoned links. Thousands of users have suffered loss of funds with these scams in recent months.
Massive hacks to smart contracts: we have already witnessed important hacks to protocols such as Ronin (655m USD losses), Mt.Gox (25,000 Bitcoins in 2011, which today is a fortune) among others that sowed distrust among investors. There is no way for a user to be exempt from these types of events although there are now legal regulations to protect the investor

Conclusion

Cryptocurrencies represent a revolutionary shift in finance, with Bitcoin’s recent surge underscoring their growing impact. Understanding these digital currencies involves recognizing their decentralized, blockchain-powered nature and key features like transparency and security. Advantages include faster, cost-effective transactions, financial inclusion, and programmability through smart contracts. However, the industry’s infancy comes with risks like wallet errors, phishing scams, and smart contract hacks. Navigating these challenges requires vigilance, but the potential for financial innovation and transformation is undeniable.