Cryptocurrency basics

Cryptocurrency burst into the hearts and minds of everyday households in 2017, when the value of Bitcoin skyrocketed. Although the industry itself began a lot earlier, this was the first time crypto became a topic of mainstream conversation. Seemingly overnight, crypto was everywhere. This curiosity came with a lot of questions about what cryptocurrency really is. At dinner tables, barbecues, and in everyday conversations people asked, “Do you have any Bitcoin?”.

With so many questions, it’s helpful to start with the basics of what sets cryptocurrency apart. There’s a lot of misinformation surrounding the crypto industry, but at its core, cryptocurrency is a digital currency that operates on a technology called a Blockchain. Think of it like the dollars in your bank account, but with one major difference, no banks or governments control it. Instead, transactions are secured by a decentralised network of computers, volunteered by people worldwide. These computers work together to verify and record every transaction, and, in return, participants earn small rewards in the form of cryptocurrency. It’s a system where no single person, business, or organisation has control, ensuring transparency and security for everyone involved.

Once purchased, crypto holders have to decide the safest way to store their asset. Cryptocurrency can be stored in two main ways: on exchanges or in “cold storage” wallets. Crypto exchanges are websites that make it easy to buy, sell, and store cryptocurrencies online. However, since exchanges are connected to the internet, they can be vulnerable to hacks or mismanagement. For added security, some people prefer to store their cryptocurrency in “cold storage” wallets. 

A cold storage wallet is a physical device that often resembles a USB stick. Investors can transfer coins onto in the same way you transfer money from account to account. The digital coins are then untouchable until you reconnect that device into a computer. In this way, cold storage wallets act like a personal safe for your crypto. Although this may seem excessive, it ultimately depends on your risk tolerance. Exchanges are more convenient, but they carry risks. Large exchanges have gone broke before, leaving customers unable to access their funds. A well-known industry saying has emerged from this: “Not your keys, not your crypto.”

Cryptocurrency is an umbrella term that covers tens of thousands of digital currencies, each with their own unique quirks. With so many coins available it is essential to understand their differences. Let’s start with the ones you’re most likely to encounter as a beginner. Not all of these currencies are created equal. In fact, when most people discuss crypto, they’re usually referring to a small number of leading coins. Bitcoin, for example, is the most recognized and holds the largest market cap (the total value of all its coins in circulation) at the time of writing. Often seen as the “founding father” of cryptocurrency, Bitcoin’s price movements tend to influence the entire market, with many other coins following its trend.

Ethereum is the second most popular cryptocurrency after Bitcoin. Unlike Bitcoin, which was designed as an alternative to traditional government-issued money, Ethereum was created to support complex digital agreements known as smart contracts. Think of Ethereum’s smart contracts as similar to a vending machine. When specific conditions are met (like inserting the correct amount of money), the contract automatically executes and dispenses the agreed-upon outcome. This technology allows Ethereum to facilitate not just transactions but also decentralised applications (dApps), making it a flexible platform for a wide range of online interactions.

Outside of Bitcoin and Ethereum, there are other cryptocurrencies called altcoins and meme coins. Altcoins are alternatives to the two major coins, designed to address specific limitations or offer new functionalities. For instance, Litecoin was created to enable faster transactions than Bitcoin, while Solana reduces fees associated with processing smart contracts, a feature that Ethereum is known for. 

“Meme coins” are a different beast entirely, emerging from the depths of internet culture rather than serious financial innovation. These coins are typically created for entertainment purposes, often gaining popularity due to humorous names or online hype. Entire online communities rally around these coins in hopes of striking it rich, though the coins themselves usually lack any functional purpose. While a few early buyers might profit from sudden price increases, most investors risk losing their money as these coins often resemble pyramid schemes. It’s in this speculative, high-risk space that cryptocurrency sometimes gains its reputation for volatility and risk.

A common misconception is that cryptocurrency is primarily used by criminals. This perception dates back to the early 2010s, when the now-defunct dark web marketplace Silk Road accepted Bitcoin for illegal transactions. The anonymous nature of Blockchain has also contributed to this reputation. Whilst transactions are traceable, the identities behind them can remain hidden. Despite this stereotype, the industry is not overrun by organised crime. In fact, today, cryptocurrency is widely used for legitimate purposes.

Many people are drawn to cryptocurrency for its speed and efficiency in payments, especially for international transactions. In many cases, major cryptocurrencies process payments far faster than traditional banking methods. For instance, sending money overseas through a bank can take days or even weeks and incur high fees. By contrast, certain cryptocurrencies can facilitate transactions in seconds, often with little to no fees. This can make crypto a more practical choice for people sending money to family abroad or paying international invoices, as it’s often faster and more affordable than traditional banking systems.

Beyond this benefit, some people view cryptocurrency as a way to protect their wealth from economic instability, much like gold. When governments print excessive money to fund short-term goals, it can lead to inflation. As we’ve all recently experienced, this can drastically reduce the purchasing power of a consumer’s dollar. Unlike fiat currency, cryptocurrency is generally immune to such government decisions. For instance many cryptocurrencies have a fixed or limited supply. New coins are governed by preset rules rather than political agendas. As a result, some investors choose to convert their cash to crypto to shield themselves from potential economic mismanagement.

That doesn’t mean that the Blockchain is without issues. Despite its strengths, The technology faces a significant challenge known as the Blockchain trilemma. The issue involves balancing three key principles. Security, scalability, and decentralisation. Security ensures that transactions are safe from attacks, scalability allows the network to handle a large volume of transactions efficiently, and decentralisation prevents control by a single entity. However, no cryptocurrency has managed to achieve an ideal balance of all three. For instance, a secure and decentralised coin may struggle to scale, while a scalable, secure coin might lack decentralisation, making it vulnerable to central control. Although many have attempted to solve this trilemma, a perfect solution has yet to be found.

From an investor’s perspective, cryptocurrency is an extremely risky asset class. The lack of regulation can leave the door open to fraudsters and unregulated projects, making it difficult for new investors to navigate safely. Even when avoiding bad actors, investors face price volatility. Although stories of crypto millionaires are common, so too are accounts of investors losing it all. Cryptocurrency portfolios can experience rapid swings in value, sometimes losing or gaining large percentages within hours.

In Australia, exchanges now require licences and must follow a regulatory framework, while in the U.S., the SEC is pursuing projects it deems fraudulent. Additionally, governments worldwide are exploring Central Bank Digital Currencies (CBDCs), which would use Blockchain to create digital versions of national currencies. CBDCs could allow governments greater control over money flows within the economy, impacting aspects like privacy and monetary policy.

While CBDCs would give governments significant oversight over individual transactions, making it possible to monitor spending patterns, it’s likely that CBDCs will become a part of the financial landscape in some form. Many hope that they will be integrated in a way that complements, rather than replaces, traditional currency. It now seems unlikely that any cryptocurrency will ever fully replace fiat currency. Though Bitcoin emerged over 15 years ago, its adoption for everyday transactions remains limited.

Instead, the future of cryptocurrency is likely to be in each use case. What I mean by this is the application of cryptocurrencies to solve niche problems is, in all likelihood, the future of the industry.

Here’s an example. Inner-city apartment buildings have a unique issue. They often lack the roof space needed to install enough solar panels to power every unit. To address this, a cryptocurrency project enables people with solar panels to contribute their excess energy to the grid and earn tokens in exchange. Each token represents a unit of renewable electricity. Residents in apartment buildings can then buy these tokens from the energy company to access renewable energy, even if they don’t have their own solar panels. This allows individuals to pay specifically for energy sourced from renewable sources.

Another innovative use of Blockchain technology is in the secure tracking of grocery products. Have you ever wondered how long the meat at the supermarket has been sitting on the shelf, or how fresh those tomatoes really are? A system has been developed where farmers attach a unique, secure token to each food package barcode. This token allows consumers to access information such as the product’s harvest date, packaging time, and place of origin by simply scanning the barcode with their phone. Supermarkets can buy these tokens on behalf of the farmers and assign them to individual products, creating a tamper-proof record that builds transparency and trust with their customers.

The potential applications of Blockchain technology are endless, spanning industries like finance, sport, and governance. Despite this, these digital coins aren’t likely to replace established national currencies like the Australian dollar. Instead, cryptocurrencies are poised to solve meaningful real-world problems by leveraging Blockchain’s unique capabilities. If the industry can achieve widespread adoption and demonstrate practical value, it could have a bright future.

A quick disclaimer: This article references multiple cryptocurrencies by name and/or function, but none of these mentions should be taken as a recommendation or endorsement. This content is intended solely for educational purposes to provide a basic understanding of the industry. Before making any investments, it’s essential to conduct your own research and make well-informed decisions based on your unique financial situation. Further, within this article there is a link to an Australian crypto exchange (Coinstash). Whilst this exchange is Australian owned and regulated, I do receive material benefit from you clicking the link and/or signing up. The presence of this link should not be taken as financial advice.