Have you ever wondered how cryptocurrencies like Bitcoin, Litecoin, Dogecoin, or Anycoin work? Here is your 3 minute guide to cryptocurrencies!
What is it?
Think online banking or PayPal. Your balance is just numbers on a screen. You might be surprised, but banks are only required to have a certain percentage of their total cash figure in vault cash. The rest is digital. PayPal is just a facilitator and don't handle any physical cash and it's digital.
What is it worth?
The U.S. dollar is a piece of paper; it has value because people it's a fiat currency (money that derives it's value from government regulation) and people exchange it for goods. In the event that the government fails, you're left with pieces of paper.
Hyperinflation, where fiat currency loses it's value, has happened before. Yes, even to the U.S.. and has happened to other governments before](http://en.wikipedia.org/wiki/Hyperinflation). Even Germany (Weimar Republic), dealt with hyperinflation in the 1920's — During the hyperinflation, people used wheelbarrows to move money to buy a loaf of bread.
What are altcoins?
Altcoins are any coins that aren't Bitcoins. As of April 7, 2015, there are 545 different cryptocurrencies, with 544 being altcoins.
How do you determine altcoin prices?
Different coins have a different worth. A lot of people get confused because a Bitcoin is worth a few hundred dollars, while one dollar is worth a few hundred Dogecoins. Consider that there are only 21,000,000 Bitcoins (forever, as Bitcoin is deflationary) and there are 100,000,000,000 Dogecoins.
It's the same way how 1 USD = 0.72 EUR, but how also 1 USD = 102 YEN.
It's all relative.
Who uses these cryptocurrencies?
A lot of companies have started taking them. Many companies are accepting them including Overstock, Zynga, and PayPal to name a few.
Who determines the price of cryptocurrencies?
No one — or technically, everyone. It's capital markets.
Most of the confusion happens because people look at it as a currency, and unlike they do importing and exporting, they're not used to dealing with multiple currencies and having it change daily.
An easier way to look at it is like a stock, a commodity (i.e., gold), or another asset. Stock price changes based on supply/demand. Gold price changes, relative to fiat, based on supply/demand. Even apples and oranges change price based on supply/demand.
When could I use cryptocurrencies?
You can use them in place of online transactions or even POS (point of sale) transactions. Alternatively, you can invest in it as an asset class (the same way you can invest in the EUR).
Where can I spend cryptocurrencies?
CoinDesk keeps an updated list of where you can spend Bitcoins. It ranges from online stores, real-life casinos, and charities.
Why use cryptocurrencies instead of cash?
This is probably the most common question asked.
First, we need to take a look at the evolution of trade:
- Initially, trade was done through a barter system. You have an asset I want, I have an asset you want, let's trade. Here, a apple farmer can trade his apples to a sheep herder for wool.
- Here, we run into a problem. What if you don't have something I want? Metals, particularly gold and silver, were often used as a mechanism for trade.
- With the rise of kingdoms and nations, many wanted to show their reign and would melt metals and recast them to showcase an emblem with their nation.
- Eventually, nations realized that metals weren't efficient, and paper money was created.
- With the rise of the internet, we now have online banking, where currency is just digital figures.
This is a simple look, but it's obvious that cryptocurrencies are the next evolution of trade.
Like most features in evolution, the unregulated — capitalistic supply/demand — aspect is based off the Great Recession of 2007.
How are cryptocurrencies created?
Cryptocurrencies are created by being mined — having computers solve complex equations.
Bitcoin's protocol uses CPU mining. ASIC (application-specific integrated circuit) miners, computer parts built solely to mine for Bitcoins, make mining for normal people unprofitable.
Litecoin and other scrypt-based cryptocurrencies like Dogecoin, use GPU mining. That means they use graphic cards to solve the equations. There are currently ASIC scrypt miners, but it's still currently profitable to mine using graphic cards.
Think Bingo (whoever gets it first, gets it), that was skill-based instead of luck-based (based on the mining power), where you had a group of people for each Bingo card (most mining is pool-based, and often includes thousands of individuals).
What do you think about cryptocurrencies? Let me know on Twitter (@sebfung).
Like my blog posts? Subscribe.