1. What Is a Blockchain?
Cryptocurrencies exist on something known as a blockchain. Blockchains are entirely virtual, but it helps to imagine them as a chain of blocks, hence the name. Below is a simple representation of a standard blockchain.
Blockchains store data in chronological order using hashing, a cryptographic method. Hashing converts plaintext to random characters, making data much harder to exploit. Hash functions are crucial in cryptocurrency, including transactions and the mining process (which we’ll discuss later). These are one-way algorithms that map arbitrary-sized data to fixed-size data. In short, they are required to maintain the integrity of the blockchain data.
Each block in a blockchain contains various kinds of data, such as a list of verified transactions and the storage cap. Different cryptocurrency networks have different block sizes. Bitcoin, for example, has a relatively small block size of 1MB. Each block also contains the hash of the previous block.
When the network verifies a transaction, it is recorded in a block. This record is immutable and permanent and can be viewed by anyone if the blockchain is public. Most cryptocurrencies have public blockchains, including all the market’s big players like Bitcoin, Ethereum, Dogecoin, and Litecoin. These transactions are confirmed via consensus mechanisms, which we’ll get into soon.
2. How Do Cryptos Gain Value?
Various factors play into a crypto’s value, including hype, marketing, and sheer luck. Bitcoin, for example, has become widely popular because it was the world’s first cryptocurrency, created by the elusive Satoshi Nakamoto in 2008. When Nakamoto launched Bitcoin, each Bitcoin was worth nothing. It required investment to increase in value.
Bitcoin gained a loyal following in its early years and started to bleed into the mainstream in 2017. At this point, Bitcoin was worth a few thousand dollars, a value that rose over the following years. When crypto boomed in late 2020, Bitcoin was already a familiar and established name, so many new crypto investors chose to invest in it instead of newer coins.
Hype can also give a coin value. If a new project launches and catches the attention of enough investors, this increased demand contributes to price hikes. This can also happen if a project or asset is marketed well enough. Crypto marketing often takes place on social media platforms, such as Twitter.
But coins can also lose value rapidly, as we’ve seen happen repeatedly, be it from scandal, technical issues, or otherwise. This is why crypto investments are risky.
3. Coins vs. Tokens
When you hear about cryptocurrencies, you may hear them described as coins and tokens. So, what’s the difference between the two?
A coin is an asset that exists on an original blockchain. In other words, it is the native asset of the blockchain. For example, Dogecoin is the original and sole currency existing on the Dogecoin blockchain.
A token is an asset that exists on top of a pre-existing blockchain. Tokens are common on the Ethereum blockchain, as it’s a popular choice for building crypto projects. Ethereum’s native asset is Ether, which is used to pay for services on the blockchain. Because Ether is native to the Ethereum chain, it is a coin. But Shiba Inu is an asset developed on the pre-existing Ethereum blockchain. Therefore, it is a token.
4. What Is a Crypto Exchange?
A cryptocurrency exchange is a platform you can use to trade crypto assets. Many crypto exchanges exist today, including Coinbase, Huobi, Kraken, Uniswap, and Binance.
If you want to buy or sell some crypto, you can use a crypto exchange (though crypto wallets are also an option). Exchanges can also hold your funds for you between trades.
On top of this, you can check market statistics on exchanges and stake your assets. Staking is a part of the proof of stake consensus mechanism and allows users to lock up cryptocurrency assets for a period in exchange for rewards. You don’t lose your assets; you dedicate them to the staking process.
But what are consensus mechanisms? How do they work?
5. Consensus Mechanisms
The two most popular consensus mechanisms used by crypto blockchains are proof of stake and proof of work.
Proof of stake involves validators, individuals on the blockchain network that verify and confirm transactions, ensuring that they’re not phony or illegal. Validators are also known as nodes. When a validator confirms a block of transactions, all other nodes on the network must verify it. In other words, they must reach a consensus on the block’s validity.
Validators secure the network by staking a holding of crypto funds. They get paid for securing the network via staking rewards.
For example, validators on the Ethereum network must stake at least 32 Ether to validate independently. But users can stake smaller amounts of crypto, contributing to a validator’s 32 Ether minimum. The user will get a cut of the validator’s staking rewards, proportional to how much they staked initially.
Next up, you’ve got the proof of work mechanism. This is an older method used by the likes of Bitcoin and Dogecoin. Proof of work involves miners. These individuals (or nodes) must use specialized hardware to solve complex computational problems to secure the network. If a miner solves the problem, they can mine a block on the blockchain.
Because proof of work is a consensus mechanism, all other miners on the network must once again verify the block before it is added to the chain. This kind of widespread teamwork makes the network more fair and trustworthy.
6. CeFi vs. DeFi
CeFi is a shortened version of “centralized finance.” Centralized finance involves centralized platforms, which dedicate all the power and data to a small group of decision-makers. Binance, Kraken, and Coinbase are all examples of CeFi platforms. CeFi lets you use traditional currencies, like USD, GBP, and EUR, in your crypto trading. However, centralized platforms are more vulnerable to technical crashes and malicious attacks.
DeFi is a shortened version of “decentralized finance.” Decentralized finance uses decentralized platforms, which spread power and data across all users. This casts a wider net for the decision-making process, which, in this case, is known as governance. While decentralized platforms only allow for the use of cryptocurrencies, they are often considered safer because their structure makes them less exposed to technical crashes and malicious attacks.
7. Crypto Wallets
Crypto wallets store your private keys. Private keys are what you need to authorize a transaction. So, if someone has your private key, they can take your crypto.
There are two main kinds of crypto wallets: hardware and software. Hardware wallets are physical devices, whereas software wallets are entirely virtual. Most crypto wallets are software, the likes of which have become incredibly popular. But some prefer hardware wallets because they are isolated from the internet, and therefore remote attacks.
8. Crypto Jargon Explained
If you’ve ever delved into the crypto market, you may have come across terminology that doesn’t make sense. But don’t worry; we’ll go over the most popular crypto jargon here so that you know what you’re reading.
Decentralized network: a network wherein power and data are spread across multiple connection points or nodes Centralized network: a network wherein power and data are harbored by a small group of individuals Liquidity pool: a mass of crypto holdings on a decentralized platform deposited by various users Yield farming: the process of earning rewards by depositing assets in a liquidity pool Minting: the process of creating new coins for circulation Burning: the process of effectively destroying coins by moving them to an unusable wallet Mining: the process of circulating new coins and creating new blockchain blocks by solving complex computational problems Bear market: a term used when asset prices have fallen by over 20% from recent highs Bull market: a term used when asset prices have risen by over 20% from recent lows
We have a useful crypto glossary and a guide to crypto acronyms if you want to read about this kind of terminology in more depth.
The Crypto Industry Is Complex but Can be Navigated
The cryptocurrency realm can certainly be off-putting, as there seems to be so much you need to understand before investing a cent. And while this is true, you can get to grips with this industry bit by bit, first by learning the basics.
