The content and opinions provided on this site have not been provided or commissioned by any issuer of the financial products and/or services appearing on this site. The content and opinions have not been reviewed, approved or otherwise endorsed by an issuer. Offers may be subject to change without notice. For more information, please read our full disclaimer.
Since its rapid ascent to popularity in the 2010s, cryptocurrency has been a constant topic of discussion. Many initially dismissed digital currencies as a fad, but their staying power has proven the opposite to be true. If you're interested in breaking free from financial institutions and harnessing computer power to generate funds, virtual currencies could be for you.
Bitcoin and Ethereum are among the most popular cryptocurrencies and have experienced significant price surges since their introduction. Investing in cryptocurrencies is still possible, and it's important to learn about the most popular options, how cryptocurrency exchanges work, and the importance of transaction verification.
The History of Cryptocurrency
Cryptocurrency has a rich history that dates back to the 1980s. Today, it is synonymous with complex computer systems, but its origins come from academia. Although cryptocurrency has evolved since this time, understanding the history of crypto will help you understand its future, too.
Early Origins of Crypto
David Chaum probably couldn’t have imagined the complex virtual currency system his work would eventually inspire. When he published research in 1983, his ideas were purely hypothetical — a speculative proposal of an anonymous system that would enable electronic payments. The key to his proposal — cryptography — would prove to be prophetic in some sense.
He eventually developed these ideas into a novel precursor to cryptocurrency called Digicash. Users were required to withdraw bank funds using software and solve an encrypted key before transferring the funds elsewhere. Digicash then inspired several similar digital finance programs powered by cryptographic puzzles, paving the way for the eventual introduction of modern cryptocurrency.
Establishing the Blockchain
The emergence of the modern cryptocurrency system followed the establishment of the blockchain. This system was pioneered by Satoshi Nakamoto, who published the so-called “white paper” on Bitcoin in 2008. This document outlined the basis of cryptocurrency technology, the objectives of its creation, and the role users would play in the system. The blockchain was thus established to support the launch of Bitcoin, the first modern virtual currency.
Emergence of the Market
In the early stages of Bitcoin, its real-world value was negligible. This remained true until 2011, when Forbes published a report on digital currencies, and the value of one Bitcoin finally hit $1.00. New cryptocurrencies soon began emerging, including several variations of Bitcoin such as Litecoin and Bitcoin XT. Cryptocurrency was no longer an underground occurrence — it was a mainstream sensation. People rushed to invest in cryptocurrencies, hoping that their investments would continue to rise in value. The competition spurred the creation of an informal crypto market where users bought, sold, and traded their currencies.
Understanding How Crypto Works
Cryptocurrency demands a series of complex calculations, but the system itself is relatively simple. A public ledger is used to anonymously record all users’ transactions, balances, and distributions — and this information is stored in the blockchain. If you want to learn how to invest in cryptocurrencies, you need to understand how the blockchain works.
Blockchain Distribution
The blockchain serves several purposes in the world of cryptocurrency. In addition to its function as a public ledger, it is the vehicle for the distribution of cryptocurrencies. As users solve encrypted puzzles, they are rewarded with coins in a specific digital currency. Each block is linked to the next, prompting users to continuously solve a puzzle — called a hash — that contains details of a transaction.
In solving the hash, the user verifies the transaction of another user, thus establishing a decentralized system of accountability. It should be noted, though, that not all blockchains are decentralized. Some blockchains utilize a centralized system that relies on users whose identity has been verified. This eliminates the anonymity that cryptocurrency is often marketed by, but it allows for a greater degree of security and minimized risk of theft.
Mining for Crypto
The process of solving a hash is called mining. This task is attractive because it allows users to earn cryptocurrency without selling or trading their own. Mining also benefits the blockchain as a whole because it authenticates other transactions. To mine a cryptocurrency, users must run superpowered computer programs that continuously solve complex cryptographic equations. This cannot be done by a human alone, and the excessive energy expenditure that’s required for mining has prompted some critique of its environmental impact.
Providing Proof of Work
When a hash has been solved successfully, it will trigger a blockchain transaction’s approval. This approval is issued in the form of proof of work — a verification mechanism that demonstrates a user has indeed completed the necessary transaction. This minimizes the risk of fraud within the blockchain network, and it also incentivizes users to continuously mine for more currency.
Some cryptocurrencies use a similar — but different — verification method called proof of stake. This consensus mechanism functions much like proof of work, but rather than relying on a decentralized group of users, it employs designated validators who verify transactions with their own crypto.
Different Cryptocurrencies
Some digital currencies have become so popular that they could be considered name-brand crypto. Indeed, the most popular cryptocurrencies such as Bitcoin and Ethereum are typically the most in-demand — and with good reason.
Bitcoin
As the first major digital currency — and still the most popular — Bitcoin has inspired many copycats. Its technology is based on a peer-to-peer network that leverages blockchain transactions verified by proof of work. Several factors set it apart from other virtual currencies, though, including the scarcity imposed by its creators. While other cryptocurrencies allow for unlimited mining, Bitcoin’s supply is capped at 21 million, meaning that miners will eventually find every coin. This has helped Bitcoin retain value, and experts predict that it may increase in value once it has been completely mined.
Ethereum
Ethereum emerged in 2015 as a major competitor against Bitcoin. It has several similarities, including its blockchain system, but it also has several differences. The two key factors separating the two cryptocurrencies are the consensus mechanism and the market cap. While Bitcoin utilizes a proof of work verification system, Ethereum utilizes proof of stake. Ethereum also differs from Bitcoin in the fact that there is no market cap on its supply. There are over 120 million Ethereum coins in circulation, and that number may increase infinitely as miners continue to work the blockchain.
Solana
Solana is the newest of cryptocurrency’s big three. It’s only been around since 2020, but it’s made a big splash in its few years of existence. This is largely due to its status as the fastest blockchain on the market, which is the result of a unique synchronization process. Solana’s consensus mechanism is also unique as it is neither a proof of work nor a proof of stake system. Instead, it utilizes a combination of these technologies to create a proof of history verification method. This approach relies on automated timekeeping to order and verify transactions on the blockchain.
Types of Blockchains
Just as there are many virtual currencies, there are also several types of blockchains that a currency can use to support transactions. One of the biggest initial marketing points of cryptocurrency was its decentralization, but there are other kinds of systems that miners can exploit.
Public Blockchain
A public blockchain — also sometimes called a “permissionless blockchain” — is an open-source system that can be accessed by anybody. They are usually decentralized and reliant upon the transparency of each transaction, which is achieved through the maintenance of the public ledger. Its advantages include its accessibility and the availability of tokens, but it has several disadvantages, too. Most notably, critics say that public blockchains offer minimal scalability for long-term performance.
Private Blockchain
Private blockchains rely on the same technology as their public counterpart, but rather than offering an open-source experience, they utilize a closed network. This type of blockchain is more likely to be centralized, too, with an appointed authority approving new participants — but many private blockchains still maintain a partially decentralized structure. Proponents of permissioned blockchains note that they are typically more efficient than public systems. This may also facilitate a greater potential for scalability as more currencies are introduced and more miners enter the blockchain.
Consortium Blockchain
Consortium blockchains are also sometimes called federated blockchains, and they are tailored to specific organizations rather than individual users. This type of blockchain is typically partially decentralized, and it combines features of both a public and a private blockchain. Its greatest benefit is the increased level of security that is achieved by granting access only to approved groups of users — also called “nodes.” This structure emerged in 2019, so it has not yet had its longevity tested, but it’s likely to become a mainstay if its current popularity holds steady.
Hybrid Blockchain
Hybrid blockchains — like federated blockchains — combine certain aspects of public and private systems. Some parts of the blockchain are available for public use while others are reserved for private, permitted users. Identifying information on users is stored in smart contracts so that it can only be accessed when a transaction is verified. There are many benefits to a hybrid system, but its greatest advantage is its insulation against hacking. Only half of the blockchain’s users are granted direct access to the network, so fewer users are able to compromise the blockchain’s infrastructure.
Familiarize Yourself With Financial Concepts
Cryptocurrency can be overwhelming to a beginner, but it’s also an exciting opportunity for anybody who’s ambitious and computer savvy. Digital currencies may be the money of the future, but for now, it’s still important to develop financial literacy for real-world transactions.