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What Are Forks and How Do They Impact the Price of Cryptocurrency?
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Last Updated on November 30, 2020
Cryptocurrencies are beginning to completely change the world of finance.
In the beginning, there was Bitcoin, which was designed to function as a decentralized digital alternative to cash. Over time, a number of more specialized currencies have appeared, such as Ripple and Monero. These new currencies didn’t just appear from nowhere, many came about as a result of a fork.
Forks occur when the user base or developers decide that something fundamental about a cryptocurrency needs to change. This can be due to a major hack, as was the case with Ethereum, or as a fundamental disagreement within the community, like we’ve seen with Bitcoin and Bitcoin Cash.
A fork can have a substantial impact on a cryptocurrency. They are often predicated by large price fluctuations and have proven to be quite controversial in the past. To understand why, let’s start at the beginning by asking ourselves, ‘what is a cryptocurrency fork?’
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What is a Fork and How Does It Work?
In its broadest sense, a fork is simply a change in the blockchain’s protocol that the software uses to decide whether a transaction is valid or not. This means that almost any divergence in the blockchain can be considered a fork. However, there are two main varieties – hard forks and soft forks.
A soft fork is any change that is backward compatible. When a soft fork takes place, older nodes (computers that connect to the cryptocurrency’s network) will still recognize new transactions as being valid. However, any blocks that are mined will be considered invalid by the updated nodes.
This means that, in order to be successful, soft forks require the majority of the network’s hash power. Otherwise, they risk being the smallest chain and becoming orphaned from the Network, essentially becoming a “hard fork.”
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A hard fork is any change that breaks backward compatibility. Nodes running the old software will see any new transactions as invalid. This means that in order to mine new “valid” chains they will need to update. If a large enough percentage of the community decides that they want to continue using the old rules then the chain will split, resulting in two separate currencies.
A hard fork requires majority support (or consensus) from coin holders with a connection to the coin network. In order for a hard fork to be adopted, a sufficient number of nodes need to update to the newest version of the protocol software. This allows them to use the new coin and blockchain.
Any nodes that chose not to update will be unable to use the new blockchain. If enough users don’t update then you will be unable to get a clean upgrade which could lead to a break in the blockchain. There are a number of ways to ensure that consensus is in place before fully activating an update.
Soft forks sometimes use miner-activated updates, where the hashpower of a new protocol needs to equal a certain percentage before the update is adopted. Dash uses its masternodes in order to adopt major changes to the blockchain protocol. But whatever method used, the end result is the same. A majority of the community needs to agree before any fundamental changes can be implemented, or else you risk a hard break.
The end result of a successful upgrade is that a new coin will fork off from the blockchain, from the block where the upgrade took place. Two separate coins with two separate ledgers, all originating from the same blockchain.
In the case of updates like SegWit, everyone ideally updates to the new protocol, so only one coin exists. In cases of hard forks, like Bitcoin Cash, two different coins and blockchains will run simultaneously after the fork. The latter case is an excellent example of a true “hard fork” and these generally end one of two ways:
- One blockchain becomes dominant, resulting in the other blockchain having low community adoption and value.
- Both blockchains are adopted, co-existing and operating independently of one another with roughly equal community adoption and value.
The first outcome is the most common, as happened with Ethereum and Ethereum Classic, with Ethereum vastly outperforming Ethereum Classic. The second is rarer, but it does happen. Bitcoin Cash and Bitcoin ended up broadly coexisting once the SegWit 2.x update failed to materialize.
Forks can be disruptive experiences for a community. There are often competing visions for the future of a cryptocurrency and this can lead to a point where traders and miners feel that they have no choice but to go their separate ways.
For example, the lead up to the Bitcoin and Bitcoin Cash split happened after a series of increasingly venomous debates within the community. There is still a great deal of ill-will between the now fractured communities, particularly surrounding Bitcoin Cash’s claims to be Satoshi’s “true vision” for Bitcoin.
Sometimes, this level of disruption can be enough to prevent a fork from taking place. The controversial Segwit 2.X fork was abandoned in November 2020 due to the fact that its proponents had “not built sufficient consensus for a clean blocksize upgrade at this time.” Fears that the upgrade may lead to another hard fork and would further destabilize Bitcoin put the plans on hold.
What Are the Effects of a Hard Fork?
Hard forks can have a profound impact on the cryptocurrency and not just because of the uncertainty caused. The Bitcoin Cash hardfork is a good example of a quirk that can occur. Holders of the “parent” cryptocurrency end up with an equal number of forked off coins.
For example, if you had held 10 Bitcoin at the time of the Bitcoin Cash fork, you would have 10 Bitcoin Cash. This can lead to some really interesting ripples within the market.
Large traders, or Whales, can make big waves on the market. Whales are generally large organizations that own hundreds of thousands of Bitcoins. This is enough that their decisions will strongly influence the direction of the market. Some large private traders, or Dolphins, also have enough stake to influence the market to a certain degree.
Let’s imagine that the manager of one of these whales knows that a fork is about to happen and it will result in them obtaining one new coin for every original coin they hold. This gives them a strong incentive to increase their stake in the parent token. Thus, they begin to buy up every token they can find. Their huge size means that they can artificially drive the price of the parent currency higher in the lead up to the fork as the Whales and Dolphins buy up everything they can find.
They will continue to do this until the night of the split. The Whales are rewarded for their investment with new tokens on a one-to-one ratio. Because Whales know that the price of the parent company has been inflated by their actions they proceed to dump both the new token and the parent token on every exchange they can. This can cause the value of both the forked and parent token to crash in value. Over time, their values will begin to stabilize as the traders use their profits to purchase more cryptocurrency.
The above example applies to an extreme case where the entire blockchain is cloned. Not all forks will result in “free” cryptocurrency.
The above example also applies to splits where the entire blockchain is cloned. Many forks only copy the underlying code, so while a new coin is corrected it does not create duplicates. In these cases, traders act a little differently. Depending on the circumstance surrounding the fork you may see traders abandoning the old coin in favor of “safer” bets until they think the market has stabilized.
It is also possible to see traders largely abandon the original cryptocurrency in favor of the new fork, as happened with Ethereum and Ethereum Classic (with the former strongly outcompeting the latter).
Should You Invest Before a Hard Fork?
A hard fork marks an unstable time for a cryptocurrency. The community will often be divided over the issue and the market is generally very volatile, even by cryptocurrency standards. How you will react will largely depend on the stake you have in the currency and the type of fork you are looking at.
In the case of a hard fork, where you will be getting “free” currency, it makes sense to keep hold of your currency or even increase your investment. The downside of this is that other large traders are doing the same. If you are concerned that you might not be able to react quickly enough to sell off before the Whales, you might be better advised to sell your investment just prior to the fork.
You will lose out on the “free” currency but you may be able to make a profit from the Whales looking to increase their stake. You can then use this to buy a bigger share after the inevitable crash.
If you’re looking at a soft fork then your choices are a little easier. If you believe that the fork will help the currency, the best course of action will be to scoop up currency from concerned users, taking advantage of price fluctuations to increase your stake. If you believe that the fork will be bad for the currency then you should sell before the crash. Remember – there is still a chance the currency will split if the community is not behind the fork.
Hard Fork or Soft Fork – Remember That Your Capital is at Risk
Remember that, no matter how certain you are, the market will not always react the way you assume it will. Cryptocurrency is an exceptionally volatile commodity, so you should be prepared to lose money. Ensure that you follow the golden rule and never invest capital that you cannot afford to lose.
What is Cryptocurrency? Your Complete Crypto ABC
Welcome to my complete beginner’s guide to What is Cryptocurrency.
The short and easy answer to the title question is that cryptocurrency is decentralized digital money. But what exactly does that mean and how does it work?
In this guide, I will answer all the questions you have about cryptocurrency. I’m going to tell you when it was invented, how it works and why it’s going to be so important in the future. By the end of this guide, you’ll be able to answer the question, “what is a cryptocurrency?” for yourself.
The world of cryptocurrency moves fast so there’s no time to waste. Let’s get started!
When I hear a new word, I look up its definition in my dictionary. Cryptocurrency is a new word for most people so let’s write a crypto definition…
Table of Contents
How Does Cryptocurrency Work?
Miners try to solve mathematical puzzles first to place the next block on the blockchain and claim a reward.
An exchange is a business (usually a website) where you can buy, sell or trade cryptocurrencies.
Cryptocurrency wallets are software programs that store public and private keys and enable users to send and receive digital currency and monitor their balance.
Below is a list of six things that every cryptocurrency must be in order for it to be called a cryptocurrency;
- Digital: Cryptocurrency only exists on computers. There are no coins and no notes. There are no reserves for crypto in Fort Knox or the Bank of England!
- Decentralized: Cryptocurrencies don’t have a central computer or server. They are distributed across a network of (typically) thousands of computers. Networks without a central server are called decentralized networks.
- Peer-to-Peer: Cryptocurrencies are passed from person to person online. Users don’t deal with each other through banks, PayPal or Facebook. They deal with each other directly. Banks, PayPal and Facebook are all trusted third parties. There are no trusted third parties in cryptocurrency! Note: They are called trusted third parties because users have to trust them with their personal information in order to use their services. For example, we trust the bank with our money and we trust Facebook with our holiday photos!
- Pseudonymous: This means that you don’t have to give any personal information to own and use cryptocurrency. There are no rules about who can own or use cryptocurrencies. It’s like posting on a website like 4chan.
- Trustless: No trusted third parties means that users don’t have to trust the system for it to work. Users are in complete control of their money and information at all times.
- Encrypted: Each user has special codes that stop their information from being accessed by other users. This is called cryptography and it’s nearly impossible to hack. It’s also where the crypto part of the crypto definition comes from. Crypto means hidden. When information is hidden with cryptography, it is encrypted.
- Global: Countries have their own currencies called fiat currencies. Sending fiat currencies around the world is difficult. Cryptocurrencies can be sent all over the world easily. Cryptocurrencies are currencies without borders!
This crypto definition is a great start but you’re still a long way from understanding cryptocurrency. Next, I want to tell you when cryptocurrency was created and why. I’ll also answer the question ‘what is cryptocurrency trying to achieve?’
The Origin of Cryptocurrency
In the early 1990s, most people were still struggling to understand the internet. However, there were some very clever folks who had already realized what a powerful tool it is.
Some of these clever folks, called cypherpunks, thought that governments and corporations had too much power over our lives. They wanted to use the internet to give the people of the world more freely. Using cryptography, cypherpunks wanted to allow users of the internet to have more control over their money and information. As you can tell, the cypherpunks didn’t like trusted third parties at all!
At the top of the cypherpunks, the to-do list was digital cash. DigiCash and Cybercash were both attempts to create a digital money system. They both had some of the six things needed to be cryptocurrencies but neither had all of them. By the end of the
the nineties, both had failed.
The world would have to wait until 2009 before the first fully decentralized digital cash system was created. Its creator had seen the failure of the cypherpunks and thought that they could do better. Their name was Satoshi Nakamoto and their creation was called Bitcoin.
Understanding cryptocurrency means first understanding Bitcoin…
The Story of Bitcoin
No one knows who Satoshi Nakamoto is. It could be a man, a woman or even a group of people. Satoshi Nakamoto only ever spoke on crypto forums and through emails.
In late 2008, Nakamoto published the Bitcoin whitepaper. This was a description of what Bitcoin is and how it works. It became the model for how other cryptocurrencies were designed in the future.
On January 12, 2009, Satoshi Nakamoto made the first Bitcoin transaction. They sent 10 BTC to a coder named Hal Finney. By 2020, Satoshi Nakamoto was gone. What they left behind was the world’s first cryptocurrency.
Bitcoin became more popular amongst users who saw how important it could become. In April 2020, one Bitcoin was worth one US Dollar (USD).
By December 2020, one Bitcoin was worth more than twenty thousand US Dollars! Today, the price of a single Bitcoin is 7,576.24 US Dollars. Which is still a pretty good return, right?
In 2020, a programmer bought two pizzas for 10,000 BTC in one of the first real-world bitcoin transactions. Today, 10,000 BTC is equal to roughly $38.1 million – a big price to pay for satisfying hunger pangs.
So, Bitcoin has succeeded where other digital cash systems failed. But why? What is cryptocurrency doing differently? The thing that makes cryptocurrency different from fiat currencies and other attempts at digital cash is blockchain technology. Let’s find out how it works…
What is Blockchain?
All cryptocurrencies use distributed ledger technology (DLT) to remove third parties from their systems. DLTs are shared databases where transaction information is recorded. The DLT that most cryptocurrencies use is called blockchain technology. The first blockchain was designed by Satoshi Nakamoto for Bitcoin.
A blockchain is a database of every transaction that has ever happened using a particular cryptocurrency. Groups of information called blocks are added to the database one by one and form a very long list. So, a blockchain is a linear chain of blocks! Once information is added to the blockchain, it can’t be deleted or changed. It stays on the blockchain forever and everyone can see it.
The whole database is stored on a network of thousands of computers called nodes. New information can only be added to the blockchain if more than half of the nodes agree that it is valid and correct. This is called consensus. The idea of consensus is one of the big differences between cryptocurrency and normal banking.
At a normal bank, transaction data is stored inside the bank. Bank staff makes sure that no invalid transactions are made. This is called verification. Let’s use an example;
George owes 10 USD to both Michael and Jackson. Unfortunately, George only has 10 USD in his account. He decides to try to send 10 USD to Michael and 10 USD to Jackson at the same time. The bank’s staff notice that George is trying to send money that he doesn’t have. They stop the transaction from happening.
The bank stopped George from double spending which is a kind of fraud. Banks spend millions of dollars to stop double spending from happening. What is cryptocurrency doing about double spending and how do cryptocurrencies verify transactions? Remember, they don’t have stuff as the bank does!
How Does Blockchain Work?
Cryptocurrency transactions are verified in a process called mining. So, what is cryptocurrency mining and how does it work?
Cryptocurrency mining might sound like something you do with a shovel and a hard hat but it’s actually more like accounting. Miners are nodes that perform a special task that makes transactions possible. I’ll use an example to show you how it works using the Bitcoin network.
- George owes Michael 10 BTC. George announces that he is sending Michael 10 BTC to the Bitcoin network.
- Miners take the information and encrypt it. This is called hashing. To this information, they add other transaction information and hash that too. More and more information is added and hashed until there is enough to form a block.
- The miners now race against each other to guess the encrypted code or block hash that will be given to the new block before it’s added to the blockchain. The lucky miner that guesses the right code gets to add the new block to the blockchain.
- Now, all the other nodes on the network verify the transaction information in the new block. They check the whole blockchain to make sure that the new information matches. If it does, then the new block is valid, and the winning miner can add the new block to the blockchain. This is called confirmation.
- Michael receives 10 BTC from George.
Mining cryptocurrency uses a lot of computer power, so miners are rewarded for the work they do. On the Bitcoin network, miners who confirm new blocks of information are rewarded with 12.5 BTC of new Bitcoin. This is why it’s called mining. Instead of mining for gold or coal crypto, miners are digging for new Bitcoin!
So, What is Cryptocurrency Mining For?
It’s the way cryptocurrency networks like Bitcoin verify and confirm new transactions. It stops double spending without the need to trust centralized accounting as banks do. Cryptocurrency blockchains aren’t secured by trust or people. They are secured by math done by computers!
For more information, check out my Blockchain Explained guide.
Now you know how blockchains and crypto mining work. Next, I’ll tell you how you can join a cryptocurrency network…
Using cryptocurrencies isn’t like using fiat currency. You can’t hold cryptocurrency in your hand and you can’t open a cryptocurrency account. Cryptocurrency only exists on the blockchain. Users access their cryptocurrency using codes called public and private keys.
It’s a bit like sending emails. If you want someone to send you an email, you tell them your email address. Well, if you want someone to send you cryptocurrency, you tell them your public key.
Now, if you want to read your emails or send an email, you need to enter your email password. This is how private keys work. Private keys are like passwords for cryptocurrency. Public keys can be seen by anyone, but private keys should only be seen by you. If there is one paramount detail you should learn from this What is Cryptocurrency guide, it’s that keeping your private keys safe is extremely important!
Private and public keys are kept in wallets. Crypto wallets can be online, offline, software, hardware or even paper. Some can be downloaded for free or are hosted by websites. Others are more expensive. For example, hardware wallets can cost around a hundred US Dollars. You should use several different kinds of wallets when you use cryptocurrency.
Whoever has the private and public keys owns the cryptocurrency, so don’t lose your wallets! Cryptocurrency is pseudonymous, remember? There is no way to prove your own cryptocurrency unless you have the keys to it.
I’ve told you about how the first cryptocurrency was created and how it works. I’ve also told you about how cryptocurrency is stored and used. Now, let’s look at some other cryptocurrencies that have been created since Bitcoin…
The Rise of Cryptocurrencies!
Bitcoin changed the way people think about money. Hundreds of other cryptocurrencies have been created since and they all want to change the world!
Check out a few of the cryptocurrencies that have come along since Bitcoin;
- Litecoin is a lot like Bitcoin but its transactions are processed four times faster. Litecoin mining is easier than Bitcoin mining, so users with less powerful computers can become miners.
- Ethereum uses more advanced blockchain technology than Bitcoin. It’s sometimes called Blockchain 2.0. Ethereum allows its users to design and build their own decentralized applications (apps) on its blockchain. If Bitcoin wants to replace banks, then Ethereum wants to replace everything else. Ethereum developers can build dApp versions of centralized apps like Facebook, Amazon, Twitter or even Google! The platform is becoming bigger than just a cryptocurrency. So, what is cryptocurrency when it’s not really cryptocurrency anymore? It’s Ethereum! A platform that uses blockchain technology to build and host decentralized apps.
Ethereum has quickly skyrocketed in value since its introduction in 2020, and it is now the 2nd most valuable cryptocurrency by market cap. It’s increased in value by 2,226% in just last year – a huge boon for early investors.
Would you like to know more about Ethereum? Check out my What is Ethereum guide.
- IOTA is a pretty special cryptocurrency, it doesn’t have a blockchain! IOTA uses a DLT called the Tangle. Miners don’t confirm new transactions, users do…When a user wants to make a payment using the Tangle they have to verify and confirm two other user’s transactions first. Only then will their payment be processed. It’s like getting students to grade each other’s homework instead of the teacher doing it. The Tangle is thought to be a lot faster than Bitcoin, Litecoin and Ethereum! If you thought that was weird, check this out — IOTA isn’t even designed to be used by humans! It’s designed for the Internet of Things. That’s any machine with an internet connection. IOTA will help the IoT communicate with itself. IOTA actually means the Internet of Things Application. Imagine that! In the future, your driverless car will use IOTA to go to the gas station, fill up with gas and pay. All without any humans being involved.
Cryptocurrencies aren’t just for sending money without using a bank. They can do all kinds of cool things. These cryptocurrencies and many others are available to buy and sell on crypto exchanges. So, what is cryptocurrency trading?
Buying and selling cryptocurrencies has become a very big business. The total value of all the cryptocurrencies in the world is more than 350 billion US Dollars. Just under 17 billion US Dollars’ worth of cryptocurrency was bought and sold today!
You can trade online with crypto exchanges like Binance, Bitstamp, and Coinbase. You can also arrange to trade cryptocurrencies in-person with peer-to-peer sites like LocalBitcoins.com
You can trade online with crypto exchanges like Binance, Bitstamp, and Coinbase. You can also arrange to trade cryptocurrencies in-person with peer-to-peer sites like LocalBitcoins.com.
A cryptocurrency market is an exciting place. Traders can make millions and then lose it all. Cryptocurrencies are created overnight and then disappear just as fast. My advice to any newbie trader out there is to only spend what you can afford to lose. I know I sound like your Grandma, but it’s true!
Crypto trading should be used as a way to support the technology and not as a quick way to get rich!
Since you started reading this guide, you’ve been getting closer and closer to understanding cryptocurrency. There’s just one more question I’d like to answer. What is cryptocurrency going to do for the world?
Can Cryptocurrency Save the World?
Cryptocurrency has a lot of critics. Some say that it’s all hype. Well, I have some bad news for those people. Cryptocurrency is here to stay and it’s going to make the world a better place.
Centralized organizations have let us down.
- In 2008, banks cost taxpayers trillions of dollars and caused the world economy to fall apart.
- The credit checking agency, Equifax, lost more than 140,000,000 of its customers’ personal details in 2020.
- This year, Facebook was forced to apologize for selling its users’ personal data.
Cryptocurrencies offer the people of the world another choice.
The governments of Syria, Yemen, and Libya have all failed to protect their people from violent civil wars.
What is the cryptocurrency to the people of Syria? It’s hope. Thirty percent of UN Aid is lost to third-party corruption so UNICEF has been using Ethereum to raise money for the children of Syria.
About 2 billion people around the world don’t have bank accounts. One in ten Afghanis are unbanked, many of them women. What is the cryptocurrency to an Afghani woman? It’s freedom. Bitcoin is giving women in Afghanistan financial freedom for the first time.
Blockchain technology could be used for elections in some of the most corrupt countries in the world. What is the cryptocurrency to the people of Sudan or Myanmar? It’s a voice. Free elections could be held without fear of violence or intimidation.
Cryptocurrencies can help make the world a fairer, safer and more peaceful place for us all to live in.
Final Thoughts: What is Cryptocurrency?
So far, you’ve learned what cryptocurrencies are and how they work. You also know how to store them and where to trade them. However, understanding cryptocurrency is more than just understanding blockchains and mining. Understanding cryptocurrency is about understanding what those technologies can do for you.
Cryptocurrencies have the power to change our lives forever. They can help you take back control of your money and your information. Some people will ignore them and hope they go away. Others will join the party. Which will you be?
In this guide, I’ve told you everything you need to know about cryptocurrency.
What Is a Cryptocurrency?
A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology—a distributed ledger enforced by a disparate network of computers. A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation.
- A cryptocurrency is a new form of digital asset based on a network that is distributed across a large number of computers. This decentralized structure allows them to exist outside the control of governments and central authorities.
- The word “cryptocurrency” is derived from the encryption techniques which are used to secure the network.
- Blockchains, which are organizational methods for ensuring the integrity of transactional data, is an essential component of many cryptocurrencies.
- Many experts believe that blockchain and related technology will disrupt many industries, including finance and law.
- Cryptocurrencies face criticism for a number of reasons, including their use for illegal activities, exchange rate volatility, and vulnerabilities of the infrastructure underlying them. However, they also have been praised for their portability, divisibility, inflation resistance, and transparency.
Cryptocurrencies are systems that allow for the secure payments online which are denominated in terms of virtual “tokens,” which are represented by ledger entries internal to the system. “Crypto” refers to the various encryption algorithms and cryptographic techniques that safeguard these entries, such as elliptical curve encryption, public-private key pairs, and hashing functions.
Types of Cryptocurrency
The first blockchain-based cryptocurrency was Bitcoin, which still remains the most popular and most valuable. Today, there are thousands of alternate cryptocurrencies with various functions and specifications. Some of these are clones or forks of Bitcoin, while others are new currencies that were built from scratch.
Bitcoin was launched in 2009 by an individual or group known by the pseudonym “Satoshi Nakamoto.” As of Nov. 2020, there were over 18 million bitcoins in circulation with a total market value of around $146 billion.
Some of the competing cryptocurrencies spawned by Bitcoin’s success, known as “altcoins,” include Litecoin, Peercoin, and Namecoin, as well as Ethereum, Cardano, and EOS. Today, the aggregate value of all the cryptocurrencies in existence is around $214 billion—Bitcoin currently represents more than 68% of the total value.
Some of the cryptography used in cryptocurrency today was originally developed for military applications. At one point, the government wanted to put controls on cryptography similar to the legal restrictions on weapons, but the right for civilians to use cryptography was secured on grounds of freedom of speech.
Central to the appeal and functionality of Bitcoin and other cryptocurrencies is blockchain technology, which is used to keep an online ledger of all the transactions that have ever been conducted, thus providing a data structure for this ledger that is quite secure and is shared and agreed upon by the entire network of individual node, or computer maintaining a copy of the ledger. Every new block generated must be verified by each node before being confirmed, making it almost impossible to forge transaction histories.
Many experts see blockchain technology as having serious potential for uses like online voting and crowdfunding, and major financial institutions such as JPMorgan Chase (JPM) see the potential to lower transaction costs by streamlining payment processing. However, because cryptocurrencies are virtual and are not stored on a central database, a digital cryptocurrency balance can be wiped out by the loss or destruction of a hard drive if a backup copy of the private key does not exist. At the same time, there is no central authority, government, or corporation that has access to your funds or your personal information.
Advantages and Disadvantages of Cryptocurrency
Cryptocurrencies hold the promise of making it easier to transfer funds directly between two parties, without the need for a trusted third party like a bank or credit card company. These transfers are instead secured by the use of public keys and private keys and different forms of incentive systems, like Proof of Work or Proof of Stake.
In modern cryptocurrency systems, a user’s “wallet,” or account address, has a public key, while the private key is known only to the owner and is used to sign transactions. Fund transfers are completed with minimal processing fees, allowing users to avoid the steep fees charged by banks and financial institutions for wire transfers.
The semi-anonymous nature of cryptocurrency transactions makes them well-suited for a host of illegal activities, such as money laundering and tax evasion. However, cryptocurrency advocates often highly value their anonymity, citing benefits of privacy like protection for whistleblowers or activists living under repressive governments. Some cryptocurrencies are more private than others.
Bitcoin, for instance, is a relatively poor choice for conducting illegal business online, since the forensic analysis of the Bitcoin blockchain has helped authorities to arrest and prosecute criminals. More privacy-oriented coins do exist, however, such as Dash, Monero, or ZCash, which are far more difficult to trace.
Criticism of Cryptocurrency
Since market prices for cryptocurrencies are based on supply and demand, the rate at which a cryptocurrency can be exchanged for another currency can fluctuate widely, since the design of many cryptocurrencies ensures a high degree of scarcity.
Bitcoin has experienced some rapid surges and collapses in value, climbing as high as $19,000 per Bitcoin in Dec. of 2020 before dropping to around $7,000 in the following months. Cryptocurrencies are thus considered by some economists to be a short-lived fad or speculative bubble.
There is concern that cryptocurrencies like Bitcoin are not rooted in any material goods. Some research, however, has identified that the cost of producing a Bitcoin, which requires an increasingly large amount of energy, is directly related to its market price.
Cryptocurrency blockchains are highly secure, but other aspects of a cryptocurrency ecosystem, including exchanges and wallets, are not immune to the threat of hacking. In Bitcoin’s 10-year history, several online exchanges have been the subject of hacking and theft, sometimes with millions of dollars worth of “coins” stolen.
Nonetheless, many observers see potential advantages in cryptocurrencies, like the possibility of preserving value against inflation and facilitating exchange while being more easy to transport and divide than precious metals and existing outside the influence of central banks and governments.
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