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A Beginner’s Guide to Cryptocurrency

Cryptocurrencies are gaining an increasing amount of traction with each passing year for several reasons. Also referred to as crypto assets, cryptocurrencies are actually virtual (or digital) coins that are used as money in the digital world. You may use cryptocurrencies to purchase anything from other crypto coins that may hold intrinsic value to a brand new car.

Of course, cryptocurrencies are not physical products; they only exist in a digital form, and their value depends on sheer supply and demand forces rather than outside interventions. They are also not subject to depreciation (inflation does not affect their value). We could say that digital coins are quite comparable to gold (the greater the demand, the more their value goes up) but, unlike gold, they can be used to pay for goods and services too.

What is, perhaps, the most vital asset of cryptocurrencies is that they eliminate privacy concerns when you make transactions using them, given that each crypto coin transaction is secured with cryptography (hence, the name “crypto” currency) with the aid of blockchain technology – a public ledger that publicly confirms and records all transactions. Plus, every transaction is controlled by computer algorithms and users; not a central government.

 

Cryptocurrency Pros Overview

Where cryptocurrency has won people is in the fact that it hands the power of money-making to the general public, away from the central federal banks. Banks cannot seize or freeze digital coin wallets or accounts or send taxmen to examine them (the accounts) because the digital coin is transferred via a peer-to-peer network of users.

Compared to conventional (fiat) money, digital coins come with added benefits, some of which are listed below:

• Every digital coin transaction is transparent because it is recorded in public view.
• Cryptocurrency transactions contain no sensitive or personal information of the customer, making it nearly impossible to steal personal data for dark purposes.
• Transactions are secure, anonymous, and irreversible, which provides an extra layer of protection against identity theft.
• International payments are easy and cheap as cryptocurrency is not tied to any country or subjected to regulation.
• No need to pay fees or provide documentation to set up a crypto coin address, unlike conventional bank accounts.
• Virtual coin holders get to choose their own fees when spending their digital coins. They can have a transaction confirmed with zero processing costs if they are willing to wait a bit longer (up to 3 days max).
• Transactions are verified in a few minutes among peers once you broadcast a transaction, which makes transferring money with digital currency easy.
• The distributed nature of cryptocurrency makes the digital coins secure to use as there is no central software to hack.

Some of the above statements may sound like Chinese to new-comers. Rest assured, though, that things will start to clear up, starting now.

 

Cryptocurrency Basics

The idea behind the creation of cryptocurrencies belongs to Satoshi Nakamoto, who dreamed of changing the way people think about money and wanted to introduce a new monetary system, where a digital form of currency would be regulated by math and centralized authority. Also, he longed for money that would not be tracked by any formal institution.

As of now, a trusted, central server that kept records of transactions and balances was the solution to the double-spending problem (a fraudulent activity where the same amount of money is spent twice). Nevertheless, this entailed a central authority in control of your money which also had all your personal information at hand. Cryptocurrency has come to change with a decentralized network of peers (meaning virtual coins are transferred between peers without needing a middleman to complete each transaction) and the help of the Blockchain that allows everyone on the network to see the balance of every account.

This is what we call the Blockchain, and is hosted on many computers across the world, also called cryptocurrency “miners”, which lend their processing power to verify every transaction a virtual coin holder makes. Then, they (the computers/miners) register these transactions on the blockchain, and the computer owners receive tokens for their services.

However, to run such a system, it is crucial to have a sound infrastructure that can eradicate the possibility of cheating or manipulating the system in any way.

 

How Cryptocurrencies Work?

Everything is actually basic cryptography. Transactions between peers are possible with the use of a cryptocurrency or virtual or digital wallet (consider it something like your digital bank account). The individual creating the transaction uses their wallet to transfer balances or funds to another account. To ensure the safety of each transaction you make, you get a unique set of keys; whoever has those keys owns the amount of digital coins associated with these keys (pretty much like when you own a bank account; you also own the money in it). Whenever you create a transaction, you need to sign it off with your private key. The recipient of the transaction also has a key (unique; not the same as yours – think of it as their own IBAN) so that the transaction can be completed.

Every transaction made between peers is sent out to all the users that host a copy of the blockchain (the digital coin’s network) and must be confirmed by everybody (gain consensus), then encrypted, and finally added and recorded to the public ledger (every single user of a given digital coin can also have access to the ledger).

It should be noted that although the amount of each transaction is public, the person that sent it (the transaction) is kept anonymous/encrypted. To ensure against bad actors and attempts to tamper with the blockchain, the miners are called to solve advanced cryptographic puzzles (to verify each transaction) which are not only extremely difficult to crack but also require a ton of effort and computing power to add incorrect data to the blockchain, which makes any attempt to trick the system not worth it.

Several transactions (“chains”) are added sequentially to the ledger – these are called “blocks”. So, that’s about how the term “blockchain” was coined. One of the first cryptocurrencies introduced to give the seller the power to make decisions is bitcoin, which has made headlines numerous times since 2008 when it was created.

 

About Bitcoin

We have seen the value of Bitcoins skyrocket between 2011 and 2013 mainly due to the activity of criminal traders who bought bitcoins in batches of millions of dollars to push money under the radar of law enforcement. Eventually, though, bitcoin has become highly controversial because it is unregulated by any central authority, which means that no tax agency or police can track your money if you use it. Also, central banks cannot log money movement and are unable to create bitcoins. However, all that regime will probably change in the coming months or years considering that unregulated money comes with increased risk of money laundering.

With bitcoins, you can make transactions by check, wiring or cash. To create bitcoins, it takes elaborate mathematical computations that are performed by miners, who act as both ledger keepers and auditors and earn new bitcoins every week for their accounting and support work. Now, if you want to trade bitcoins or other virtual currency, you need to have a digital wallet that is stored either on a device you use the most, such as your computer drive or your smartphone, or in the cloud. Then, you may use a cryptocurrency exchange or online broker (websites where you can purchase, sell or trade digital for traditional currency or digital money) or a peer-to-peer crypto exchange market to buy or sell bitcoins (or other virtual coins).

Notes

• Bitcoins will not be supplied to the digital market indefinitely. There will be a total of 21 billion of them created and then there will be no new ones made. It is estimated that we have a good 20 more years before we reach that upper cap, given that as of 2017, over 11 billion bitcoins have been created.
Cryptocurrency wallets, Bitcoin included, provide no insurance protection so losing your hard drive data or wallet password means that you also lose (for good) the content of your wallet. In addition, once a transaction is made, you cannot reverse it. When a bitcoin or other cryptocurrency changes hands, it is irreversible and final.
• The value of bitcoin varies, with recent reports signifying a drop below $5,000. There will always be highs and lows with cryptocurrencies, as are with any stock in the stock market. At some point in time, bitcoin exceeded $19,000. It is not unlikely to see it climb back up or even exceed that number. To see today’s value, you can visit websites that provide such details or a crypto exchange.

 

Cryptocurrency Tax Details

Cryptocurrency is legal in the U.S. and most of the world in every aspect. For the US crypto traders, in particular, digital money is taxed as an investment property so you will need to tally losses and profits at the current market value of the virtual coin when you trade, use or sell it. Then, you will have to pay the capital gains tax in a year (calendar year, that is). If you are planning to focus on doing substantial crypto-to-crypto trading, it is suggested to consult an accountant due to the varying tax complications involved in trading digital coins.