Cryptocurrencies: a close look at the technology
At its core, cryptocurrency is a system of values. When investors buy a cryptocurrency, they bet that the value of this asset will rise in the future, just as stock market investors buy securities when they believe that the company and stock prices will rise.
The valuation of shares is reduced to a discounted estimate of the company’s future cash flows. There is no comparable valuation metric for cryptocurrencies, because there is no base company: the value of a cryptocurrency depends only on the appetite of investors.
The evaluation of the cryptocurrency comes down to one of two factors: the probability of buying an asset by other investors, or the usefulness of the cryptocurrency blockchain.
How does it work?
Cryptocurrency works on blockchain technology, but what is blockchain? This term has become so commonplace that its meaning is often blurred. Blockchain is simply a digital register of transactions. This registry (or database) is distributed over a network of computer systems. No single system controls the ledger. Instead, a decentralized network of computers supports the operation of the blockchain and authenticates its transactions.
Proponents of blockchain technology say that it can improve transparency, increase trust and security of data shared on the network. Detractors say that the blockchain can be cumbersome, inefficient, expensive, and can consume too much energy.
Rational crypto investors buy a digital asset in case they believe in the power and usefulness of the underlying blockchain. All cryptocurrencies work on the blockchain, which means that crypto investors are betting (whether they know about it or not) the stability and attractiveness of this block chain.
Transactions with cryptocurrency are permanently recorded in the basic blockchain. Transaction groups are added to the “chain” in the form of “blocks” that verify the authenticity of transactions and maintain the network operability. All transaction packages are recorded in a general ledger, which is publicly available. Anyone can view transactions made in the main blockchains, such as Bitcoin (BTC) and Ethereum (ETH).
But why do people allocate computing power to verify blockchain transactions?
The answer is simple: they receive a reward in the base cryptocurrency. This incentive-based system is called a proof-of-work (PoW) mechanism. Computers that “work” on “proving” authenticity of blockchain transactions are called miners. In exchange for their energy, miners receive newly mined crypto assets.
Cryptocurrency investors do not store their assets in traditional bank accounts. Instead, they have digital addresses. These addresses have private and public keys – long strings of numbers and letters that allow cryptocurrency users to send and receive funds. Private keys allow you to unlock and send cryptocurrency. Public keys are publicly available, and allow the owner to receive cryptocurrency from any sender.
It is fair to say that Bitcoin has changed the paradigm, since there was nothing like this before. It gave rise to a completely new technology, a new platform for investing, and a new way of thinking about money.
Cryptocurrency was born as a mass movement with an ideology directed against the establishment, but today corporations and financial institutions use cryptocurrencies because they are able to destroy clumsy outdated systems and diversify investment portfolios.
As innovation continues to change the cryptocurrency sector, including exciting new projects such as decentralized finance (“DeFi”), the value of cryptocurrency will continue to evolve.