Basically, cryptocurrency is paperless and digital money. If we take a look at today’s traditional currencies, all of these are owned by an authority which is country and they are controlled by banking institutions and monetary reserves. However, cryptocurrencies are not under control of any authorities. This means everyone has own cryptocurrency at any time. You can create your own digital currency just with several lines of codes and turn to people’s use through public cryptocurrency markets. Although inflation and deflation terms still exist, the value of cryptocurrencies is determined by the market. This causes a new generation of economics for digital money.
There are two new terms entered in our lives. These are crypto and currency:
Crypto is the abbreviated version of the word Cryptography in the field of computer science. Since we are using cryptographic technologies to store and make a computation on data, we called these new currencies as cryptographic currency or cryptocurrency shortly.
Currency has the same meaning as we currently use in today’s financial world. The standard currency can be issued as bank notes or coins. Since cryptocurrencies are created based on the currencies we use today, they have almost the same characteristic specialties with traditional currencies in the field of finance. The main difference is cryptocurrencies have ability to programmable so we do not physical bank notes or coins for using cryptocurrencies and it is a more secure way to make financial operations.
Properties of a Cryptocurrency and Transactions
Since cryptocurrencies are the digital version of traditional currencies, it is necessary to provide some features for the validity and use of money.
- Decentralized: A cryptocurrency should work without any centralized authority to avoid the single center of control.
- Anonymous: All transactions on the chain should not carry personal information of the owner. A wallet address is enough to make operations.
- Trustless: There should not be any 3rd party control on the cryptocurrency. Trustless does not mean unsafe, it means there is no need to trust anybody or any other parties.
- Instantaneous: Unlike a banking transaction, a cryptocurrency transfer should be done immediately by a chain without physical or centralized control.
- Immutable: Once a transaction has sent to the chain, the operation should not be undone.
- Fungible: A cryptocurrency currency should be interchangeable.
- Limited Supply: While creating a cryptocurrency, the supply limit should be determined and should not be changed in future
How It Works
To understand how cryptocurrencies work, it is important to look first at the technical explanation.
Decentralized cryptocurrencies are self-regulating systems. Therefore, any authority such as a bank or a government cannot control the cryptocurrency. Once you create a digital currency and define its properties you cannot change them in the future. The technology acts as an authority but with self-governing properties. Every transaction is encrypted and recorded on the public chain immediately and permanently. When a writing operation comes to the chain, it is distributed to the network which consists of independent nodes and confirmed by specialized computer hardware and software. This operation holding by miners is called mining. Since all miners make a computation instead of systems controlled from one place, they take an incentive for this operation. This system is applied in all writing processes on the chain. That is why we need to pay for writing transactions while reading from the chain is free.
If we are talking about cryptocurrencies, there are two main money-related terms; coins and token. Basically, coins have their own blockchain and tokens are built on a blockchain.
As I mentioned before, a cryptocurrency is decentralized and digital money. A token is a type of cryptocurrency and issued on top of an existing blockchain like Bitcoin or Ethereum. And tokens are used as a utility or asset.
When it is easy to translate a coin into direct dollars and make a purchase on the exchange, token valuation and purchasing is a little different. Since there are SEC regulations for tokens, they released in ICO (Initial Coin Offering) or IEO (Initial Exchange Offering). According to regulations, a token’s type should be either a utility or a security.
First of all, if you attend an ICO to get a token or an application want you to use a token, it is most probably a utility token.
In the decentralized world, applications or smart contract may need specialized tokens to access the service. According to terms, a utility token gives an investor access to a service or a product even if you are not an accredited investor. This means when you are using a Decentralized Application (ÐApp) which works based on Smart Contracts, you need to a utility token to access and use the application.
Security tokens have a closer meaning to the real financial world term; securities. Unlike utility tokens, you need to be an accredited investor to get a security token because of SEC regulations.
Since security tokens represent part-ownership in a tradeable, real-world asset external to the blockchain, you do not use them to access an application. These are only part of the service stock.
Stablecoins are digital currencies whose values are fixed as they are known. Even if the name is a coin, actually stablecoins are generally tokens. This means they do not have their own blockchains but has characteristic of coins.
Stablecoins are popular while there are rapid changes in the value of the crypto market. The reason is that the value of stablecoins is pegged to traditional currencies like the US Dollar or Euro. You cannot use stablecoins as an access key or an asset for a decentralized product. These are only a good way to keep your cryptocurrencies in the fixed value with the fiat currencies. Stablecoins consistently equals to 1 US Dollar or Euro, except for short changes. Therefore, if you want to avoid multiple transaction fees by converting it to fiat currency, you can still keep your funds in cryptocurrency.