Cryptocurrency has become a buzzword in recent years, but what exactly is it, and how does it work? Simply put, cryptocurrency is a digital or virtual currency that uses cryptography to secure and verify transactions and control new units’ creation.

Cryptocurrencies are decentralized, meaning they are not controlled by any central authority, such as a government or financial institution. Instead, they rely on a network of computers to maintain and validate transactions on a distributed ledger called the blockchain.

However, governments worldwide are piloting central bank digital currencies (CBDCs), a digital version of fiat currencies. The CBDCs are modelled against stablecoins and will be solely controlled by governments as they race to catch up with the crypto craze and the future of money, as highlighted by World Economic Forum’s Digital Currency Governance Consortium. 

The blockchain is essentially a digital ledger that records all transactions publicly and transparently. Each block on the chain contains a cryptographic hash of the previous block, which makes it virtually impossible to alter previous transactions.

How does cryptocurrency works?

So how do cryptocurrencies actually work? When a user wants to send cryptocurrency to another user, they create a transaction that is broadcast to the network. Miners on the network then compete to validate the transaction by solving a complex mathematical puzzle. The first miner to solve the puzzle receives a reward in the form of new cryptocurrency units.

Once the transaction is validated, it is added to the blockchain, and the recipient receives the cryptocurrency. This process is called mining, and it is a crucial part of the cryptocurrency ecosystem, especially for cryptocurrencies based on proof-of-work (PoW) like Bitcoin [BTC]. 

Cryptocurrencies also have a finite supply, with most having a maximum limit on the number of units that can be created. This is in contrast to traditional fiat currencies, which can be printed indefinitely.

What are the benefits of Cryptocurrencies?

One of the main advantages of cryptocurrency is that it can be used for peer-to-peer transactions without the need for intermediaries such as banks or payment processors. This makes it a fast and efficient way to transfer value globally. Here is a list of the benefits of cryptocurrencies: 

  1. Decentralization: Cryptocurrencies are decentralized, meaning they are not controlled by any central authority, such as a government or financial institution. This makes them more resistant to censorship and interference from outside parties.
  2. Security: Cryptocurrencies use advanced cryptographic techniques to secure and verify transactions. This makes them virtually immune to fraud and counterfeiting.
  3. Privacy: Many cryptocurrencies offer a high level of anonymity and privacy, making them a popular choice for those who value their privacy.
  4. Fast and efficient transactions: Cryptocurrencies allow for fast and efficient transactions, with no need for intermediaries such as banks or payment processors. This makes them a convenient and cost-effective way to transfer value globally.
  5. Low transaction fees: Cryptocurrencies generally have lower transaction fees than traditional payment methods, making them a more affordable option for sending and receiving money, whether internal or cross-border.
  6. Global accessibility: Cryptocurrencies are accessible to anyone with an internet connection, regardless of location or financial status. This makes them a powerful tool for financial inclusion and economic empowerment.
  7. Transparency: Cryptocurrencies use a public ledger called the blockchain, which records all transactions in a transparent and immutable manner. This makes tracking and verifying transactions easy, increasing trust and accountability.
  8. Potential for innovation: Cryptocurrencies are still a relatively new and evolving technology, with many exciting possibilities for innovation and disruption in various industries.

However, cryptocurrency also has its downsides. 

  1. Volatility: Cryptocurrencies are known for their high volatility, with prices sometimes fluctuating wildly in short periods. This makes them a risky investment and can lead to significant losses for investors. For example, BTC hit $68K in November 2021 but dropped to $16K in December 2022, only to rebound to $28K in March 2023. 
  2. Lack of regulation: Cryptocurrencies are not regulated by governments or financial institutions, which can make them vulnerable to fraud, market manipulation, and other illegal activities. However, several jurisdictions are rolling out crypto regulations as adoption increases. In the US, SEC is cracking down on crypto staking and exchanges like Kraken and Coinbase for offering unregistered securities (‘tokens”).
  3. Security risks: While cryptocurrencies use advanced cryptographic techniques to secure transactions, there have been instances of hacks and thefts of cryptocurrencies. Once stolen, cryptocurrencies are virtually impossible to recover.
  4. Limited acceptance: While more businesses are beginning to accept cryptocurrencies as a form of payment, they are still not widely accepted, which can limit their utility and value.
  5. Technical challenges: Cryptocurrencies are built on complex technology, and users must understand how they work to use them safely and effectively. This can be a barrier for some users.
  6. Energy consumption: Mining cryptocurrencies requires significant amounts of energy, which can have a negative impact on the environment and contribute to climate change.
  7. Lack of recourse: Since cryptocurrencies are not regulated, there is often little or no recourse for users who experience issues with exchanges, wallets, or other cryptocurrency services.

Despite these challenges, cryptocurrency continues gaining traction and is being adopted by businesses and individuals worldwide. As technology continues to evolve, we will likely see new and innovative uses for cryptocurrency in the future.

In summary, cryptocurrency is a digital currency with cryptography and a decentralized network to secure and verify transactions. It is an innovative and potentially disruptive technology that has the potential to change the way we think about money and finance.