You may have read internet advertisements telling you that if you bought a few hundred dollars of Bitcoin in the beginning, you would be a millionaire today. How did cryptocurrencies like Bitcoin become so valuable? Why are they even valuable in the first place? The answers to these questions can be complicated, but we’ll break them down into the essential facts you need to know.
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What is electronic money?
Cryptocurrencies are digital currencies that do not rely on a central record-keeping authority such as a bank or government organization to track account balances and transactions. This grants cryptocurrencies a similar degree of anonymity to traditional cash, although no cryptocurrency is truly anonymous, despite what you may have heard. Worse yet, with the way crypto works, your crypto transactions could be anonymized in the future.
How could this happen? The cryptocurrency uses a distributed decentralized ledger called blockchain to keep a permanent record of every transaction made in currency. Cryptocurrency accounts, known as “wallets”, do not have the names of the people attached to them, but each wallet is unique and the address of that wallet is a matter of publicly recorded on the blockchain. So if you want to know who the wallet belongs to, you just need to find the third-party information that associates the wallet with a specific person.
Cryptocurrencies are so named because they use cryptographic methods and technologies to secure the blockchain ledger against tampering. passwordcation is also an important part of how more currencies are released into circulation, a process known as mining, which we will cover a little later. So in summary:
- Cryptocurrencies are digital cash.
- It is decentralized and not controlled by any organization.
- It uses a distributed public ledger called the blockchain.
- Cryptographic methods and technologies are at the heart of cryptocurrencies.
How are cryptocurrencies created?
Cryptocurrency is software. It’s a computer program that runs on computers connected to a network. So if you want to create a cryptocurrency, you have to write software to make it possible.
Many Cryptocurrencies are Open Source, so you don’t need to start from scratch when building your own coin. The puzzle has been solved and the entire developer community is working to create newer, better cryptocurrencies based on older iterations.
Let’s say you want to create your own cryptocurrency from scratch. Then you will have to deal with some problems. This can be how to make sure your ledger can’t be tampered with, how to verify transactions, and most importantly, how you get the computing power to handle all the functions that a single currency does. electronics need to work?
For blockchain-based cryptocurrencies like Bitcoin, the answer to that question is mining.
What does “mining” cryptocurrency mean?
A cryptocurrency miner is a computer that verifies transactions before they are added to the blockchain. In the case of Bitcoin, transactions are added to 1MB blocks, but the exact size varies from currency to currency.
Once a block of transactions is verified and added to the chain, the miner who verified the block is reimbursed for that work in the newly “mined” or “unearthed” cryptocurrency. This way, people are motivated to provide the computing equipment and energy needed to power the currency.
Transaction validation is not a challenge for modern computers, so how is the reward for validating a new block awarded? This is where it gets a little weird, but it makes sense.
Miners must present a validated block of transactions and Answers to a challenging cryptographic puzzle will be awarded. It’s basically like you’ve been given a combination key, and you have to guess the combination over and over until you get it. For a four-digit key, you have to guess (at most) 10,000 times before getting it right. If you and someone else compete to guess the combination first, whoever can guess the most in the shortest amount of time has the best chance of winning the right combination.
This is what happens with mining, except there could be billions or trillions of possible combinations. Therefore, you need a so many computing power to get enough guesses (known as failure rate) for a chance to be the first and get attractive rewards.
Different currencies differ based on this basic concept, known as “proof of work”. Unfortunately, there are so many problems with the proof-of-work model that we don’t have enough space to discuss it here. However, alternative methods such as “proof of stake” are also making their way into the crypto world.
Why are cryptocurrencies valuable?
So why does Bitcoin, Ethereum or (seriously) DogeCoin have any real-world value? This is not a question of technology but a question of human psychology and sociology.
We use specific materials in the physical world (e.g. gold or silver) as representations of value. For example, a material like gold certainly has intrinsic value like a metal, but it doesn’t have any objective value as a commodity.
Money used to be the stand for diamonds, oil or gold. In other words, the total amount is equivalent to the actual stockpiles of goods that “support” the currency. Here commodity currency has fallen out of favor and is used by countries such as the United States fiat currency. In other words, the US Dollar is worth something because the US government says it is. It is supported by a more abstract measure of economic strength.
Cryptocurrencies have more in common with commodity currencies than fiat currencies in that it requires more (mining) effort to mine, and that at any given time the supply of it has term.
Cryptocurrencies increase in value as soon as people decide that it is worth trading something of value. On May 22, 2010, First commercial Bitcoin transaction happened when someone paid 10,000 BTC for two pizzas worth $40. With a base value established, currencies are tradable because two parties have agreed on their value and the other parties comply. Today, that 10,000 BTC is only worth $60,000! How did they become so valuable?
How do cryptocurrencies increase or decrease in value?
Understanding how we achieved these sky-high crypto values and significant value fluctuations is complex. Some currencies (such as Bitcoin) have a built-in supply limit to combat inflation caused by oversupply. Therefore, the increase in the value of one Bitcoin is not really the result of inflation or deflation. Instead, currencies like Bitcoin have become speculative commodities like gold or stocks.
Instead of using cryptocurrencies as an everyday currency as intended, people speculate on cryptocurrencies, increasing the price as demand increases and supply decreases. They then sell their cryptocurrencies in exchange for fiat currencies like US Dollars. This caused crypto prices to drop as more and more people dumped their supply, flooding the market. The whole cycle starts all over again, but when market expectations and mass market behaviors take effect, there is an overall uptrend as people wait longer to sell and harder to sell when they do.
It is hoped that one day, currencies like Bitcoin or Ethereum will stabilize and become suitable as actual currencies. However, that day seems a long way off and for now, they remain largely a speculative commodity.
