It sounds complicated, but it’s not. On this page we explain what cryptocurrencies are, what the advantages and disadvantages are and how such a value is determined.
Everyone is talking about it, but what exactly is cryptocurrency? In this introduction we tell you what you need to know before you start investing and trading cryptocurrencies yourself.
“A cryptocurrency is a digital currency that uses digital encryption techniques to produce new currency units and verify transactions, independent of a central bank…”
Okay, that’s a mouthful. Let’s start at the beginning. Cryptocurrencies can be seen as a by-product of another discovery, one we’ve probably all heard of: Bitcoin. The inventor of Bitcoin is Satoshi Nakamoto (a pseudonym) and no one knows who he really is. Bitcoin was intended to be a new electronic payment system that uses a peer-to-peer network to address the problem of “double spending,” Nakamoto said in the original explanation of Bitcoin. You can read about what this all means and what problem Bitcoin originally sought to address here. This is not directly relevant to understanding what a crypto-currency actually is.
When you take away all the noise and information about crypto and Bitcoin and look at what a crypto-currency really is, you can greatly simplify it. Try to imagine what your bank account looks like. What does this money look like? Actually, this money is nothing more than a number in a database that can only be changed under certain circumstances, right? Crypto-currencies are exactly the same. Like any form of money, it has to be verified in some kind of database, where you arrive at a certain balance and a number of transactions. With traditional money, this database lies with an authority such as the ING or Rabobank. In the case of crypto currencies this database is shared and verified decentrally across the world in an encrypted way using the blockchain. What that is and what benefits it brings you can read here.
In summary, a crypto currency is nothing more than a decentralized and encrypted version of traditional money, there is no central computer server or central authority behind it. Well-known examples of cryptocurrencies are Bitcoin, Ethereum, Ripple and Litecoin, but there are now hundreds of others – which are used for much more than just as a means of payment.
What are the advantages and disadvantages of paying with a cryptocurrency?
Cryptocurrencies have a number of properties that are different from a euro, for example. For example, payments with a cryptocurrency are:
- Open and generative; By this we mean that you don’t have to ask anyone for permission to use cryptocurrencies. The software you need can be installed and used by anyone. After installing it, it is possible for anyone to send and receive cryptocurrencies. No third party is involved, so this also means that there is no gatekeeper function, a role that a credit card company also often fulfills. As a rule, therefore, these have become redundant.
- Anonymous; No transaction is linked to the identity of a person. This sounds strange, because at the same time the blockchain is completely transparent, so how can payments be anonymous?The transparency mainly refers to the transaction traffic. This means that you can see payments from address to address, however, it is not possible to link these addresses to a particular person. Because of this, a payment with bitcoin is therefore completely anonymous, unless a person/agency happens to know which address is yours.
- Irreversible; After a payment is confirmed it cannot be reversed. By no one. Not by you, not by the bank, not by the other party. This also means that if you transfer your money to the wrong address, it is lost. So make sure you have filled in the address correctly!
- Secure; because of the way blockchain works it is virtually impossible to crack the cryptographic keys behind it. Only the owner of a private key can transmit cryptocurrencies. For example, it would take a supercomputer over a trillion years to crack the code behind a Bitcoin address. However, although the code and blockchain itself is considered secure, the weakest link in this process is the human being himself or the device on which transactions are made. We therefore recommend that you only store crypto currency on a properly secured computer or ledger.
- Fast; transactions are processed almost instantly and verified within a few minutes. The speed of a transaction takes place regardless of the location where you transfer the amount. So this means that transferring bitcoin to your neighbor and your favorite bakery is just as fast as transferring it to someone located at the other end of the globe.
Who or what determines the value of crypto currencies?
One of the things that people seem to find especially interesting is speculating on certain crypto currencies, so we’re going to take a closer look at that in this paragraph. The reason why we explain this in more detail is to make you aware of what exactly you are buying, in this way we hope to make it sufficiently clear to you what the risks but also the opportunities are when speculating on crypto currencies. Because, who or what actually determines the value of a crypto currency?
The short answer to the previous question is: you and me. Most crypto currencies have no inherent objective value of their own, so the market is largely highly speculative!
Now there are exceptions to be found, for example there are certain “stable currencies” that claim to be pegged to the dollar in order to make trading easier for certain daytraders. In addition, there are crypto currencies that are linked to the price of gold, or even oil. However, this is more the exception than the rule.
The traditional forex and stock markets are therefore much safer to speculate on. But frankly also less fun. Within crypto trading, it’s just what the public thinks the underlying product is worth. This makes speculating on crypto currencies often an emotional affair, which can cause the price to fluctuate greatly. It happens daily that one can earn thousands of dollars worth of Bitcoin, but also lose!
The value of a currency depends mainly on the confidence of the investor in the team and product behind the crypto currency. This trust is in turn influenced by developments such as a product launch, an update for certain software and/or the rollout of smart contracts. Often such developments then also lead to a price increase for the currency, as the technology behind it becomes “more valuable”.