What are cryptocurrencies and how do they work?
Crypto
September 11, 2024
By now, cryptocurrencies, especially Bitcoin, have become a popular topic. They are no longer just a trend or passing fad that fades away over time. In fact, according to data from Blockchain.com, more than 45 million people worldwide use Bitcoin – equivalent to the entire population of Spain.
Cryptocurrency transactions are here to stay, and it's better to start understanding their concept, how they work, and what some of their advantages, disadvantages, and risks are.
In today's article, we’ll explain everything basic about cryptocurrencies in the simplest way possible. We hope this content is helpful, and don’t forget to follow us on Instagram.
A cryptocurrency is a digital currency, and in the world of investments, they represent digital assets designed with cryptographic encryption. This ensures their ownership, secures transactions, and controls the creation of new units in the market.
But why is it called cryptocurrency? The name comes from its encrypted nature, with the etymology of "kryptos" meaning "hidden" – in technology, this means that the "data is protected by a key."
The unique feature of being protected through encryption makes cryptocurrency a revolutionary alternative to the traditional financial system, providing us with a secure payment system without time restrictions or intermediaries. However, not everything is a benefit; keep reading to learn more.
To better understand the concept, let’s break down cryptocurrency using the characteristics of Bitcoin.
→ It is a currency of exchange – like the dollar, peso, or sol, it can be used for purchases;
→ It is digital – it has no physical presence, existing only for computers and mobile devices;
→ It is decentralized – unlike physical money, it does not depend on governments or banks but rather on a community connected by blockchain.
With that clear, we can define that:
Cryptocurrencies are a digital medium of exchange that uses encryption methods to self-regulate transactions, control the creation of new units, and verify the transfer of assets.
Now, let’s explore some characteristics of cryptocurrencies:
→ No intermediaries are needed for transactions;
→ It has a decentralized database called blockchain, which handles shared ledger accounting to ensure each transaction, meaning it is not backed by a bank or any other entity;
→ It lacks customer protection mechanisms, unlike the U.S. stock exchange, which has the Deposit Insurance Fund or the Investor Guarantee Fund to protect its investors.
A significant difference between cryptocurrencies and conventional currencies is that the latter requires a centralized organization, such as banks or another entity, to decide how much money will be printed each year. Cryptocurrencies do not need this.
The value does not depend on what they are made of, like gold or silver, nor do they depend on a government or institution, but rather on supply and demand. The more people are interested in cryptocurrencies, the more their value tends to increase.
→ You should know that each cryptocurrency has its own algorithm, which means it is self-regulating; that is, each manages the number of new units that will be issued each year.
For example, in the case of Bitcoin, its production amount is halved every four years, and its limit is a total of 21 million Bitcoins. That means there won’t be any more bitcoins after that amount is reached. This is a significant peculiarity compared to the conventional currencies we know.
Therefore, the value of each cryptocurrency will depend on the type of crypto, its supply, and demand at that time. And who created these digital currencies?
It all started after the 2008 crisis when a person using the pseudonym "Satoshi Nakamoto" had the idea to combine technology with the internet to conduct transactions outside the control of the system, governments, banks, or institutions.
The idea was first born: "Satoshi Nakamoto" shared it in 2009 in an article describing a P2P payment system where one person could transfer a certain amount or value to another without going through any intermediary.
He called this system Bitcoin. From idea to action: after sharing the theoretical part of this new transfer system, he provided the first version of software that allows managing the network of this digital currency – the Blockchain network.
Little by little, the Bitcoin software began gaining presence in forums, strengthening its popularity and captivating its first buyers, who, being the first to trust, bought their bitcoins when they cost only $0.01 per unit. Can you imagine that?
It’s true that electronic money transactions already existed, but they required an intermediary, a bank, or another institution – which usually kept a commission – to evaluate, validate, and finalize that transaction. Now, thanks to blockchain technology, things have changed.
But what is blockchain? How do cryptocurrency transactions work?
A cryptocurrency transaction works through a chain of blocks, also known as a blockchain system.
It’s a system formed by a “chain of blocks.” This network extends in a decentralized manner as more cryptocurrencies are created.
Imagine you buy a crypto; that transaction is recorded in a block, which has a unique and unrepeatable code and stores all the information about that transaction, such as the sender and recipient of that exchange, the number of bitcoins, and other data that ensure these are real people and not bots.
Once that block has been created with all that information, it is replicated and shared across the entire network of users, who validate the transaction block. This is how the community replaces intermediary institutions, and together with encryption, it becomes a digital currency that is difficult to counterfeit.
Joining this network is relatively easy; anyone with a computer with the latest specifications that allow running blockchain software can join this chain. Now that we know how a cryptocurrency works, let’s see how it became so popular.
Here’s a brief timeline of how cryptocurrencies have gained popularity over time.
→ Initially, few people trusted this digital currency, so with such low demand, its value was minimal. However, as more people bought it, its value began to rise. Let’s look at those numbers;
→ In May 2011, it reached a price of $35, but then demand fell in 2012, stabilizing between $2 and $15;
→ In June 2013: It captivated with its advantages and became a trend in Asia, causing a price surge to $202.
And in September of that same year, it reached a price of $1,203 per bitcoin. The situation created such a scandal in the world’s financial system that several governments decided to intervene. This created uncertainty among some bitcoin holders, leading them to sell, causing its price to drop again to $500.
In 2016, it started gaining some credibility, leading some governments to accept it, such as Barack Obama’s administration, which declared it a national currency, opening the doors to different types of cryptocurrencies.
Do you know how many cryptocurrencies exist today? Keep reading!
Until last year, there were 9,953 types of cryptocurrencies in circulation, according to CoinMarketCap – and the number is now even higher. The truth is, everyone wanted to design and personalize their cryptocurrency.
Did you know that Facebook has a cryptocurrency called "Libra," intended to be exchanged in the marketplace and for other uses? However, it has faced various obstacles with banks, institutions, and government criticism, causing its value to decline.
So the number of cryptocurrencies continues to rise. Among the vast number of digital currencies, let’s take a look at the 3 most important and prominent ones:
It was the first to exist in 2009, sparking an entire sector. It is currently one of the largest in the world with over 18.7 million assets in circulation, and it is priced at $39,424.10 per unit.
It is the second in circulation with over 115 million cryptos worldwide, currently priced at $2,657.97 per asset.
It is an interesting option to start investing in cryptos and is a type of crypto asset already available on the Hapi app.
This digital currency is designed with a unique feature, being backed by conventional money, whether in dollars, euros, or yen.
This unique design aims to provide greater stability so its value doesn’t fluctuate as much, thereby generating more trust among buyers. Its current price is $1 per unit. We shouldn’t underestimate its circulation quantity, which has surpassed 58 billion users.
→ There’s also "Dogecoin," a digital currency inspired by the famous internet meme "Doge" based on the "Shiba Inu."
It was initially created as a joke, but now, as the internet community controls what becomes popular, this digital currency is reaching an interesting value. Plus, Elon Musk commented that it is the people's cryptocurrency, and its value hasn’t stopped growing.
A digital currency for the people and by the people, as deduced from Elon Musk's words. Cryptocurrencies seem to be the answer to inflation, money counterfeiting, and the centralization of banking entities.
But let's be clear and take a look at the benefits and risks of investing in cryptocurrencies.
→ Being digital currencies, they are global and can be transacted instantly anywhere in the world at any time;
→ Their transactions using blockchain technology are among the most secure available;
→ As encrypted currencies, they are impossible to counterfeit or duplicate;
→ Some currencies are designed to provide a long-term solution against inflation;
→ No intermediaries are needed to transfer crypto assets;
→ They maintain the anonymity of your identity in the transaction - although this feature is a double-edged sword.
Unlike the stock market, there is no need to wait for a specific time to buy and sell an asset.
At the same time that cryptocurrencies seem to be the answer to inflation and the system that will revolutionize the financial market, we must be aware that they are still in the testing stage, which means there are some risks you should know before making a crypto investment.
This has already been warned by the Comisión Nacional del Mercado de Valores (CNMV) and the Banco de España (BdE), who mention that investing in cryptocurrencies is a high-risk investment. But let's see why:
→ It is a highly volatile investment, as it is based on speculation;
→ Payments are irreversible: if you make a mistake with the transfer amount, it is impossible to correct it;
→ Anonymity can open the door to illegal activities;
→ It is not a universally accepted payment method.
Although cryptocurrencies were created with the idea of replacing traditional money issued by banks, they have not yet fulfilled all the key functions needed to achieve this. But, as we shared at the beginning, cryptocurrencies are still in a trial phase, and only time will tell the outcome.
One thing is certain: no one really knows what the future holds for cryptocurrencies, so you need to be brave and have a high-risk tolerance to venture into these unknown waters.
In this context, experienced investors in Latin America, like Diego Poblete and Francisco Bonilla, founders of the blog InversiónSimple, believe that "more people are involved in cryptocurrencies than in any other type of investment... thanks to its easy access, the small amount of money needed to start, and above all, the publicity of success stories of millionaires who emerged in just a few years." What do you think? Are you ready to enter the world of crypto investment?
Remember, the first step to investing safely is understanding how an investment works. It requires time, dedication, and reliable sources.
Just like investing in the stock market, you need to research which asset to invest in, its market value, how long you will invest, among other questions that must be answered before entering this world. Of course, having an ally like Hapi can make the process easier: Download the app for Android!
Because now, with Hapi, you can invest in stocks and cryptocurrencies in the same portfolio, with over 30 cryptocurrencies available!
→ Ultimately, investing in something you don't understand always represents a risk in itself.
Our investment advice is to take advantage of available online resources, listen to financial podcasts, and read blogs from veteran investors in Latin America. Staying informed daily about what's happening in the world is the best way to manage the stress of a high-risk investment.
Now that you know the risks of cryptocurrencies and want to venture into the world of cryptos, here's the option for iOS if you're in LATAM and expand your investment portfolio!
Don't miss our next weekly post: It's time to learn what fintech is and why it's a revolution!
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