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What is cryptocurrency and why does it matter?

Apr 09 2018 · by Hugo O’Connor

What is cryptocurrency? Where does it come from? How does it work? And why should I care?

In this article, we’ll answer these key questions (and more) in simple, easy-to-understand terms.
Let’s get straight into it.

What is cryptocurrency?

A cryptocurrency is a way to hold, send and receive value electronically without the need for traditional middlemen, like banks and governments. Created and stored in the blockchain (we’ll look at the blockchain in more detail below), cryptocurrencies use cryptography to verify transactions, and generate and distribute units.

Cryptography involves converting plain text into an unintelligible code, and evolved out of the Second World War as a method of secure communication. Today, it combines mathematical theory and computer science to safeguard information and assets online.

Unlike the Australian dollar and other fiat currencies, cryptocurrency is decentralised, meaning its value, creation, and exchange is verified by the people and computers that make up the currency’s network. These people agree to store and share the community’s records following a distinct set of rules.

A brief history of cryptocurrency

Cryptocurrency is by no means a new phenomenon. Years of progressive thinking and mathematical experimentation paved the way for today’s multi-billion-dollar cryptocurrency market.

For some context, here’s a timeline detailing the evolution of cryptocurrency since the late 1990s.

1998 – 2009
Attempts are made to formulate secure digital currencies verified by public ledgers and encryption. Examples include Bit Gold and B-Money.

2008
Under the name Satoshi Nakamoto, an individual or group posts a paper called Bitcoin: A Peer-to-Peer Electronic Cash System to the Cypherpunk’s mailing list.

2009
Bitcoin software becomes available to the public, and mining begins. Bitcoin is established as the world’s first cryptocurrency.

2010
Bitcoin is used as a means of exchange for the first time. 10,000 bitcoins are traded for two pizzas.

2011
New cryptocurrencies – often referred to as altcoins – emerge, including Litecoin and Namecoin.

2013
The price of bitcoin reaches $1,000 USD for the first time, before crashing to around $300.

2014
The world’s largest bitcoin exchange, Mt. Gox, has around 850,000 bitcoins stolen.

2015 – 2016
Ethereum – currently the second largest cryptocurrency – is established. Initial Coin Offerings (ICOs) facilitated by ethereum are used as a fundraising platform for startup ventures.

2017 – present
The cryptocurrency market continues to expand, and gains mainstream media coverage. Bitcoin reaches an all-time high of over $20,000 USD.

How do cryptocurrencies work?

Cryptocurrencies are varied and complex. A technical overview of how they function isn’t for everyone, so we’ll keep this explanation beginner-friendly.

Remember, there’s no need to be a computer scientist or crypto expert to get involved – if you can send an email or text message, you can buy, sell, trade, and invest in bitcoin, ethereum, and other cryptocurrencies.

Before we walk through the transaction process, let’s define a few key terms.

Wallets
Much like a regular wallet, cryptocurrency wallets are used to store assets that you own. Some wallets are held on the web by a wallet service provider, others can be installed onto your computer or smartphone like software, and some exist as external hardware. Each wallet has a unique address, which might look something like this: 1Zvi22Q8Y3Cn6nPATEBSaFFbckD9sUq6C. This address allows you to send assets to and receive assets from other users.

Blockchain
The blockchain is a peer-to-peer electronic ledger that underpins cryptocurrency networks. The blockchain maintains a cryptocurrency’s integrity by verifying and recording all transactions, and preventing units from being double-spent.

Because the blockchain is shared among the participants in the network and secured using cryptography, transaction records are ‘set in stone’ and cannot be manipulated. These records also become a part of the cryptocurrency’s history, a history that can be viewed, but never deleted or changed. Accordingly, the blockchain becomes a source of truth. A user cannot do something against the cryptocurrency’s rules without other participants noticing.

Mining
Transactions are verified and recorded on the blockchain through a process called ‘mining’. Mining allows new cryptocurrency to be minted by participants (that is, computers in the network called ‘nodes’) that follow a set of predefined rules.

Nodes complete a task known as ‘proof-of-work’. Proof-of-work involves solving an increasingly complex cryptographic puzzle. Although these puzzles require a serious amount of computational effort to solve, this effort is easily verified. Once verified, the node is rewarded with newly minted currency.

Proof-of-work results in something called distributed consensus. In other words, it gives everyone in the network access to the most up-to-date ledger.

The transaction process

The transaction process
Let’s say you want to send one bitcoin to your friend Alice. Using bitcoin software on your smartphone or computer, you publish your intention to transfer one bitcoin from your wallet address to Alice’s wallet address.

The bitcoin network then confirms two things:

  1. You actually own the bitcoin that you want to send
  2. You haven’t already sent that bitcoin to somebody else

Once that information is confirmed by bitcoin miners, the transaction is executed and recorded to the blockchain. Your wallet balance goes down by one bitcoin; Alice’s wallet balance goes up by one bitcoin. This process can take anywhere from 30 minutes to a couple of hours.

Why does cryptocurrency matter?

Cryptocurrency matters because it offers a feasible alternative to traditional, centralised fiat currencies. The values of cryptocurrencies are not determined by a single entity – such as a government or financial institution – but instead by a peer-to-peer network. In many ways, cryptocurrencies put the power of money creation into the hands of people and communities.

How can a decentralised monetary system benefit the average user on a day-to-day basis?

  • Without the need for mediation from a third-party, transactions times are fast.
  • Again, with no middleman, transaction fees are reduced or can be eliminated entirely.
  • Whether you are sending crypto to your next-door neighbour, your friend on the other side of town, or a total stranger halfway around the world, transaction times and fees remain the same.
  • In some cases, with privacy-focused cryptocurrencies, users can be completely anonymous when sending and receiving funds.

Cryptocurrencies also hold the same value around the globe, and so have the potential to facilitate emerging markets. Venezuelans, for example, have rapidly been adopting bitcoin, as their own fiat currency, the bolivar, loses value at an alarming rate.

Risks involved with cryptocurrency

Even as they become more mainstream, cryptocurrencies face a number of significant risk factors.

Regulation
Governments around the world (including China, South Korea, and the US) have recently implemented regulations around the trading and mining of cryptocurrencies.

Adoption
Tighter regulations could prevent widespread adoption, and create barriers for entrepreneurs with good ideas to use the technology.

Security
Bitcoin and other leading cryptocurrency exchanges have had their fair share of security breaches, resulting in masses of funds lost.

Volatility
Regulation, adoption, and security risks impact the volatility of bitcoin and other cryptocurrencies. Because these currencies have relatively small market caps, they can shift in value dramatically. However, as crypto begins to be perceived as a reliable store of value, it may become less volatile.

Get involved

Whether or not today’s cryptocurrencies will reach their full potential is unknown. That being said, there is no denying that the concept and revolutionary technologies have changed the face of finance for good.

If you would like to buy, sell, or learn more about bitcoin – the world’s first and most valuable cryptocurrency – Sign up now or chat to the team at Bit Trade.