Cryptocurrency Explained - In simple words

You might have seen a many youtubers explaining how much they invest in Bitcoin, Etherium, Solana, Polygon, Dogecoin (after Elon tweets about it), Shiba Inu (A Doge killer) (and something or the other of 9000+) coins and how much money they make by investing(mostly trading) on them and how they include crypto in their financial plan. But before you jump into that bandwagon, let’s understand what Cryptocurrencies are.

Evolution and history of currency

Before we jump into understanding cryptocurrencies, let take a look at how currency has evolved and what is the history around it from Barter to Bank Notes.

Barter System

Several years back before the currencies were there, people were using the 🤝 bartering system. Bartering is a system where trade is happening by exchanging goods and services. For Ex. Consider one farmer has grown apples and another one has grown oranges. Then these 2 came to an agreement to exchange apples and oranges. I know it has already triggered a lot of questions and those are exactly the limitations of this. For this trade to happen, both parties should have a need, both parties should agree on how much they want to trade.

Coins

Slowly, the currency evolved around 600B.C-700B.C where 🪙 coins were exchanged to trade goods and services. Then coins with different denominations were minted (Copper, Silver, Gold which carried their own value).

Paper Currency

Then the world moved to 💵 paper currency around 1270 A.D. and eventually banks were started and banks started to use banknotes for depositors and borrowers to carry around in place of metal coins. These notes were used to buy goods and services just like the modern day currency we use now. Earlier the notes were issued by banks and private institutions but now it was taken up by the governments.

Shift to paper currency opened gates for international trade and people started to buy currencies from different countries. Along with the trade, it opened up new conflicts and competition between countries also. This created a currency market to buy currencies from different countries.

Digital Payments

The 21st century has opened more ways on how these paper money can be traded - Plastic cards and Mobile payments. Gone are the days that you needed to carry paper notes for trade, instead you can make payment through a plastic card which enables the transaction. With the technology boom, it further more simplified to use mobile phones to perform transactions by using services like GPay, Apple Pay, PhonePe, PayTM etc..,

And in 2009, a new type of currency came to mainstream - a Virtual Currency - Bitcoin - A crypto currency.

Cryptocurrencies

In simple words, cryptocurrency is a digitally created virtual currency which don’t exist physically. You can not hold a crypto currency, you can not put it into your wallet / pocket. But you can do everything a physical / paper money does.

Following are the major components/concepts of a cryptocurrency

• Cryptocurrency is also a 💵 currency which can be used for trade transactions and everything is digital
• Cryptocurrency will also hold a 📒 ledger which contains the record of all the transactions. Unlike banks, there will be a single ledger to record transactions which are ever happened
• Cryptocurrencies are 💠 decentralised, means it is not owned by any central authority
• Cryptocurrencies are secured with cryptography. Uses a computational algorithm to solve the problem of trust and centralisation.

Cryptocurrencies use blockchain technology to maintain their shared ledger. Any transaction happened through the cryptocurrencies are recorded in their underlying blockchain

How does bitcoin transaction takes place

Let’s understand the cryptocurrency transaction by taking Bitcoin as an example. Consider Person A wants to send money to Person B, like in the normal banking flow, this will also undergoes series of steps before to transfer money from A to B

Let’s say Bob wants to send money to John,

1. Bob opens a bitcoin wallet from his mobile or computer
2. Scans a QR code of John or enter address of John where the money needs to be transferred
3. Enters the amount needs to be transferred
4. And Bob confirms the transaction
5. Now, the transaction submitted by Bob is signed using Bob’s private key
6. And the transaction is propagated to bitcoin network and the nodes in the network will validate this transactions
7. Once the transactions is validated by other nodes in network, bitcoin miners will include this transaction in their next block
8. In mining time, miners will group these transactions into blocks trying to solve Proof-of-work (a consensus algorithm) and calculate a certain hash function
9. Then the miner who solves proof of work propagates the block to network
10. Nodes will verify the new block received and add the block in the network
11. John receive confirmation of money received

What makes crypto currencies so special? How is it different from paper currency

🏦 Decentralised - As paper notes are regulated by Banking authorities of the respective countries, these crypto currencies are not owned by a single authority or corporate or an organisation. These are completely decentralised and peer-to-peer network using proof-of-work to record a public history of transactions

🔐 Secure - Crypto in the crypto currency is the use of cryptography in the currency transfer to secure communication. Cryptography uses Computational Algorithm (like SHA256), Private Key and a Public key to encrypt and decrypt a secure communication (you can see this in the earlier example of a Bitcoin Transaction)

⏱️ 24/7 Access - Unlike banks, these networks will be operating 24/7 and no restrictions on when a user can use its services and operate

✋🏼 No restriction on purchases and with-drawls - No restrictions on how much money you can withdraw from your account or how much you can use for trade in a day

💱 No currency exchange is required - As these currencies are used world-wide, no exchanges is required to convert currencies from one to another

🌏 International transfers are faster - As these currencies are not owned by single institutions and these are not specific to any country, international transfers will be really fast

These are a few major specialities I see in cryptocurrencies. Let me know what you think in the comment section below.

Though I put a title as understanding in simple words, I used few words like Proof-of-work, cryptography, mining, miners, block-chain while explaining cryptography. I’ll explain these terms in the coming posts. Please comment below if you need to know anything more.

I hope I’ve made it clear (atleast to some extent 😉) what cryptocurrencies are and how it works. This is just a beginning and a high-level view of what these cryptocurrencies are. Let me know what else you want to know more, it will help me plan my next posts.

Following are few resources which might be helpful for you to understand this space better

1. Bitcoin: A peer-to-peer electronic cash system white-paper
2. Mastering Bitcoin by Andreas M. Antonopoulos - A useful primer on the concept of a decentralised currency based in the digital world
3. If you’re interested in Investing / Trading in Crptocurrencies, you can use Vauld. Very easy and convenient to buy cryptocurrencies from India