Seasons
Cryptocurrency 101
How does blockchain work?
How can I invest in cryptocurrencies?
Frequently Asked Questions About Cryptocurrencies
Chapter 1 - Cryptocurrency 101
Contents
What is cryptocurrency?
What makes cryptocurrency special?
Why is it called digital currency?
What is public key encryption?
Who invented cryptocurrency?
What is the difference between cryptocurrencies and tokens?
What is a cryptocurrency wallet?
What is cryptocurrency?
Cryptocurrency (or "crypto") is a form of digital money that allows individuals to transfer value in a digital environment.
You might wonder how this system is different from PayPal or the digital banking app on your phone. Sure, on the surface they may seem to have the same use cases – paying friends and making purchases from your favorite website – but in reality, there’s a big difference between them.
What makes cryptocurrency special?
Cryptocurrency is unique for many reasons. Its primary function is to act as an electronic cash system that is not owned by any party.
A good cryptocurrency would be decentralized. There is no central bank or subset of users who can change the rules without reaching consensus. Participants in the network (nodes) run software that connects them to other participants so they can share information with each other.
Centralized vs. decentralized networks.
Centralized networks represent the system that would be expected to be used by an entity such as a bank. Users must communicate via a central server. In decentralized networks, there is no hierarchy: nodes are interconnected and transmit information between them.
The decentralization of cryptocurrency networks makes them highly resistant to shutdown or censorship. In contrast, to stop a centralized network, you simply need to disable the main server. If a bank’s database is wiped and there are no backups, it will be extremely difficult to determine user balances.
In a cryptocurrency system, nodes maintain a copy of the database. Each person effectively represents their own server. Individual nodes can go offline, but their peers will still be able to get information from other nodes.
Thus, cryptocurrencies operate 24 hours a day, 365 days a year. They allow value to be transferred anywhere in the world without the intervention of intermediaries. This is why we often refer to them as open to the public: anyone with an internet connection can transfer money.
Why is it called digital currency?
The term “cryptocurrency” is a combination of the words crypto and currency. This is simply because cryptocurrency uses extensive encryption techniques to secure transactions between users.
What is public key encryption?
Public key encryption powers cryptocurrency networks. It is what users rely on to send and receive money.
In a public key cryptography scheme, you have a public key and a private key. The private key is essentially a huge number that is impossible for anyone to guess. It is often difficult to comprehend how big this number is.
For Bitcoin, guessing a private key is about as likely as correctly guessing the outcome of 256 coin flips. With current computers, you wouldn’t even be able to crack someone’s key code before the universe heats up.
However, as the name suggests, you must keep your private key secret. But with this key, you can generate a public key. This public key can be safely handed over to anyone. It is practically impossible for anyone to reverse engineer the public key to get your private key.
You can also create digital signatures by signing data with your private key. This is similar to signing a document in the real world. The main difference is that anyone can tell for sure whether a signature is valid or not by comparing it to the corresponding public key. This way, the user doesn’t need to reveal their private key, but they can still prove ownership of it.
In a cryptocurrency system, you can only spend your funds if you have the corresponding private key. When you make a transaction, you announce to the network that you want to transfer your coins. This is announced in a message (i.e., a transaction), which is signed and added to the cryptocurrency database (the blockchain). As mentioned, you need your private key to create the digital signature. Since anyone can see the database, they can verify that your transaction is valid by checking the signature.
Who invented cryptocurrency?
There have been a few attempts at digital money schemes over the years, but the first cryptocurrency to be issued was Bitcoin, which was released in 2009. It was created by a person or group of people with the pseudonym Satoshi Nakamoto. To this day, their true identity remains unknown.
Bitcoin has spawned a plethora of subsequent cryptocurrencies – some aiming to compete, while others seek to incorporate features not available in Bitcoin. Today, many blockchains not only allow users to send and receive money, but also run decentralized applications using smart contracts. Ethereum is perhaps the most popular example of such a blockchain.
What is the difference between cryptocurrencies and tokens?
At first glance, cryptocurrencies and tokens seem identical. Both are traded on exchanges and can be sent between blockchain addresses.
Cryptocurrencies are intended to serve as money exclusively, either as a medium of exchange, a store of value, or both. Each unit is functionally interchangeable, meaning that one currency is worth the same as another.
Bitcoin and other early cryptocurrencies were designed as a currency, but later blockchains sought to do more. Ethereum, for example, doesn’t just provide currency functionality. It also allows developers to run code (smart contracts) on a distributed network, creating tokens for a variety of decentralized applications.
Tokens can be used like cryptocurrencies, but they are more flexible. You can mint millions of identical tokens, or select a few with unique properties. Tokens can be anything from digital receipts representing a stake in a company to loyalty points.
In a protocol that supports smart contracts, the native currency (used to pay for transactions or applications) is separate from its native tokens. In Ethereum, for example, the native currency is Ethereum (ETH), and it must be used to create and transfer tokens within the Ethereum network. These tokens are implemented according to standards such as ERC-20 or ERC-721.
What is a cryptocurrency wallet?
Essentially, a cryptocurrency wallet is something that holds your private keys. It can be a purpose-built device (a hardware wallet), an app on your PC or smartphone, or even a piece of paper.
Wallets are the interface that most users rely on to interact with the cryptocurrency network. Different wallets offer different types of functionality – obviously, a paper wallet cannot sign transactions or display current prices in the local currency it is supported by.
For convenience, software wallets (e.g., Trust Wallet) are best for everyday payments. As for security, hardware wallets are almost unmatched in their ability to keep private keys away from prying eyes. Cryptocurrency users tend to keep funds in both types of wallets.
Chapter 2 - How does a blockchain work?
Contents
What is blockchain?
How are blocks added to the blockchain?
How does cryptocurrency mining work?
Are cryptocurrencies scalable?
Who makes decisions about cryptocurrency programs?
What is blockchain?
A blockchain is a special type of database where data can only be added to (and not removed or changed). Transactions are periodically added to the blockchain in what we call blocks (which are made up of transaction information and other important metadata).
We call the overall structure a chain because the metadata for each block includes a piece of information that links it to the previous data. Specifically, it includes a hash of the previous block, which you can think of as a unique digital fingerprint.
The probability of two pieces of data producing the same output from a single hash function is very low. Because of this, if someone tries to modify an old block, its hash function will be different, which means that the hash function for the new block will also be different, and so on. It will therefore be obvious whether a block has been changed or not, because this will result in all blocks that come after that block having to be changed as well.
The hash function of each block is included in the next block. This forms a chain of blocks, or blockchain.
The entire blockchain is downloaded by the network participants. Remember how we said that anyone can verify transactions and signatures through public key cryptography? When a node receives a block, it performs a number of verifications. If anything is incorrect, the block is rejected.
When a node receives a valid block, it makes its own copy of the block and broadcasts it to other nodes. These other nodes then do the same until the block is spread throughout the entire network. This process also works for unconfirmed transactions – transactions that have been broadcasted, but have not yet been included in the blockchain.
See also: What is Blockchain Technology? The Complete Guide.
How are blocks added to the blockchain?
The integrity of the blockchain is undermined if incorrect financial information can be recorded. At the same time, there is no administrator or leader in the distributed system who maintains the ledger – so how can we ensure that participants are acting honestly?
Satoshi proposed a proof-of-work model system, which allows anyone to propose a block to be attached to the blockchain. To propose a block, users must sacrifice computing power to guess at a challenge set by the protocol.
Proof of Work is the most tried and tested scheme for achieving consensus among users, but it is by no means the only one. Other alternatives, such as Proof of Stake, are increasingly being explored, although they have yet to reach the stage of proper implementation in their true form (although two hybrid consensus mechanisms have been around for some time).
See also: What is a blockchain consensus algorithm?
How does cryptocurrency mining work?
The process referred to above is known as mining. If a miner finds a solution, the block he creates will extend the chain. As a result, he will receive a specific reward in the native currency of the blockchain.
Cryptographic puzzle miners must repeatedly solve a hash data set to produce a number less than a certain value. A one-way hash means that given the output, it is almost impossible to guess the input. But given the input, it is easy to verify the output. In this way, any participant can verify that the miner has produced a “correct” block, and reject incorrect blocks. In this case, the miner receives no reward and has wasted resources by trying to generate an incorrect block.
The results in interesting game theory make it costly for the actor to cheat, but profitable for him to act honestly. No malicious entity has the resources to attack a powerful network indefinitely. Therefore, we expect resource holders to make a return on their investment by participating correctly.
See also: What is cryptocurrency mining?
Are cryptocurrencies scalable?
As you can tell, distributed networks aren’t very efficient. Unfortunately, cryptocurrencies can only be secure and censorship-resistant if all nodes can synchronize a copy of the blockchain. The lower the requirement to keep up, the easier it is for people to join the bandwagon.
You can see why a blockchain that only adds a small block every ten minutes would be preferable, in this respect, to one that adds a huge block every five minutes. The latter would require nodes to run high-powered computers to stay in sync, and push low-powered devices offline. This would lead to more centralization, since there are fewer peers on the network.
But with small blocks, we can’t do as many transactions per second (TPS). This also means that during busy periods, it can take some time for transactions to be added to the blockchain. This is inconvenient if you want to make a quick payment, but that’s the price you have to pay for decentralization.
We call this problem the scalability dilemma. A system that scales well is one that can easily adapt to increased throughput with minimal downsides. Blockchains don’t scale well – as we’ve shown, increasing throughput with larger blocks defeats the entire purpose of a distributed network.
To increase the transaction rate per second (TPS) in a way that does not compromise the network’s decentralization, off-chain scaling seems like a viable approach. This includes a wide range of solutions – both centralized and decentralized – that allow transactions to take place without being recorded on the blockchain.
Learn more about some examples of off-chain scalability: Blockchain Scalability: Sidechains and Payment Channels.
Who makes decisions about cryptocurrency programs?
Cryptocurrency networks are voluntary. No one forces you to run software you don’t want to. In a good protocol, the code will be completely open source, so users can be sure that the system is fair and secure.
In general, cryptocurrencies allow anyone to participate in their development. New features or edits made to the code are vetted by a community of developers before being approved and published. Users can then review the code themselves and choose whether to run it.
Some updates will be backward compatible, meaning that updated nodes will continue to connect to old nodes. Other updates will not be backward compatible – old nodes will be “knocked out” from the network unless they are updated. See Chain Split: Hard Fork and Soft Fork Updates for an explanation of this topic.
Chapter 3 - How can I invest in cryptocurrencies?
Contents
Which cryptocurrency should I buy?
What should I learn before investing in cryptocurrencies?
Where to buy cryptocurrencies
Centralized Exchanges (CEX)
Decentralized Exchanges (DEX)
Person to person trading platforms
How to buy cryptocurrencies
How to Buy Cryptocurrency on Binance
How to Buy Cryptocurrencies on Binance Decentralized Exchange
How to Buy Cryptocurrencies on Binance P2P
Which cryptocurrency should I buy?
This is your choice – you should do your own research (DYOR) and make a decision based on your own analysis. However, there are several tools that can help you make better decisions. For example, Binance Research provides excellent market insights and analysis, as well as comprehensive reports on individual projects.
If you want to be able to evaluate what type of cryptocurrency to buy, it is absolutely essential that you first understand how Bitcoin works. Good news, that is exactly why we have created our own guide What is Bitcoin? !
What should I learn before investing in cryptocurrencies?
Where do we start? There are a large number of ways to analyze financial markets, and in general, most professional investors will use widely different strategies. At a high level, there are two main schools of thought for investment evaluation: fundamental analysis (FA) and technical analysis (TA).
Fundamental analysis is a method of determining the valuation of an asset that relies primarily on economic and financial factors. Analysts who use this method look at macroeconomic and microeconomic factors or the conditions of the industry or business that underpins the asset (if any). In the case of cryptocurrencies, they may also look at public blockchain data, sometimes referred to as on-chain metrics.
This can include looking at the number of transactions, addresses, early owners, network hash rate, and a myriad of other information. The goal of this analysis is to arrive at a valuation of the asset and compare it to its current valuation. Ultimately, this approach aims to determine whether the asset is currently undervalued or overvalued.
With all that said, it’s important to remember that cryptocurrencies are a new and burgeoning asset class. Fundamental analysis doesn’t play a big role when it comes to determining their valuation. There is simply no single framework for determining the value of cryptocurrencies, and most of the existing models are not very reliable. The success or failure of a cryptocurrency project can depend on a number of different factors, all of which no current framework can take into account.
Technical analysts take a different approach. Unlike fundamental analysts, technical analysts do not attempt to determine the intrinsic value of an asset. Instead, they evaluate trading and investment opportunities based on historical trading activity. They do this by focusing on price action, chart patterns, indicators, and various other charting tools to assess market strength or weakness. In essence, technical analysts believe that the past price movements of an asset can be valuable in attempting to predict future price movements of that asset.
Since technical analysis can be applied to basically any market that has historical data, it is widely used by cryptocurrency traders.
So which analysis should you learn? And why not both? Most market analysis tools work best when used in conjunction with other tools. In either case, it’s important to understand financial risk and risk management, and not invest more than you can afford to lose.
Where to buy cryptocurrencies
There are different ways to buy cryptocurrencies. The first thing you need to do is convert your local currency into cryptocurrency. After that, you can choose to hold it, trade it with other cryptocurrencies, or lend it and earn interest. Let’s take a look at the different types of cryptocurrency exchanges.
Centralized Exchanges (CEX)
You may find the concept of a centralized trading platform a bit confusing because cryptocurrencies are often referred to as decentralized. In short, centralized trading platforms are online platforms that facilitate trading by connecting buyers and sellers.
The way these platforms work is that users deposit their funds in the approved local currency or cryptocurrencies on the trading platform, and trade within the platform’s internal systems. If you are familiar with how cryptocurrency wallets work, you will know that in this case, your cryptocurrencies will be held by the trading platform. However, it should be easy for you to withdraw your funds and keep them in your own wallet, if you wish.
Some people may prefer to keep their funds on the trading platform, either because they trade regularly or because it is more convenient. However, if the trading platform is hacked, users’ funds may be at risk.
Decentralized Exchanges (DEX)
Decentralized trading platforms are different. When you use a decentralized trading platform, there will be no custodians. In fact, a more accurate way to refer to this type of trading platform would be a non-custodial trading platform.
Here’s what happens when you trade on a decentralized exchange. Instead of depositing your funds into an exchange’s wallet, you trade directly from your own wallet. When you execute a trade, the funds are transferred directly onto the blockchain using the magic of smart contracts.
Since there is no entity acting as a custodian, some consider these platforms a safer option than centralized exchanges. Another plus point may be that most decentralized exchanges do not require you to provide any personal information other than your blockchain wallet address. At the same time, custodianship of your own funds requires a certain amount of technical expertise, and you are entirely responsible for this.
Person to person trading platforms
A peer-to-peer (P2P) trading platform is also a place that connects buyers and sellers, but it differs from centralized and decentralized trading platforms. In this case, the trading platform itself does nothing more than connect buyers and sellers, and they can settle the transaction in any way they agree upon. Thus, buyers and sellers can determine the deposit and settlement method for each individual transaction.
How to buy cryptocurrencies
How to Buy Cryptocurrency on Binance
Log in to Binance, or register if you don't already have an account.
Go to the cryptocurrency buying and selling portal.
Select the cryptocurrency you want to buy and the currency you want to pay with.
Select your payment method.
If prompted, enter your card or bank details and complete the identity verification process.
Now you're done! Your cryptocurrencies will be added to your Binance account.
How to Buy Cryptocurrencies on Binance Decentralized Exchange
Using a decentralized trading platform is a bit more complicated than other options available.
Here's what you need before you start:
A wallet that can be connected to the Binance decentralized exchange (we recommend using Trust Wallet).
Some people use BNB to pay transaction fees.
Once you've done this, follow the instructions in our detailed Binance DEX guides:
Binance Decentralized Exchange: Interface Guide
Binance Decentralized Exchange: Create a Wallet
Binance Decentralized Exchange: Access Your Wallet
How to Buy Cryptocurrencies on Binance P2P
Log in to Binance, or register if you don't already have an account.
Go to the Binance P2P portal.
Decide whether you want to buy or sell.
Filter by currency, payment method, or other trading requirements.
Select a list that meets your requirements, or publish your own.
Chapter 4 - Frequently Asked Questions About Cryptocurrencies
Contents
Are cryptocurrencies legal?
Is the time of cryptocurrencies over?
Are cryptocurrencies safe?
Are cryptocurrencies anonymous?
Are cryptocurrencies valuable?
Is any digital currency considered a cryptocurrency?
What is the market value of the digital currency?
Why do I need to pay transaction fees?
I lost my key. Can I get my money back?
What is the future of cryptocurrencies?
Are cryptocurrencies legal?
Very few countries have a complete ban on buying, selling and storing cryptocurrencies. In the vast majority of countries around the world, Bitcoin and other virtual currencies are completely legal. But before you start using them, you should check whether your jurisdiction allows it or not.
It is important to remember that each country has a different approach to regulating cryptocurrency activities. Make sure you are not violating any tax or compliance rules.
Is the time of cryptocurrencies over?
The media has declared cryptocurrencies dead hundreds of times in the past decade. Yet they continue to operate just as they did in 2009. That’s not to say they aren’t volatile – prices do fluctuate wildly. And for those just trying to make a profit, bear markets can be frustrating.
However, it would be wrong to describe cryptocurrency as “dead” or out of date. It continues to attract new users, and the technology and infrastructure are becoming more complex.
Without a doubt, the fundamental innovations of Bitcoin and Ethereum will play a significant role in reshaping our current monetary systems to be more suitable for the current era. Immutability, censorship resistance, and trustlessness, or near-instant transactions using a public monetary system could completely revamp the mechanisms of economic activity on the Internet.
Are cryptocurrencies safe?
There is a degree of risk involved when using cryptocurrencies. If you forget your bank account password, you can reset it through customer support. But if you forget or lose the private keys that give you access to your cryptocurrencies, no one can help you. Using a reputable exchange can be a more forgiving option – it requires trust, but you don’t run the risk of losing your private keys.
Public key encryption has never been hacked. With good security measures in place, it is much more likely that any of your other online accounts will be hacked than that your money will be stolen. Best practices include being aware of common scams (social engineering, phishing, etc.), keeping your private keys offline at all times, and backing them up in a safe place.
Are cryptocurrencies anonymous?
Your name is not tied to your crypto addresses – they just look like random strings of numbers and letters on the blockchain. However, be careful when you assume that this makes you anonymous. You have a pseudonym – but you still have some kind of identity on the chain, just not the identity you use in real life.
There are certain methods that might allow people to link your IP addresses to your activities. In this regard, things like micro-phishing attacks and other analysis techniques can be used to reveal your identity. Remember, blockchains are essentially large public databases. If you’re concerned about your privacy, you should try to make it as difficult as possible for others to link your transactions to your name. By default, cryptocurrencies like Bitcoin aren’t private, but methods like coin mixing and CoinJoins can make analysis methods unreliable.
A small subset of cryptocurrencies (known as privacy coins) are able to obfuscate the source, destination, and amount of funds in transactions, using methods such as confidential transactions. They have stronger privacy by default but are not completely resistant to de-identification.
Are cryptocurrencies valuable?
In financial systems, value is a shared belief. Just as with anything of value, value is not inherent in the cryptocurrency itself – it is assigned by people. In other words, something has value if people believe it has value. This is true regardless of whether the object of value is precious metal, a piece of paper, or some fragment of a database.
With all that said, some see cryptocurrencies and Bitcoin as something of a scarce digital commodity. Given the expected rate of issuance and monetary policy, some argue that Bitcoin could serve as a store of value in the future, similar to gold. Since Bitcoin has been around for just over a decade, it remains to be seen whether it will stand the test of time in this regard.
Is any digital currency considered a cryptocurrency?
No. You may have heard that many nation states and central banks are working on creating their own versions of digital currency. However, these are just that – digital currencies. In fact, they are often collectively referred to as central bank digital currencies (CBDC). These currencies are essentially digital versions of local currency money, and do not have most of the advantages of digital currencies. They are issued and declared as legal tender by a central government and do not typically use a distributed ledger, such as a blockchain, to keep a record of transactions.
You may have also heard of Facebook’s Libra, another type of cryptocurrency. On the plus side, it is planned to be built on an open-source blockchain system. However, this system will not be open to the public like Bitcoin or Ethereum, which means that participants will need more than a simple internet connection to use it. What’s more, the project will be run, managed, and active by an association made up of a select few members.
So, although central bank digital currencies (CBDCs) and other forms of digital money make use of blockchain or encryption, they are quite different from cryptocurrencies like Bitcoin.
What is the market value of the digital currency?
When you look at the price of a cryptocurrency, you are only seeing part of the picture. An equally important metric is the number of individual units of that cryptocurrency in the market, the supply.
More specifically, to determine the valuation of a cryptocurrency network, you need to know how many individual units are currently in existence. This is called the coins available for trading in the market. Different cryptocurrencies may have different issuance schedules, so it is important to understand how issuance works in each network.
Market value (or market capitalization) is the price of an individual unit multiplied by the currencies available for trading in the market.
Market Cap = Currencies available for trading in the market * PriceAs you might imagine, the market cap of a cryptocurrency network is a more accurate representation of the value in the network than the price of an individual unit. A network with a low-priced coin but a higher market cap may have a higher total value (market cap) than one with a high-priced coin but a lower market cap. The opposite can also be true in certain cases.
However, it is worth noting that market cap does not represent the amount of money that has entered a particular market. For example, a common misconception among newcomers is that the market cap of Bitcoin represents the total amount of money invested in Bitcoin. However, this does not make sense because market cap is based on the price and the currencies available for trading in the market.
Why do I need to pay transaction fees?
If you send one Bitcoin to another address, you will notice that the address will receive slightly less than what you sent. This is because you pay a small fee to reward miners for adding your transaction to the blockchain.
Many cryptocurrencies use a similar mechanism to incentivize users to secure the network. In proof-of-work systems, transaction fees are typically pooled with newly minted coins (block backing) to form a block reward.
You can adjust the fees according to the urgency of your transaction. Rational miners will always seek to generate as much revenue as possible, so they will prioritize transactions with higher fees. You can look at current pending transactions to get an idea of the average fees, and set your fees accordingly.
I lost my key. Can I get my money back?
If you are certain that you have lost your keys, you will probably never get them back. The great benefit of cryptocurrencies is that they remove custodians and middlemen from managing financial transactions. However, the downside is that the responsibility now lies entirely with you. So you have to be very careful not to lose your private keys, because they are what give you ownership of your funds.
What is the future of cryptocurrencies?
What the future of cryptocurrencies will look like depends entirely on who you ask. Some believe that Bitcoin will rise to replace gold in the digital age and disrupt the current financial system. Others argue that cryptocurrencies will always be a secondary system that exists as a niche market. And then there are those who believe that Ethereum will become a distributed computing network, serving as the backbone of the new internet.
Skeptics predict that the field will eventually collapse, while enthusiasts are happy for cryptocurrencies to remain niche monetary systems. There are many possible outcomes – it’s simply too early to say for sure what will happen even a year from now. But there’s no denying that there is tremendous potential for cryptocurrencies to grow.
