Lesson 1: The Nature of Cryptocurrencies
How did cryptocurrencies appear on the market?
For the past fifty years, people have been looking for ways to improve payment systems. It has taken nearly half a century of research and experimentation on digital money. The main goal has been to make financial transactions faster, cheaper and more secure.
Finally, on October 31, 2008, a person or group of people under the name Satoshi Nakamoto released a white paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System.” This paper described a peer-to-peer payment system known as blockchain. It provided a theoretical basis for cryptocurrencies. A few months later, Bitcoin emerged. Bitcoin’s market cap has now surpassed $1 trillion, and it will undoubtedly continue to rise in value. Thus began a new era in global finance.
Peer-to-peer trading refers to a decentralized network where traders can share information and resources directly without relying on a central authority. This allows for more efficient and secure transactions, providing greater flexibility and control for individual traders. The blockchain is a database that tracks digital assets on a peer-to-peer network. The blockchain can record and distribute digital information but cannot be edited. As a result, the blockchain allows for records of transactions that cannot be changed, deleted, or destroyed. In this way, the blockchain is the ideal foundation for digital currencies — we call these currencies “cryptocurrencies.”
I think I understand... Cryptocurrency won't work on its own. There are some foundations - the blockchain - that allow cryptocurrencies like Bitcoin to work. Tell me more!Trader Festus
Why encryption?
There are many financial instruments available for trading, such as Forex, stocks, gold, indices, and more.
However, it is necessary to gain knowledge about cryptocurrencies due to several compelling reasons.
Cryptocurrency prices can change by tens of percent daily, providing great trading opportunities;
The cryptocurrency market is open during the weekend, so you can trade without stopping;
The dynamics of cryptocurrencies can differ from traditional assets, so you can diversify by trading cryptocurrencies;
Cryptocurrencies have the potential to be a game changer in the world of finance. If you can understand how they work now, you could benefit from them in the future.
Cryptocurrencies have their downsides too. You need to know about them to be prepared.
From time to time, market prices rise dramatically and fall at a rapid rate. Stop losses are essential for every cryptocurrency trader;
Since the industry is relatively new, we may see bankruptcies and reputational shocks more frequently than in traditional markets;
Understanding the basics behind cryptocurrencies can seem daunting. This course is designed to provide a brief description.
Just like any other market, cryptocurrencies have their pros and cons. Discovering these pros and cons will help you find your favorite assets and become a more experienced trader.
Learn about cryptocurrencies
Let's know cryptocurrency.
Simply put, cryptocurrency is a digital currency that can be used to purchase goods and services but uses a blockchain with strong encryption to secure online transactions.
You may come across the term “electronic ledger” when reading about blockchain.
Wait, what? What is an online ledger, and how is it encrypted? Trader Festus
A ledger is a document that records financial data and transactions. A blockchain is essentially a digital ledger of transactions. The important thing is that unlike traditional ledgers, such as accounting books, a blockchain ledger is not kept in one place and is distributed across an entire network of computer systems in a blockchain.
Another difference from traditional databases where information is stored in random folders is that blockchain information (for example, Bitcoin transactions) is stored in “blocks.” As new transactions occur, they are grouped together into these blocks. A block can contain a certain number of transactions, and when it is full, it is linked to the previous block and added to the long chain of transactions. Hence the term “blockchain.”
Blockchain technology allows you to view the time history of transactions. This is very important because it helps you avoid fraud and spending the same bitcoin twice. If Hamilton gave 1 bitcoin to Mohammed, he would not be able to give the same bitcoin to Esther - the blockchain would record the fact that Hamilton had already transferred his bitcoin.
But what if Hamilton changed the blockchain record in order to get another BTC into his account? Trader Festus
This is not possible! Every time a new transaction occurs in the blockchain, a record of that transaction is added to each participant’s ledger, not just Hamilton’s. It is impossible to tamper with data that is replicated across multiple computers. That is why we call it a decentralized database or ledger. Such a database managed by multiple participants belongs to a technological infrastructure known as Distributed Ledger Technology (DLT).
Below are the characteristics of distributed ledger technology (DLT):
Distributed. All network participants have a copy of the ledger to ensure complete transparency;
Secure. All records are individually encrypted;
Immutable. Any validated records cannot be undone and cannot be changed;
Anonymous. The identity of participants is either anonymous or pseudonymous;
Consensus. All participants in the network agree on the validity of each record;
Time stamped. A timestamp of the transaction is recorded on a block;
Programmable. Smart contracts allow you to program the next action (e.g., collect payment) that will be triggered when conditions are met.
So, does technology make all these computers in a decentralized system work like a bank that deals in cryptocurrencies? Trader Festus
Exactly. All transactions are verified by a decentralized public database. As a result, there is no need for a third party such as a bank. Due to the above-mentioned DLT properties, cryptocurrency transactions are fast, secure, and cheap.
Blockchain and cryptography
We learned that a blockchain consists of a series of separate data blocks arranged chronologically. Information about a transaction is converted into a unique set of numbers and letters by an algorithm called a hash. As you can see from the diagram below, each block contains the hash of the previous block. In simple terms, if you try to modify one block, the other blocks will keep the record, making it impossible to tamper with the system. This is what makes the chain unbreakable.
In Bitcoin, cryptography is used to create a key pair that controls access to bitcoins. The key pair consists of the private key and a unique public key derived from the private key. The public key acts as a destination for receiving bitcoins, while the private key is used to authenticate transactions and authorize them to spend those bitcoins. This system is known for its reliability and security.
Blockchain is a way of storing information across multiple nodes distributed across a network. Blockchain is a type of DLT where transactions are recorded with an immutable cryptographic signature called a Hash.
How does Bitcoin work?
Now that we’ve discussed the underlying technology, it’s time to focus on cryptocurrencies. Let’s take a look at the Bitcoin transaction process. It consists of six steps:
Anyone, including you and me, can initiate a transaction. A transaction involves the transfer of value between Bitcoin wallets and is recorded on the blockchain;
Once a transaction is initiated, it is broadcast to other computers or nodes on the network. The transaction then waits for verification;
Miners, who are responsible for processing transactions and mining new bitcoins, verify the transaction you initiated. This verification ensures that the transaction is legitimate and complies with the rules of the Bitcoin network;
Instead of creating a new block for each single transaction, multiple transactions are bundled together. These transactions from different users, including you and others, are collected into what is known as a block. This standardization helps improve the process and reduces the cost of creating individual blocks;
Block Addition: The newly created block, which contains multiple transactions, is added to the existing blockchain. A blockchain is essentially a sequential chain of blocks, where each block contains a set of verified transactions;
Congratulations! Your transaction has now been processed securely and quickly within the Bitcoin network.
Learn some of the terms you may encounter when dealing with cryptocurrencies.
Encryption Glossary
Mining is the process that Bitcoin and many other cryptocurrencies use to create new coins and verify new transactions.
Double spending is the risk of spending a cryptocurrency twice, and is a unique concern with cryptocurrencies because they are so easily duplicated. However, cryptocurrencies address this problem through consensus mechanisms that set specific initial conditions.
A consensus mechanism ensures agreement among network participants regarding a single data value or network state. The most common mechanisms are Proof of Work and Proof of Stake.
Proof of Work is like solving a puzzle. Miners (computers) compete to create new blocks filled with transactions. Whoever can solve a mathematical puzzle first wins a newly minted bitcoin. This process creates a cryptographic link between the current block and the previous block. The person who gets the newly minted bitcoin shares the new block with the rest of the network. Bitcoin operates on a proof-of-work protocol. Bitcoin is based on a proof-of-work protocol, which is secure but can be slower due to the large number of puzzles that need to be solved.
Proof of Stake (PoS) eliminates the need for computationally intensive work. In this system, nodes known as “validators” must stake their cryptocurrency into the network to participate. Validators are randomly selected to create new blocks, share them with the network, and earn rewards. Ethereum recently moved to PoS.
Lesson summary
Cryptocurrency is the result of 40 years of global technological development;
Cryptocurrencies are based on blockchain technology, where each transaction is linked to the previous one through a unique hash. This hash acts as a cryptographic representation consisting of alphanumeric characters;
Cryptocurrency is decentralized. Therefore, cryptocurrency is decentralized, meaning it is not owned by individuals or groups, and remains immune to communication failure between nodes.
In the next lesson, you will learn how to store and exchange cryptocurrencies and discover the most popular cryptocurrencies.
Lesson 1: The Nature of Cryptocurrencies
Lesson 2. Where to Store and Trade Cryptocurrencies
Lesson 3. Diversity of Cryptocurrencies
Lesson 4. What makes cryptocurrencies rise and fall?
Lesson 5. Short-Term Trading Techniques
